End of Rate Hike Cycle Is Near, UBS Global Chief Economist Arend Says
Li Ailin
DATE:  Feb 03 2023

(Yicai Global) Feb. 3 -- Interest rate rises are just one or two quarters away from ending, as the central banks of most developed economies are about 80 percent through raising borrowing costs, according to the global head of economics and strategy research at Swiss banking giant UBS.

“We’re definitely now nearly at the peak,” Arend Kapteyn told Yicai Global in an interview, with the environment likely to be “much more disinflationary than people think.”

Taking their lead from the US Federal Reserve, major central banks have been cranking up interest rates since last year to stamp out the worst bout of global inflation in decades.

US rates climbed to the highest since 2007 yesterday after the Fed set its benchmark rate 0.25 percentage point higher at a range of 4.5 percent to 4.75 percent. The European Central Bank and Bank of England followed suit today, both with 0.5-point increases.

Kapteyn also made predictions for the global housing market, the US stock market, and technology sectors.  

Extracts from the interview are published below.

Yicai Global: Are we near the end of the rate hiking cycle?

Kapteyn: For most of the developed markets, central banks are now within about a quarter, maybe two quarters, depending on the central bank, of the end of the cycle. We’re certainly sort of 80 percent of the way there in most cases.

Europe, I think is a little bit less clear, because of the December ECB meeting, which was surprisingly hawkish. For the Fed, for instance, we think we're now one hike away from the end of the cycle. We think we're getting very close in Australia, very close on the Bank of England, etc. We’re definitely now nearly at the peak.

The argument we’re making is No. 1, the environment is going to be much more disinflationary than people think. The other thing is that if we're right on the recession and seeing negative payroll growth in the US, then the reaction function completely changes. So there's only one instance in the last 40 years where the Fed has been willing to incur more than one month of job loss before they cut. So everything now hinge really on where the labor market goes.

YG: What are your top three predictions for 2023?

Arend Kapteyn: The first is that we're going into a much more disinflationary environment globally than people expect. The general market narrative is that somehow inflation is going to get stuck about a percentage point above central bank targets. And we just don’t believe that. We think we could actually land at or below the targets by the very end of this year.

The second theme is are we going into recession and is the market actually pricing it? We don’t think the market’s pricing it and we think we do go into recession.

The third is how do the central banks then respond to that? We actually think, particularly in the case of the US, the central bank will respond much more forcefully to that than the market is pricing by hundreds of basis points.

YG: What could the global economy look like in a year ahead? 

Kapteyn: Growth is cracking under the weight of monetary tightening. We already had a substantial deceleration into the end of 2022. Inflation has been eating away at people's real disposable income. We have energy insecurity in Europe. Now on top of that we have monetary tightening and most of the impact of that tightening has still yet to make itself felt.

So what we're forecasting is about 2.2 percent global growth in 2023. That would be the weakest since 1993 if you exclude the pandemic and the global financial crisis. So basically slow grind, lower everywhere, but no major financial crisis anywhere.

YG: Why do you expect near zero growth in the US both this year and next?

Kapteyn: Basically we think the economy is going into recession, probably from the second quarter onward.

So what we're seeing is much more consumer distress than we're seeing in other countries. The savings rate has fallen to less than half of its pre-pandemic levels. Looks unsustainably low. The excess saving stock is being run down at a 1 trillion analyzed rate, basically under any FED hiking cycles. We will start to see negative payroll growth from probably sometime in the second quarter.

The US is one of the only countries in the world that has actually not approved anything to help consumers deal with the inflation shock. We've also seen capex intentions roll over and now pointing to contraction. We're seeing residential investments falling at the fastest pace basically under any Fed hiking cycle. And now on top of that, we need to layer on the monetary tightening that the Fed is doing. So if you fast forward another couple of months then we think we're gonna start to seeing negative payroll growth from probably sometime in the second quarter.

What people need to keep in mind is that the lags associated with the tightening and the magnitudes are just really large, so every hundred basis points of tightening by the Fed, as a rule of thumb, will reduce output by about a 100 basis points, so one to one. They're doing 500 basis points tightening, so you really have a lot of incremental weakness are still to come through in the data.

YG: What does China’s reopening mean for the global economy, and what do you think are China's key growth drivers in the post-pandemic era?

Kapteyn: February onwards consumption in particular is gonna pick up quite rapidly. The most important impact potentially other than for China itself, which is positive, is the increase in their energy demand. We're gonna approach something that looks more like a stable equilibrium where there's just lots more consumption dependency, less reliance on property, less reliance on exports than we have seen in the pre-pandemic era.

That's gonna give us slightly lower growth around 5 percent in the next couple of years after we’ve recovered this year. But potentially it's something that is ultimately more sustainable.

YG: Are we heading for another global housing crash?

Kapteyn: We are in a house price correction. I don't think it's a housing crisis in the sense that we had it in ’08 and ’09, because I just don't think it's doing the same amount of balance sheet damage.

The way to think about it that we’re experiencing the largest global mortgage rate shock in 50 years. So on average across the world mortgage rates are going up about 3 percentage points. If you run that through to models it should give you about a 15 percent average house price correction. That sounds like a low number. What you need to take into account is that we’re coming off one of the longest upswing in global house prices since the pre-GFC era, and so I think it's very easy to envisage something that is twice as large, maybe a 30 percent correction.

YG: The US stock market closed out its worst year since 2008, and was one of the worst-performing global assets last year. Has it hit bottom?

Kapteyn: That's one of the big debates in the market. And the reason we don't think so is because we're applying a very traditional sort of recession blueprint, which is that as you go into recession, and we're not there yet, the market tends to derate quite substantially and earnings also need to correct.

We believe that consensus earnings forecasts are about 15 percentage points too high, so we think earnings for the S&P500 this year will be about minus 11 percent.

As you start to sort of materialize those earnings downgrades, and that will last three quarters, we think that by the second quarter the S&P500 could go down as low as 3,200 before it then rebounds and roughly ends the year where it started.

As you start to go into a recessionary environment, you’re also going to price more cuts and you have an offset to your earnings weakness. So that is the big market debate. Things may get worse before they get better, but how much worse?

YG: What are your thoughts on tech stocks?

Kapteyn: They're just particularly vulnerable to interest rates going up. At this moment, the biggest impact on evaluations was for those companies. Now that should stabilize in the next couple of months and then get better in the second half of the year. In the second half of the year, we would expect those type of stocks to start to outperform, basically as you reverse the liquidity shock that we had in 2022.

We are in a correction cycle where you know we have these tech price cycles. There is sort of an auto-correction mechanism where once those prices decline enough and the discounting has gone far enough, then you start to pull back in demand. And so we're approaching the point at which that is starting to happen.

YG: Is the classic 60/40 portfolio set for a comeback after its worst returns since the global financial crisis?

Kapteyn: We don't agree with that at all. In our view, this is going to be a historically strong year for fixed income. Although the hiking cycle will finish and may potentially get reversed, in level terms, interest rates are still high relative to equity yields. On a relative basis it’s just not that interesting to be exposed to equity.

Now on top of that, you have historical weak global growth. From earnings’ perspective you're also not really paid a lot for taking that equity exposure. So the percentages should really be the reverse.

This year, if you're trying to sort of optimize your volatility, you probably need to have about 65 percent in bonds and 35 percent in equity. And if you’re trying to maximize your returns, the percentages are even more skewed toward fixed income.

So certainly for this year, it’s too early to apply those standard rules or percentages. We'd be relatively underweight on equities in general, but there will be pockets like China where we would very eagerly be exposed.

Editor: Tom Litting

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Keywords:   UBS