Hike rates

Continuous Disclosure: Recession Isn’t Inevitable – Why We Shouldn’t Raise Rates Too Much

Investors are increasingly concerned about the economic environment and the prices of financial assets. Photo / 123rf

Stock markets have crashed into bearish territory, but inflation continues to rise.

The only way out is to raise interest rates until we are in recession, right?

Not necessarily, says David McLeish, senior portfolio manager at Fisher Funds.

In the latest episode of the Continuous Disclosure Podcast, McLeish warns that we risk inflicting more economic damage than necessary with overly aggressive rate hikes.

“It certainly looks like a real bear market now,” he said.

“The market for most of our investing careers has shown a lot of resilience and an ability to bounce back very, very quickly, so the fact that stock prices have fallen for most of the six months suggests that something something different is brewing than what we’ve had before.”

Investors were clearly starting to worry about the economic environment and financial asset prices, he said.

“Headline inflation looks pretty terrible right now. It’s about the highest level we’ve seen in over thirty years and so it’s no surprise that inflation is on the edge of the line. everyone’s language.”

But McLeish does not see the recession as inevitable.

David McLeish, Senior Fixed Rate Portfolio Manager at Fisher Funds.  Photo / Provided
David McLeish, Senior Fixed Rate Portfolio Manager at Fisher Funds. Photo / Provided

“That’s not to say the risks of recession aren’t high,” he said. “I actually think the odds are very high right now. But I think the recession can be avoided.”

For this to happen, central banks need to back out of the amount of rate hikes they are currently planning.

In New Zealand, the OCR is expected to increase to 3.9% (from its current level of 2%).

The markets predicted that it could reach 4.5%.

For central banks to pull back, either inflation needs to subside faster than expected, or they could look at near-term inflation levels and decide they’ve done enough to lower inflation in the longer term. term.

Right now, they were taking a more aggressive stance that indicated a recession.

“There is this opinion that this is the necessary medicine that we all have to take to bring inflation under control.”

“We build this narrative based on a lot of economic assumptions and conventional wisdom,” he says. “A lot of this is based on the belief that inflation expectations are the engine of inflation.”

The traditional theory is that if public expectations of the direction of prices rise too much, it can cause true inflation.

But this theory has been challenged by some economists.

The debate was far from settled, McLeish said, but we were raising rates at a rapid pace and on the basis of “questionable” theory.

McLeish said he fears that if central banks raise interest rates too aggressively, they could unnecessarily cause a recession and ultimately do more harm than good.

Central banks tell us they want to drive demand down to the level of tight supply, but there were arguments to be made that higher rates might actually further constrain supply, he said. declared.

“Higher interest rates actually make it more expensive to finance investment projects, the cost of capital goes up. We clearly need more investment, we need more production capacity if we want to make in the face of the supply-side inflationary impulse that we are experiencing,” he said.

Higher interest rates also reduce supplier certainty about supply prospects. So, by lowering demand, they will make suppliers more uncertain about bringing supply online.

A third point was that higher interest rates can cause suppliers to reduce inventory levels, which was part of the problem we had in 2020 and 2021.

“There are a number of factors that suggest that by lowering demand you may not be solving the inflationary problem either.”

Meanwhile, while there was clearly still a long way to go, there were promising signs that the global supply chain bottleneck was starting to clear, McLeish said.

“Freight costs are falling, port congestion is now starting to ease and orders to inventory levels have come down again,” he said.

“This is just the beginning, we are still a long way from normal conditions, but the rate of change and the direction of this change is intended to alleviate these concerns.”

Continuous Disclosure is a podcast from the NZ Herald.
Continuous Disclosure is a podcast from the NZ Herald.

Continuous disclosure is available at IHeartRadio, Spotify, Apple podcast, or wherever you get your podcasts. New episodes are released every other Wednesday.

You can find more New Zealand Herald podcasts at nzherald.co.nz/podcasts Or on IHeartRadio.