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Opinion CLOs
Markets are flipping their forecasts —from recession to overheating
by Lisa Lee
Lisa Lee
Managing editor
Creditflux
There’s cause for worry as the Federal Reserve cuts into a booming economy
Earlier this year, developed economies looked on the verge of beating the scourge of inflation. Now the Federal Reserve risks giving up the hard-won battle by loosening the monetary spigot.
Pity the members of the Federal Open Market Committee. Their dual mandates have been in contention recently, with the US labour market showing signs of weakness even as price rises pick up pace and erode purchasing power. Then there is President Donald Trump jawboning his wishes for lower interest rates and pushing for the ouster of Federal Reserve governor Lisa Cook.
In September, Fed officials, as widely expected by markets, lowered the policy rate by a quarter-percentage point, to between 4% and 4.25%. There was only one official dissent, by the newly-appointed Stephen Miran, who had sought a bigger cut of half a percentage point.
Consensus is fraying at the Fed
The minutes of the last meeting, released just before press time, show that while most expect further easing for the rest of the year, that’s despite “upside risks to their outlooks for inflation”. Interestingly, the general consensus among them has frayed, with a number cautious about more rate cuts and a few seemingly downright worried.
And there’s plenty of cause for worry. The Federal Reserve is cutting into a booming economy. Gross domestic product (GDP) perked up to an annualised rate of 3.8% in the second quarter, the fastest pace in nearly two years, handily beating expectations for economic activity.
US consumers, notably the well-to-do segment, are opening their wallets and spending freely. Consumer spending is up 2.5% for the first half of the year, and retail sales increased 0.6% in August, according to Commerce Department data.
Financial markets, while still forecasting for two additional rate cuts, are thus flipping their expectations on the pathway of the economy. No longer are they beset with the doom and gloom of an impending recession. Nor are they worried about consumers glum about tariff-induced price increases and corporations posting lower profits, investing less and even defaulting on their obligations.
The new concern surrounds an overheating of the US economy. According to many economists, the impact of the fiscal spending spree that will come from the One Big Beautiful Bill Act and pass-through of cost increases from tariffs (now set at the highest levels in a century) will be felt next year and beyond.
The US isn’t alone. The UK is looking at the return of inflation with a particularly pernicious rise in food costs. The Organisation for Economic Co-operation and Development (OECD) hiked its inflation prediction to 3.5% this year, the worst among the G7 economies, which suggests that shoppers will be spending more at Aldi and Lidl than M&S and Waitrose. That’s going to tie the hands of the Bank of England in terms of further lowering interest rates, and make Chancellor of the Exchequer Rachel Reeves’ job of filling the multi-billion budget ‘black hole’ all the more challenging.
In Japan, the rise of Sanae Takaichi as the new leader of the ruling Liberal Democratic party — which puts her on track to be the nation’s first female prime minister later this month — portends more stimulus spending. That’s likely to fan a declining but high inflation rate.
The Eurozone is doing better. Its central bank has ceased rate cuts to take a wait-and-see posture on what tariffs will do to prices. But while inflation in the bloc has mostly been under the European Central Bank’s target of 2%, the latest reading showed prices roses above that level in August.
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