Fed U-turn likely if US enters recession but risk-appetite may rise only gradually

The final estimate for March quarter GDP in the US suggested the world's largest economy shrank 1.6 per cent in the quarter. But at the same time, Fed Chair Jerome Powell made a do-what-it-takes statement saying Fed would not let the economy slip into a higher inflation regime even if it means raising interest rates to levels that put growth at risk.

If the US economy, or for that matter, developed markets, do slow down, it will raise demand concerns and commodity prices may take a hit. The recent surge in Covid cases in China and its impact on metals is a fresh example. A fall in commodity prices could ease inflation globally and may prompt Fed to go slow on or even reverse rate hikes, analysts said in an ETMarkets Midyear Survey, adding that the immediate period could be painful for domestic equities as one may see intensified FPI selloff.

Religare Securities hopes the recessionary environment may address inflation concerns. This will address the Fed's primary concern of maintaining price stability, it said, adding that interest rates will not increase in that case to an extent participants expect in the current scenario.


"But with the growth going to zero, expecting equity markets to do well would be quite naive," the brokerage said.
Deepak Jasani of HDFC Securities said that even as the US Fed is expected to reverse the hawkish moves and start cutting rates once the economy enters recession, it may not result in an immediate turnaround in the equity markets as risk appetite may take its own time to build up.

An old adage goes as: When the US sneezes, the world catches a cold. Analysts said the US recession would have a contagion effect on other economies. Historically, whenever the commodity prices have been elevated, more likely than not, recessions have occurred, said Yesha Shah, Head of Equity Research, Samco Securities.

"This is also the reason why globally, the sell-off has continued. In many of the previous deep market corrections and recessions, markets stopped falling when the Fed intervened and loosened the monetary policy. This does not seem likely now, given that interest rates are lower than inflation rates. So should a recession occur, it can become challenging for equity markets to hold their ground," Shah said.

Data showed FPIs have sold equities worth Rs 2,17,049 crore so far in 2022. This is against an inflow of Rs 25,752 crore in 2021.

A US recession will impact global markets as flows will continue to dry up, said Pankaj Pandey, Head – Research, ICICIdirect, even as he feels fear of impending recession, essentially, might force the Fed to go slow in the hike cycle.

"However, more important than recession is weakening of the inflation cycle that we believe might begin to show if crude and commodities cycle begin to reverse," Pandey said.

Vinit Bolinjkar, Head of Research, Ventura Securities, said one might find many articles about the decoupling of economies, no major world economy can decouple in today's world, given high interdependence post globalisation. In case of a recession in US markets, global markets are also expected to go down, he said.

Meanwhile, a couple of analysts, such as Yash Gupta- Equity Research Analyst at Angel One, felt any recession in the US is expected to be short-lived and once the global supply chain issue resolves, the stance of the Fed too would change.

"Globally, equity markets have seen a huge sell-off post the central bank actions and more or less they have discounted the rate hikes and liquidity tapering," Gupta said.

Nishit Master, Portfolio Manager, Axis Securities, said a US recession if accompanied by lower inflation due to the destruction of demand, would lead to a change in the US Fed stance. An easing monetary policy, in that case, will be good for Indian markets.

"On the other hand, if the recession is not followed up with significantly lower inflation, US Fed will not be in a position to ease its monetary policy and will lead to a double whammy for global and Indian markets as liquidity conditions will continue to remain tight while demand from world’s largest economy will also slow down," he said.

Punit Patni, Equity Research Analyst, Swastika Investmart, also sees the recession to be short-lived. He felt that post a huge selloff globally, markets are more or less discounting the rate hikes and liquidity tapering.

We expect the Fed to be proactive in dealing with recessionary pressures and take appropriate measures to ensure that there is no sustained weakness in the economy," said Shiv Chanani of Elara Securities India.

(Disclaimer: Recommendations, suggestions, views, and opinions given by the experts are their own. These do not represent the views of Economic Times)