The zero that awaits us is not negligible

By Alexis Bienvenu, fund manager of LFDE

We’re gradually approaching the end of this instalment of rate hikes from the US Federal Reserve. At the very least, even taking a pessimistic stance, we have probably already seen two thirds of the full extent of the hikes. Starting from a range set at 0 to 0.25% in March 2022, the Fed has now raised its intervention rates to a range of 3.75% to 4%. The market is currently expecting rates to peak in the first quarter of 2023 at barely over 5% in the US. Even if the market is wrong and rates rise higher than this level, say to 5.5% or even 6%, that would leave 150 to 200 basis points to go, compared with the increase of 375 basis points already seen, and in any case, the latest inflation figures do not suggest that a hike of this magnitude is necessary. So in the worst case, just one third of the total is still to come. Unless, of course, we are faced with an extreme situation where underlying inflation rises to above 6%, which looks extremely unlikely from today’s perspective.

Thus the market’s primary concern is no longer focused so much on the remaining rate increases to come as on the cumulative effect of the increases already carried out on the economy in the medium term – the inevitable economic slowdown to rein in inflation. Investors now expect growth to be practically zero in the US in 2023, and even slightly negative in the eurozone. And such a “zero growth” outlook would in truth represent a lesser evil, since this would not be a collapse and would result in the Fed ending rate rises in the second quarter, or even reducing them at the end of 2023, providing inflation follows the expected downwards trajectory.

This scenario would be the lesser evil. But how likely is it? Time and again, experience shows that the market’s medium-term expectations are worth little. Market expectations for one year out are often extremely far from reality, whether in relation to inflation, interest rates or growth. We only have to think of the moderate inflation forecasts produced by the Fed in 2021, or its growth forecast of 4% for 2022, whereas the consensus now stands at under 2%.

The growth recorded for 2023 is therefore likely to be well above or well below the level of zero currently expected. What factors could tip the balance?

As regards growth, the likely fall in US inflation, combined with a significant but acceptable rise in wages, could mean that consumer spending remains resilient.

On the downside, the collapse of real estate prices, slight signs that employment momentum is running out of steam, the unavoidable consequences of the war in Ukraine, and the possibility of inflation remaining entrenched at a high level could result in outright recession, which would take time to emerge from as we would have to wait for monetary policy to reverse completely. And all this would come at a time when China – struggling with the collapse of its real-estate bubble – would be able to do little to support global economic momentum, in contrast to its role throughout the last two decades.

It is impossible to see which of these two scenarios will prevail currently, but whatever the outcome, another type of zero will ultimately skew the balance in the long run. As we are currently being reminded by COP 27, this is the decarbonisation of economies required now and for the long term, to achieve “zero carbon” within a few decades. To date, any fall in CO₂ emissions has been correlated with a fall in growth. We will need to invent a new model if the reality is to be different this time. This is the advantage of these two zeros, one in the short term and one in the long term: they will force us to reinvent ourselves, which humanity – and the market as one of its most efficient inventions – excels at. The zero that awaits us is not negligible – it is the impetus to achieve something much bigger.