TOP 2022 TREND, DRAGFLATION: U.S. MOVES CLOSER TO DRAGFLATION

The U.S. economy contracted by 1.4 percent during this year’s first quarter, the commerce department reported on 28 April.

The GDP’s implosion moved the country to the precipice of a recession, which is defined as two consecutive quarters of economic contraction.

Several factors contributed to the economy’s reversal after rocketing ahead 6.9 percent during 2021’s final quarter, the country’s best growth record since 1984.

COVID infections multiplied, inflation ran at its fastest clip in 40 years, and lingering supply chain kinks were not fully resolved. Russia invaded Ukraine, which cut off supplies of grain and other foodstuffs from the war zone, and the West imposed sanctions that further reduced essential supplies and drove prices higher.

Government spending at state and local levels declined. Businesses invested less in inventory amid rising prices and materials shortages.

Although consumer spending expanded by 2.7 percent during the period, falling exports cut 3.2 percent from growth.

More bumps on the economic road lie ahead, as the U.S. Federal Reserve prepares to raise interest rates sequentially through the year and is likely to boost its key rate by a half-point this week.

The first quarter’s receding economy caught many analysts by surprise. 

Dow Jones had expected 1-percent growth for the quarter; economists surveyed by Bloomberg predicted a 1.1-percent expansion. Goldman Sachs had forecast a 35-percent chance of a recession, but not until next year.

However, Deutsche Bank, picking up on our forecast of Dragflation, predicted “a major recession” for the U.S. this year in a 19 April research note to clients.

The reason: to lasso inflation, the Fed will have to raise interest rates so aggressively that the economy suffers, the bank warned in a report titled, “Why the Coming Recession Will Be Worse Than Expected.”

“We regard it…as highly likely that the Fed will have to step on the brakes even more firmly, and a deep recession will be needed to bring inflation to heel,” the report stated.

“It is sorely tempting to take a go-slow approach hoping that the US economy can be landed softly on a sustainable path,” the bank said, but “this will not happen.”

“Our view is that the only way to minimize the economic, financial, and societal damage of prolonged inflation is to err on the side of doing too much.” 

TREND FORECAST: How much is to “err on the side of doing too much”? The bet on The Street is that the Federal Reserve will raise interest rates by 50 basis points this week. On the longer haul, others are betting that even if the Fed raises rates aggressively in the coming months, its aggressive monetary tightening is already priced into markets.

We maintain our forecast that with each interest rate rise, equity markets and the economy will decline. Therefore, the higher interest rates rise, the deeper they will both fall.