US May Be Headed for a Recession – and It Won’t be Pretty for the Global Economy

Even after two 75-basis-point hikes in interest rates, there is a wide differential between interest rates and the inflation rate. The yield curve has inverted, ie, short-term government bonds are yielding higher interest rates than the 10-year paper. Historically, such a situation has always been followed by a recession.

In the past, an inflation-induced recession lasted about two years. Unemployment typically shoots up within a year of recession setting in. While consumer spending and employment figures do not reflect this grim outlook now, stagflation will take its toll and hit the US economy quite badly in 2023. Going ahead, as we move to a multipolar world with new economic and military superpowers, the ‘reserve currency’ status of the dollar will be challenged.

The share of US dollar assets in global forex reserves has declined from 70% to 60% over the last decade. Over the years, trade deficits have been increasing. Last year, the US trade deficit was $859 billion. The US dollar has held out against other currencies on account of huge international capital account inflows. The international fisher effect doesn’t play out in the case of the US dollar in spite of high inflation and the currency progressively losing its purchasing power. This is very evident as in these uncertain times, the dollar is getting stronger even though the US has higher inflation and lower interest rates vis a vis many other countries. This is because it is seen as a ‘Safe Haven Asset’. While the US Dollar is getting strong now on account of rising interest rates, it is likely to further weaken the domestic manufacturing competitiveness.

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