Decoupling of Global Economies amid Accelerating Downturn
The authors are economists of Shinhan Investment Corp. They can be reached at keonhyeong.ha@shinhan.com. -- Ed.
Monetary tightening has tipped the global economy from slowdown into a recession. As the global economies are no longer synchronized, the pace of decline will differ by country going forward.
The US is likely to gain a greater relative advantage toward the year’s end. The domestic demand-oriented economy is propped up by a strong jobs market despite monetary tightening. US companies have solid fundamentals even amid slowing real economic demand, with pre-tax corporate profits up 7.6% QoQ in 2Q22 according to the national accounts data. Cost increases have been successfully passed onto consumers by raising prices. The pace of growth is expected to slow in 1Q23, given the one-year lag between growth of pre-tax corporate profits and employment numbers.
The effects of monetary tightening also happen with a lag. The real economy takes a direct blow from monetary policies when the policy rate rises above the neutral rate. US Fed officials currently estimate the upper end of the neutral rate at 3%. The federal funds rate will be higher than the neutral level if a hike of more than 50bp is decided at the upcoming September FOMC meeting.
Historical data show that yield curve inversions (10Y US Treasury yield – federal funds rate) happen when the policy rate tops the neutral rate. Jobs growth slows down sharply six months after the inversion. During the period that saw the fastest decline in employment in the past, the number of people on the payroll began to decrease nine months after the yield curve inversion.
The federal funds rate is projected to exceed the neutral rate in September, triggering an inversion of the yield curve. The growth in employment should lose momentum in 1Q23, followed by a steep drop in 2Q23. To put it in another way, we expect to see strong downside rigidity in US domestic demand, with jobs continuing to grow for the remainder of the year.