Despite interest rates being hiked to their highest level since the mid-2000s and a mini crisis in the US banking sector, the US and other developed market economies remain in relatively robust health. A recession has, so far, been avoided.
One explanation why the usual economic cycle has not been followed might be the unique set of circumstances that have played out since the pandemic or, maybe its just a matter of time and monetary policy is working with longer lags this time around. While a soft landing could be achieved, warning signs of a hard landing persist and there is a path, with a meaningful probability that leads to recession.
Inflation remains central to understanding potential outcomes. Over the past year, it has been easing and it is possible to build a reasonable case for inflation falling back to 3%. However, returning inflation to 2% on a sustainable basis may be a much bigger challenge. From a bond investors’ perspective, the most important consideration is that the slowdown in inflation means central banks are likely at, or very close to, the peak in rates.
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