A recession is needed to lower inflation in the United States

There may well be a further sell-off in risk assets that will continue into 2023, but this could be a buying opportunity.

In 2022, we will see the most aggressive coordinated tightening by central banks in decades. The question is, when will all of this end? The answer is when they feel they have inflation under control, which again depends on their respective economies.

The US labor market remains tight

In the United States, there is a strange combination of economic forces. If you look for weak points, you find them in GDP – the most comprehensive measure of economic activity. Admittedly, GDP grew in the third quarter of 2022, but it contracted in the previous two quarters. There is a real recession in the real estate market, where both activity and prices are collapsing. Economic data is down, but this is offset by the strength of the labor market. There, all the indicators show that the situation is tense. Low unemployment means higher wages and rents, the two strongest and most persistent sources of inflation in the United States. On Friday, the employment report for October will be released. Until it turns negative, the US central bank will be under pressure to keep raising interest rates.

We have long believed that a recession is necessary to bring down inflation in the United States. This would result in reduced profit margins and lower revenues. We are in the third quarter reporting season and the overall picture shows that companies are already struggling to meet analysts’ expectations. The earnings outlook is not good. Investors expect disappointing updates.

European inflation fears

Germany’s inflation rate hit 11.6% in October, well above expectations. The European Central Bank faces a shaky economy and high inflation – an explosive mix for a central bank.

Tax uncertainty in Britain

In the United Kingdom, the Bank of England (BoE) must act in the context of an uncertain budgetary situation. We think it will take the easy way out and raise interest rates by 75 basis points, in line with market consensus. The UK economy is already struggling and the sudden rise in mortgage rates will only add to the costs. Interest rates will remain low, even if the BoE raises them to 3% as expected, but the era of ultra-low rates is over. And that doesn’t bode well for the housing market.

Optimism for 2023

The context is difficult for the economy and risky investments. Stock prices have already fallen sharply and investors expect economic weakness. There may well be a further sell-off in risk assets that will continue into 2023, but this could be a buying opportunity.

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