Investment Institute
Viewpoint Chief Economist

If it’s not a skip, it’s probably a peak

  • 31 July 2023 (5 min read)

  • “Dovish hikes” across the Atlantic. The peak is there – or nearly there
  • Another strong GDP print in the US despite restrictive monetary conditions fuels the “soft landing” hypothesis. We are unconvinced – even more so in the Euro area case.

We have had “dovish hikes” from both the Fed and the ECB last week. We still see it as marginally likelier than not that the ECB Governing Council will add a last 25 bps hike in September while we are more confident that we are already at the beginning of a long plateau at the Fed, but the gist is the same: both central banks will probably stop at some point in Q3 2023 having brought their policy rates at roughly twice the equilibrium level.

The juxtaposition of this high level of policy restriction with another strong US GDP growth print and tangible disinflation over there is fuelling hopes that a “soft landing” is all it will take to converge to the Fed’s 2% target, and Peter Hooper has just offered a very cogent narrative on how a recession could be avoided in the US. We are unconvinced though. While the Fed has started tightening nearly 18 months ago – the usual transmission lag – it has reached restrictive territory in September 2022 only, and we think the bulk of the impact has not yet passed through. Peak impact could coincide with the exhaustion of the excess savings Hooper mentioned as one of the factors which could help avoid a US recession.

Some of the “protective factors” listed by Hooper can also be found in the Euro area – credible central bank, sound financial position of the private sector, specific nature of the Covid-triggered inflation wave – except for the labour market institutions which remain probably more conducive to second-round inflation effects than in the US and may force the ECB to inflict much more macro damage to “break the back” of inflation. In any case, it is already clear that the Euro area is underperforming the US, and we are concerned with how the monetary tightening is increasingly affecting so-far resilient member states such as Italy and Spain. So, as much as we would like to leave our readers with a rosy view before our August recess, in a nutshell we see an already “hardish” landing materialising in the Euro area, while the soft landing in the US, albeit more plausible, still looks far from certain in our view.

If it’s not a skip, it's probably a peak
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