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We are all aware that central banks around the world have been hiking interest rates to reduce inflation back to normal levels. The US economy, and particularly the labour market, have been more resilient than most expected. This means the US central bank might have to hike interest rates higher than in other jurisdictions to tame inflation. A consequence of this is that it will probably send the US economy into recession. And if history repeats itself, stock markets will fall.
If this scenario plays out, what actions should you take now?
There are three economic scenarios
Share markets have been wrestling with three possible economic scenarios as follows:
§ Hard landing: this means that the Federal Reserve’s interest rate hikes achieve their aim of curtailing inflation but at the cost of sending the US economy into recession.
§ Soft landing: this is a Goldilocks scenario where the Federal Reserve hikes rates just enough to cool inflation, but not too high that it causes a recession (or it is able to cut rates in time to avoid a recession).
§ No landing: it is possible that the US economy continues to be resilient, and inflation remains stubbornly high which means the Federal Reserve must hike rates higher for longer.
US labour market is stubbornly robust
The problem that the US central bank has (that the RBA doesn’t) is wage inflation is high at 4.6% over the year ended 28 February 2023. If it cannot cool the labour market and stop incomes rising, it probably won’t be able to return inflation to normal levels. The US labour market is proving to be very robust and although there are some signs that it is starting to slow, data is somewhat mixed.
As reported late last week, the US unemployment rate did rise in February from 3.4% to 3.6% p.a., not because there were fewer jobs but because the participation rate increased (i.e., more people are attracted to return to the labour market and look for jobs). This helped the three-month annualised wage inflation rate slow to 3.6% (compared to the 12-month reading at 4.6%), so there are signs that wage growth is slowing.
This is the most important issue that markets are watching. If we see more data that confirms wage inflation is slowing, a soft-landing scenario might be considered more likely.
The other noteworthy difference in the US (compared t
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