Are we headed for an economic slowdown?

by Kristina Hooper, Chief Global Market Strategist, Invesco

Key takeaways

It’s been a busy summer for global policymakers, including the Bank of Canada which recently raised its benchmark interest rate by a full percentage point. As central banks continue the process of tightening, we asked Invesco’s Chief Global Market Strategist Kristina Hooper what she sees in store for monetary policy, the Canadian economy, and markets in the months ahead. Here she responds to our top three questions:

As policymakers raise interest rates to combat inflation, do you think a recession is becoming more likely in Canada and the U.S.?

Yes and no. By that I mean that tightening — especially aggressive tightening — increases the likelihood of recession. There is no way around it. However, there is an argument to be made, which Bank of Canada governor Tiff Macklem has made, that ‘frontloading’ rate hikes can reduce the chances of recession because it enables a faster control of inflation, which in turn means fewer total rate hikes in the tightening cycle.

I think there is some truth to that. For example, in the U.S., the Federal Reserve (Fed) got very aggressive very quickly, and it seems to be working as longer-term inflation expectations have fallen in the past month. This could mean the Fed has less total tightening to do in order to get inflation under control, thereby reducing the chances of recession.

I also believe central banks can reduce the likelihood of sending their respective economies into recession by being very data dependent and reacting to incoming data. That helps to take a blunt instrument — which monetary policy truly is — and make it a bit more like a surgical tool.

How do you see the business cycle evolving over the coming months? And how big a risk is persistent inflation?

Canada and the U.S. are both in store for significant slowdowns; they are already beginning to experience them. Whether these slowdowns turn into broad-based recessions remains to be seen, but regardless I think the downturns will be relatively short-lived given that both economies have some real strengths.

Persistent inflation is a big risk to economies because of what it forces central banks to do. However, I don’t think we are experiencing truly persistent inflation. I am confident inflation will start to moderate, and that central banks will get it under control.

What should investors be considering when addressing these challenges (inflation, slowing business cycle) — what are the longer-term portfolio implications? Where are you currently seeing opportunities?

I believe that, for the long term, investors should maintain long-term allocations. There are no events or conditions today that should alter long-term asset allocations. Investors can try to take advantage of conditions with short-term tactical allocations, but it can be difficult. Tactically, I would be risk neutral in this environment because I anticipate a significant slowdown.

I would favour a slight overweight to equities, but prefer defensive sectors such as healthcare and technology, given that historically they have performed better in the slowdown phase of the economic cycle. I would favour the U.S. and Canada over other developed markets and would be neutral between developed markets and emerging markets. Within emerging markets, I would have a preference for Asia emerging markets given greater growth potential as China rebounds.

Within fixed income, I would favour quality credit over risky credit. In alternatives, I would favour real estate, infrastructure and energy. In terms of currencies, I would favour the Canadian dollar and the U.S. dollar.

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