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U.S. Economy May Be Headed Toward Mid-Cycle Slowdown
The U.S. economy is moving from a post-reopening boom phase toward a moderating period, says Mitsubishi UFJ Financial Group ((MFUG). Depending on the Federal Reserve’s policy prescription, this may end up feeling like a mid-cycle slowdown in the second half of 2022, according to MUFG’s 2022 U.S. Macro Strategy Outlook, titled “The year ahead: balancing macro risks and markets.”
Written by George Goncalves, head of U.S. macro strategy at MUFG, the report outlines key themes for 2022 tied to a quicker pace of Fed tightening, fiscal policy inflexibility, global and geopolitical issues, and the potential tightening of financial conditions against a presently healthy U.S. economic backdrop.
“The risk of less fiscal support ahead, combined with the Federal Reserve combating inflation in 2022, could end up tightening financial conditions materially,” Goncalves writes. “This could ultimately push the economy back to pre-COVID-19 stagnation, or worse – end up shortening the business cycle.”
Other observations from “The year ahead: balancing macro risks and markets” include the following:
- In MUFG’s view, the Fed’s interest rate tightening cycle is long overdue. MUFG expects at least two rate hikes in 2022, with the potential for more if inflation does not recede or alternatively if the Fed does not start shrinking its balance sheet as we expect in the second half of 2022.
“We have been pretty vocal that the Fed kept the QE program running longer than needed over the course of 2021,” writes Goncalves. “Now comes the tricky part and what amounts to the modern-day Volker-like challenge for the Fed: would they continue a tightening campaign in the face of a material decline in markets.”
- As the Fed embarks on a hiking path, U.S. rates are poised to rise over the course of 2022, led by the front end of the yield curve. However, MUFG says there’s upside risks to its long-term rate forecasts.
- In MBS, the spread basis between MBS and U.S. rates should widen as the Fed tapers, however a wider basis is likely to bring back investors sitting on the sideline. MUFG expects between $600 billion and $800 billion net issuance this year.
- Investment-grade credit spreads will likely trade within a range of 85-125 basis points. MUFG believes these spreads are weighted more toward widening over time versus tightening more, because of rising rates and the anticipation of some economic deceleration in the second half of 2022.
- MUFG’s credit team remains relatively constructive on the high yield sector. They’re expecting high-yield spreads to remain toward the tighter end of their projected range of 285–385 basis points.
- ◦Economy
