Fidelity International’s Salman Ahmed is sticking by his call for a recession even as Wall Street ups wagers that the Federal Reserve has navigated the US economy toward a soft landing.
Expect the full effects of the central bank’s monetary policy tightening — and a downturn — to materialize next year following a wave of corporate debt refinancing over the next six months, according to Ahmed, the firm’s global head of macro and strategic asset allocation.
“The end point of the cycle is recession, because the transmission channel will kick in,” he said in an interview. “If the Fed doesn’t back off at some point, everybody has to pay these higher real rates.”
After the easy-money years of the pandemic left corporations with a slew of debt maturing in a new era of higher rates, the lagged effects of the central bank’s tightening will be what finally pushes the economy over the edge, said Ahmed who contributes to asset allocation strategy for Fidelity’s $47 billion multi-asset business.
Higher debt-servicing costs tend to reduce the firepower companies have to invest and pay workers, other things being equal. Rich stock valuations and tight credit spreads are a sign that the coming downturn is not yet fully priced into markets.
“Borrowers are not feeling the full pressure of the interest rate because they are sitting on locked rates, which is not a permanent phenomenon,” he said. “A company which financed itself at 2, 3, 4% is going to be financing at 10, 11, 12% now. That’s a huge shock.”
To prepare for the wall of refinancings hitting in early 2024, Fidelity International has upgraded their weighting on cash to overweight after being neutral for the last two months. They remain underweight stocks, are overweight investment-grade credit over high yield, and moved their overweight on government bonds to neutral for the month of September.
Ahmed’s glum forecast comes as many economists on Wall Street are scrapping their calls for a recession.
To him, the strength of the economy in the face of higher interest rates is a sign that the lagged effects of monetary policy are still working their way through the system, not a precursor of a soft-landing.
While the surprising resilience of the American consumer and labor market has forced Ahmed to push his estimates for the coming economic slump into next year and lowered his team’s odds of a recession from 80% to 60%, a downturn remains Ahmed’s base case.
His reasoning is backed up by a recent study from a group of Fed officials. Historically, it takes about a year for companies to feel the full effects of interest rate hikes that have already occurred, regardless of future rate increases, the report found.