Macroeconomic & Geopolitical

Not a Pivot

November 2022 – 10 min read

Inflation is resilient and rates keep rising. Our central Stagflation Shock scenario, with persistent inflation and slower growth, continues to play out, though there is mounting evidence inflation may be resistant to policy tightening. Smaller hikes would indicate success, not a pivot in central banks’ resolve.

The bond market is on a rollercoaster ride. Since the pandemic ended and Russia started waging war in Ukraine, nothing has been working as before. Prices have been on a rip, desperately seeking the adjustment of supply and demand. With their economic models performing so poorly, central banks have preferred to remove the forward guidance investors rely on. Rarely have markets displayed so much volatility in their attempts to price in such unpredictability. Investors have been hoping against hope that central banks would signal some sort of policy pivot soon.

Is inflation here to stay? We give 100% odds that central banks will not wait to figure it out.The policy transmission lags are long and high inflation can perpetuate these elevated price pressures. The cost of waiting is higher than that of triggering a recession. In advanced economies, the strength of demand is fueled by high savings stocks, banks’ willingness to lend, and post-lockdown appetites. Central banks have to offset these extraordinary drivers.

Our central scenario posits that the large number of rate hikes likely in just a few months will finally slow the economy. The resilience of U.S. demand means the 5% peak policy rate priced in seems likely. In Europe, energy price inflation and the Ukraine war will play the hand of the ECB in reducing demand. A reduction in the size of rate hikes will indicate success rather than a pivot in central banks’ resolve to bring inflation not just lower, but also back to target. Since March, our central “Stagflation Shock” scenario with persistent inflation and slower growth continues to play out,and we keep its odds at 60%.

The dark horse in this environment is the continuing evidence that inflation may be more resistant to policy tightening. Expectations of rising prices and a tight labor market can lead to solid wage increases, reinforcing consumers’ purchasing power. This enhances firms’ ability to pass through high input costs. Strong growth coupled with high inflation would require even more policy tightening. Unless they raise their inflation target and risk a blow to credibility, central banks will be forced to keep hiking up to the eve of a recession. This raises the prospect of a much more prolonged downturn and its timing is impossible to predict and may well lie beyond the 12-18 months of our scenarios. For now, with prices still coming in hot, we raise the odds to 30% of lingering inflation, resilient growth, and rising pressures in an economy best described as “Boiling Over.

We have reduced the odds of our “Steeper Slide” scenario to 10%.Economic activity does not seem to bend quickly under the pressure of high inflation and tight financial conditions. Extraordinary circumstances require letting go of the old normal, but we keep the door open to the risk of a financial accident triggering unexpected weakness in demand.

These scenarios apply primarily to the Western world. Japan’s growth remains weak and signs of mild inflation are seen as a gift. The zero-COVID policy and continuing property crisis keep the powerful Chinese consumer in limbo. Other emerging markets are focused on avoiding financial instability from the Fed’s rapid hikes and the strong dollar. Rapid capital outflows would aggravate currency weakness, exacerbate domestic inflation, and exaggerate a growth downturn.

By: Agnès Belaisch


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Kathryn Asher

Associate Director, Economist

Agnès Belaisch

Managing Director, Chief European Strategist

Finley Birt


Matteo Cominetta

Director, Head of Macroeconomic Research

Christian Floro

Associate Director

Christopher Smart, PhD, CFA

Chief Global Strategist & Head of the Barings Investment Institute

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