THINK Ahead: No, central banks aren’t about to cause a recession
At a Glance
The desk is taking a cautious stance on the potential for central bank rate hikes to trigger a recession, as articulated by James Smith in the recent commentary. He argues that higher interest rates, particularly in the U.S. and Eurozone, may not have the same contractionary effect as they have in past cycles due to the prevalence of fixed-rate mortgages. Per the full note , only around 4% of U.S. mortgages are variable rate, suggesting a muted impact on consumer spending despite the hawkish shift from the Fed and ECB. With updated forecasts anticipating further rate increases before year-end, the desk believes current market expectations may be overestimating the risks of an imminent recession as existing borrowers remain relatively insulated from immediate rate impacts.
Key Takeaways
Full Analysis
What the desk is arguing
The desk argues that central banks, while maintaining a hawkish posture, are unlikely to trigger a recession in the near term. This view, grounded in James Smith's analysis, highlights how the nature of modern mortgage structures mitigates the immediate effects of rising interest rates. Such insights emphasize the decoupling of monetary policy from direct economic repercussions, a shift not fully recognized by the market.
Smith points out that, unlike pre-financial crisis periods when a higher percentage of mortgages were on floating rates, today's landscape reveals that only about 4% of U.S. mortgages are variable. This substantially lowers the sensitivity of consumer spending to Fed actions, as many homeowners remain locked into lower fixed rates, protecting them from current higher rates on new loans.
This raises questions about the prevailing narrative that positions central bank actions as recession catalysts. The view that existing homeowners will feel significant pressure from rate hikes is arguably overstated, given that many are still benefiting from historically low mortgage rates.
Where it sits in our coverage
Our consensus target for the EUR/USD is 1.075, with a range spanning from 1.04 to 1.12. Notable firm targets include: - jpmorgan: 1.10 by Mar26 - bofa: 1.04 by Mar26
This cautious stance aligns with jpmorgan's outlook but diverges from bofa, which suggests a more pronounced downturn. Our position is at the upper bound of the consensus spread, reflecting an optimistic take on the resilience of the economy despite hawkish policy signals.
How other firms see it
Firms like jpmorgan and ms align with our view that while rate hikes may tighten margins, they won't necessarily precipitate a recession in the near term. Conversely, bofa stands in opposition, suggesting that the economic environment may be more susceptible to adverse effects from rate increases.
Key indicators to watch include the EUR/USD trajectory, which is closely linked to ECB monetary policy decisions. Also noteworthy will be updates on mortgage applications and consumer spending data as the market assesses rate impact moving forward.
Market Implications
Traders should keep an eye on the EUR/USD around the 1.075 mark, as the upcoming economic data could signal shifts in consumer sentiment and lending responses to rate hikes. Observing housing market indicators will also be crucial in gauging resilience to higher rates.
From the original
Opinions Opinion by James Smith THINK Ahead: No, central banks aren’t about to cause a recession Published 13:43 Rate hikes are undoubtedly contentious right now. Some think it's an error. But a recession starter? James Smith explains why he just isn't that convinced We've recent
Related speeches
4 itemsTHINK Ahead: The case for rate cuts
The desk is positioning for potential rate cuts to re-enter the conversation sooner than expected. Per the full note from James Smith, the consensus among market participants seemingly discounts the prospect of easing until 2028; however, the desk believes this view underestimates the shifting economic indicators across the US, Europe, and the UK. With inflation remaining elevated at 4% and labor market recovery showing signs of faltering, there could be room for the Federal Reserve to pivot back to an easing policy next year. This contrasts with our internal coverage which suggests a focus on rate stability rather than cuts in the near horizon.
Rates Spark: A Fed hike could shake sentiment
The desk interprets the recent research from ING which suggests that even if the Federal Reserve holds rates steady, the market still prices a 30% chance of a hike that could disrupt sentiment in the short term. This uncertainty might lead to upward pressure on EUR and GBP front-end rates, reflecting a hawkish tilt that could result in further positive positioning in European rate markets. However, should the Fed proceed with a hike, tighter financial conditions could dampen positive market sentiment and impact risk assets. Per the full note [source], longer-dated rates may struggle to maintain their upward momentum in such a scenario.