Strategists at JP Morgan Chase believe that US equities could fall sharply, but the market appears to be unmindful of the risks. This raises the possibility of a ‘boil the frog’ recession for the US economy, JP Morgan warns.
It’s said that a frog will boil to death in water that gradually gets hotter, rather than jumping out before it’s too late, as it doesn’t realise that the water is getting dangerously hot. It’s an analogy that describes what could happen with the US economy as the US Federal Reserve (the Fed) gradually raises the heat, i.e., the interest rate. Rates in the US are already hovering near decadal highs.
Many economists and investors have been worried whether the economy is heading for a recession as inflation remains well above the Fed’s target of 2 percent. The Fed left rates unchanged at its last meeting, as expected, but its quest to rein in inflation is far from over.
In its mid-year global economic outlook report, released on June 22, JPMorgan strategists stated that inflation is likely to stay higher than the Fed’s target of 2 percent. Of course, high inflation isn’t just a problem for the Fed, as central banks in Europe, the United Kingdom, and other regions face similar challenges.
Federal Reserve Chairman Jerome Powell reiterated at the last Federal Open Market Committee (FOMC) press briefing that the Fed will look to hike rates two more times before the end of this year.
Soft landing
While central banks are striving for a soft landing and a pause in rate hikes, strategists at JP Morgan said that inflation is likely to remain persistently higher, hampering the prospects for a meaningful pause. “Instead, central banks look likely to continue to fight against elevated inflation risks.”
This brings the focus back to the boiling-the-frog kind of recession. While central banks may not intend to create a downturn, the risk that they may “boil the frog,” or kill the economy, by tightening too far has increased, says Bruce Kasman, Chief Economist for JPMorgan Chase, and the author of the report.
Hence, central banks are focusing on balancing inflation and growth by tweaking interest rates. The problem is that the current scenario heightens the risk of embedding inflationary psychology in the system while raising rates more aggressively might eventually break the global financial system.
Kasman says Europe is in the same boat as the US, as is the United Kingdom, where the Bank of England just raised rates by another 50 basis points (bps) as inflation in the UK remains stubbornly high. Hence, the poor frog may boil across the pond too.
“When we’re thinking about this boiling-the-frog scenario, we’re thinking about dynamics that are both synchronized in central bank tightening, but also more likely to be synchronized in terms of the downturn when it comes.”
Concern of central banks
The big worry for all central banks is a wage-price spiral, where both wages and prices move up in lockstep, forcing rates to move ever higher. That eventually compresses corporate pricing power and hurts profit margins, while banks pull back on lending, tightening credit conditions, Kasman adds. “And that eventually is what kills the economy.”
“It’s the central banks that boil the frog from my point of view, not necessarily intentionally,” he says. We aren’t seeing the recession take hold yet, he adds, since it takes a while for rate hikes to sweep through the economy and inflation to come down sharply. Whether the frog — i.e., the global economy — survives the onslaught of inflation may only be known later on.
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