US and Europe on the brink of recession. Who will save whom?

A soft landing scenario for the economy and financial markets seems unlikely. Fitch Ratings’ latest macro-outlook speaks about recession in the coming year

Everywhere we turn now for business news, we see headlines about how the monetary pain is spilling over into the financial markets and warnings about the next recession. All because of the rapid increase in interest rates engineered by the Federal Reserve in the attempt to bring inflation down, which in June 2022 reached the highest peak in over forty years. So far, the Fed’s measures have proven too slow to succeed in taming the inflation rate. Moreover, for almost all countries, a strong dollar makes their fight against inflation even harder. Analysts urge that things are about to get more complicated.

What does that mean? There are different scenarios of how economic growth will be affected, but all start with the same idea: we are on the brink of recession. Last week, Josep Borrell, the EU’s foreign policy chief, finger-pointed the Federal Reserve for charging central banks to follow its multiple rates rises and respond to currency depreciation pressures. The EU’s top diplomat warned that this situation "will bring us to a world recession” and compared the US central bank’s influence to Germany’s dominance of European monetary policy before the creation of the euro. He fears many countries might encounter a government-debt crisis like Greece did in 2009.

Throughout 2022, the Federal Reserve has increased interest rates five times, boosting the range from near-zero to 3,25 percent with the aim to curb inflation and create the so-called “soft landing” for the US economy and consumers. It was the fastest monetary policy modification since 1980. Inflation rates hit high peaks in the United States and the world following the Covid-19 pandemic and Russia's war against Ukraine, which led to an imbalance between robust demand and constrained supply.

The last super-sized interest rate rise was made in September by 0.75 percentage points, matching the hikes in June and July, thus reaching the highest level since early 2008. The Federal Reserve Board Chair, Jerome Powell, stated that more increases are expected in the coming months as the institution tries to put the brakes on the rapid run-up in prices. The European Central Bank, which struggles with a high inflation of 10 per cent, increased the deposit rates by 1.25 percentage points after the last two policy meetings. By the end of this month, analysts expect a further 0.75 percentage point rise.

What is clear so far is that the Fed’s attempt to slow the worst inflation in four decades has failed. On one hand, the US central bank took some time before tightening its monetary policy. Months before the Fed’s decisions, many voices criticized the institution for not taking a quick stance against the growing inflation. Some specialists talk about a déjà vu scenario from the 80s when the sharp rise of the interest rates brought the developing or underdeveloped states of Latin America and Africa to their knees. On the other hand, it takes time for these measures to produce an effect.

After years of flooding the financial markets with billions of dollars and euros, in 2022, central banks are forced to lift interest rates aggressively, which puts pressure on states, companies, and individuals in debt. Many developed European countries ended up borrowing at interest rates even higher than 3%, for a 10-year term, compared to the same period in 2021, when the interest rates were negative. Still, many economists believe that the Fed is not doing yet, enough, or fast enough.

A recent survey conducted by the Financial Times, in partnership with the Initiative on Global Markets at the University of Chicago Booth School of Business, suggests the Federal Reserve is far from ending its monetary policy tightening campaign. Almost 70% of the 44 economists interviewed by FT between September 13 and 15 believe the federal funds rate rise cycle will peak between 4% and 5%. And 20% of them said it must exceed that level.
This prognosis has been confirmed by policymakers. The Chair of the Federal Reserve Board, Jerome H. Powell, admitted that “the chances of a soft landing are likely to diminish” and confirmed what many other specialists said months before. Even more striking are the revisions of the previous forecast: the borrowing costs will rise to 4.4 percent by the end of the ear, and we will witness higher interest rates in the years to come than initially foreseen. The Fed’s inflation target has suffered a significant movement from to 2% to 2.8%, and the current projections for the unemployment rate show an increase of nearly a percentage point, to 4.4% by the end of next year from 3.5% as of September. These adjustments paint a gloomy picture for households and businesses with slower growth, higher unemployment rate, and potentially, a recession.

The latest news from Fitch Ratings shows that in the third quarter of 2022, the global macro-outlook deteriorated further. The financial company announced European and American recessions in the coming year based on the risks from the European gas crisis, China’s property market issues, and rate rises in the US.

The recession in 2023 is expected to be less impactful than the previous ones, according to some analysts, but another question is rising. If during 2008-2009, states managed to save the markets, now who will jump to provide financial assistance to save the states?