Global economy to grow, but high interest rates here to stay

Old Mutual Wealth’s Izak Odendaal said the US, and by extension, the rest of the world, is likely to avoid a recession and have a “soft landing”, but interest rates will stay high for some time.

Odendaal’s comments come after the US announced that its core consumer price index (CPI) data, which excludes often-volatile food and energy costs, rose 0.2% for a second month. 

That marked the smallest back-to-back gains in more than two years.

Economists view the core measure as a better indicator of underlying inflation than the overall CPI, which increased 0.2% in July and 3.2% from a year ago.

This data was seen as a step in the right direction for the US Federal Reserve, which like many central banks worldwide, has been implementing interest rate hikes to bring inflation down to its target.

“The latest CPI report is just one of a number of key data releases Fed officials will have in hand ahead of their September meeting,” Bloomberg reported.

“Should current trends continue, the Fed will likely leave rates unchanged next month.”

Odendaal told Moneyweb Now that there is a persistent trade-off in the economy to keep track of – “as long as the economy remains strong, there’s always the chance that you’re going to see continued upward pressure on prices”.

He explained that this is because consumers have money to spend, jobs are plentiful, and they are still spending for the time being.

“Ironically, part of what’s happening is that, as inflation comes down, the real purchasing power of that income increases because the inflation rate was 9%, and it’s now at sort of 4%, and wage growth is still 4%, 5%, 6%,” he said.

“So people’s incomes are growing in real terms, and I think that is why there’s a spending power, and people want to go out and have a good time.”

“For the time being, it seems all is well, but obviously, these moments don’t last forever.”

He said that many economists and the market are pricing in a recession, although the probability seems to be decreasing.

“If you look at what the equity markets have been doing this year, it’s certainly not pricing in a recession.”

Instead, the markets are pricing in a soft landing – in other words, a scenario where inflation falls and the economy cools, but there is no outright decline in income activity, employment, and profits.

“As long as the economy’s humming the way it is now, it’s difficult to say that there’s going to be a recession in the next 12 months or so.”

He said many investors assume that a soft-landing scenario is one where the Fed cuts rates and “we go back to a low interest-rate world”. 

However, Odendaal said that is very unlikely since, as long as there is momentum in the US economy, there will be the fear that inflation can either remain elevated or revive.

“And in that kind of environment, it’s very difficult to see the Fed cutting rates.”

Odendaal said a more likely scenario is a higher-for-longer interest-rate environment with solid growth for some time.

However, the higher-for-longer interest rates will mean this growth will slow over time. 

“I think the link here is how long it takes for these high interest rates to impact consumer spending and business activity,” he said. 

“It takes longer than most people would’ve anticipated, but it’s also not that unusual for interest rate cycles to take time to impact economic activity.”

However, Odendaal said it is important to note that the Fed made a mistake in waiting too long to start raising interest rates.

“As inflation was starting to rise in 2021, they were very slow to act. I think that there is fair criticism,” he said.

For comparison, the South African Reserve Bank (SARB) started its interest rate hiking cycle in November 2021, while the Fed started its cycle in March 2022. However, the SARB has implemented 10 consecutive rate hikes in this time, while the Fed has implemented 11.

“To give them credit, policymakers across the world were operating in an extremely uncertain environment because all of this was still the aftershock of Covid.” 

“Covid was this hopefully once-in-a-century kind of shock to the economy, and all kinds of strange, unexpected things happened. We are still dealing with the after-effects of that Covid shock.”