US likely to see slowdown in interest rate hikes

Falling inflation rates are expected to see the US Federal Reserve announce a smaller interest rate hike on February 1, but the US is still not out of the woods in avoiding recession, according to leading market economists.

“We are expecting a 25 basis point increase in US rates on 1^st February to 4.5-4.75% – and that the Federal Reserve’s tone will be relatively dovish. We are also expecting one small rate increase in March and then some stabilising as inflation falls sharply,” says Andrew Hunter, senior US economist at Capital Economics, which predicts interest rates will peak at 4.75-5% this year.

“However, we still anticipate a recession in the US at some point. It is hard to say exactly when but we don’t think it will be in the first half of the year. High interest rates continue to be one of the biggest threats to the US corporate sector.”

Hunter believes earnings expectations are still a “bit too optimistic”, but the corporate sector could recover quickly if there is a cut in interest rates; Capital Economics is forecasting this to happen in the second half of this year.

“Over the course of this year, US inflation will not fall back all the way – but it should be back to normal levels by the end of this year,” says Hunter.

According to the US Bureau of Labour Statistics, inflation fell to 6.5% in December 2022 – having fallen every month since its peak of 9.1% in June 2022.

However, an inflation measure recently described by Federal Reserve Chairman Jerome Powell as “most important” in determining where inflation will go has increased after being largely flat for the previous two months.

The Fed has said it is closely watching the cost of services excluding shelter, which is a category in the consumer price index, or CPI, a monthly report that measures the cost of goods and services commonly used by Americans.

CFOs are taking measures

Tony Tiscornia, CFO at Coupa Software also anticipates 2-3 smaller rate hikes from the Fed and then a slowdown.

“However, everyone is still a bit cautious. Business leaders and economists have kept anticipating a rate hike slowdown but the Fed has doubled down on doing everything possible to cut inflation,” he says.

“This is impacting CFOs from multiple angles. For over a decade, the cost of capital was low, and companies could be more aggressive with their investments. A lot of debt was also raised during the Covid-19 pandemic when rates were lower. Now we are seeing the flip side of this. Rates have increased and the cost of borrowing is higher and, as a result, CFOs are looking at conserving cash, picking out their projects carefully and thinking twice about business investments.”

Tiscornia says many CFOs have also become more focused on prioritising the investment of their dollars to get a better return. “There has also been some reduction in hiring and there have already been some big layoffs in the US. Discretionary spending has become much more conservative,” he adds.

Many US companies have already seen their valuations fall, which Tiscornia believes will make profitability one of the most important metrics for investors and CFOs have to keep their expenses down.

“There have been cases where earnings and outlook were softer than set but at the same time buy-side investors expectations may have been too optimistic. Generally, the earnings levels being reported now are lower than expected overall,” he says.

Possible US recession

Tiscornia notes that over the last 12 to 18 months, CFOs have seen the potential for a US recession, and this has enabled them to prepare for how they run their business and manage cash.

“Many CFOs believe that we are still likely to see some sort of recession in the US but whether it is light or deep remains to be seen. Interest rate hikes are going down, which is good for business, but earnings are also very important,” he says.

“Given the importance of cost management and profitability, however, many CFOS may now wish they had better visibility into their spending,” he says, pointing that companies still need to focus more on both automation and digitisation to improve visibility.”

Meanwhile, David Carrick, CFO at financial services group Apex believes there is no confirmation yet that inflation has peaked.

“We expect the Fed will continue to raise rates in the first half 2023, with these tailing off in the second half of 2023. We also still see the potential case of inflation drastically reducing on the back of certain outcomes of some of the current global macroeconomic headwinds, with subsequent significant interest rate decreases following to stave off stagflation,” he says.

“Any recession would be short lived within the US, and  any protracted recessions will come first in either Europe or the UK.”

Carrick points out that a recent McKinsey survey revealed 46% of CFOs now consider rising interest rates the biggest potential risk to their company’s growth, followed by inflation (32%). “As the cost of borrowing to finance investments rises, CFOs are considering what tools they have at their disposal to adapt to the high inflation environment,” Carrick says.

“The majority of our client contracts have inflationary increases embedded within contracts, which allows us to offset much of the rising inflation. Apex Group further mitigates interest rate increases by helping clients to maximize their return on interest income,” he continues,  adding this also benefits the company.

Carrick notes that central banks’ forward guidance on tightening monetary policy has provided  CFOs with necessary information needed for their investment plans in 2023.

“CFOs have many levers including increasing prices, recalibrating capital spending plans and modifying hedging strategies,” he says. “Apex Group has completed an interest rate hedging programme,  positioning the company well to limit any increased cost on interest rate increases, whilst also allowing it to potentially benefit from any unexpected interest rate decreases caused by protracted recessions or large  falls in inflation.”

UK interest rate expectations

All eyes will be on the Bank of England on February 2, which is expected to announce a 0.5% rate hike to combat inflation further. The UK’s Consumer Prices Index (CPI)  including owner occupiers’ housing costs (CPIH) rose by 9.2% in the twelve  months to December 2022 – only a slight decline on 9.3% in November, according to the Office for National Statistics (ONS). 

“In the UK we are expecting another 50 basis point increase in interest rates this week to 4%,” says Hunter. “The US has always been ahead of other developed economies in terms of rate rises and the UK is now starting to see a slowdown in inflation, similar to that already witnessed in the US. However, in terms of core measures of inflation not that much has changed. We see UK base rates peaking at about 4.5% this year.

“In the UK we have been expecting a recession for some time and this is still not properly reflected in the data yet. We are experiencing a fall in gas prices and it may end up being a smaller recessionary hit.”

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