Outlook

With the balance of inflation risks swiftly tilting to the downside, markets expect central banks to begin normalizing policy settings in the coming months. Federal Reserve Chair Jerome Powell’s comments during a mid-December post-decision press conference were widely read as implying a willingness to follow canonical policy guidelines—like the Taylor Rule—in moving even before evidence of a downturn arrives. Further, Fed Board Governor Waller’s late-November comments—in which he explicitly said reducing rates would have “nothing to do with trying to save the economy or recession”—have helped ratify market expectations for a fast and furious cutting cadence. The European Central Bank’s...

Given the significant progress seen thus far, it would take a meaningful re-acceleration in price growth to motivate additional interest rate hikes in major economies, and a deep downturn could force central banks into delivering the easing currently priced into markets. But because inflation has fallen in line with policy expectations, real interest rates remain elevated, and could ultimately settle well above pre-pandemic levels as the world grapples with changing demographics, geopolitical uncertainties, extraordinary levels of indebtedness, deepening capital scarcity, and higher long-term volatility risks. For households, businesses, and governments, the extremely demand-stimulative borrowing environment that prevailed for more than...