U.S. Could Be Transitioning To a Mid-Cycle Economic Downshift and It May Start Toward End of 2022, MUFG Says

The U.S. economy is moving from a post-reopening boom phase toward a moderating period, which, depending on the policy prescription, may end up feeling like a mid-cycle slowdown in the second half of 2022, according to Mitsubishi UFJ Financial Group’s (MUFG’s) 2022 U.S. Macro Strategy Outlook titled “The year ahead: balancing macro risks and markets.”

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Authored by George Goncalves, Head of U.S. Macro Strategy at MUFG, the report outlines key themes for 2022 tied to a quicker pace of Fed tightening, fiscal policy inflexibility, global and geopolitical issues, and the potential tightening of financial conditions against a presently healthy U.S. economic backdrop.

“The risk of less fiscal support ahead, combined with the Federal Reserve combating inflation in 2022, could end up tightening financial conditions materially,” Mr. Goncalves writes. “This could ultimately push the economy back to pre-COVID-19 stagnation or worse – end up shortening the business cycle.”

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Other observations from “The year ahead: balancing macro risks and markets” include the following:

• In our view, the Federal Reserve interest rate tightening cycle is long overdue. MUFG expects at least two rate hikes in 2022 with the potential for more if inflation does not recede or alternatively if the Fed does not start shrinking its balance sheet as we expect in the second half of 2022.
• As the Fed embarks on a hiking path, U.S. rates are poised to rise over the course of 2022, led by the front end of the yield curve. However, there is upside risks to our long-term rate forecasts.
• In mortgage-backed securities (MBS) the spread basis between MBS and U.S. rates should widen as the Fed tapers, however a wider basis likely brings back investors sitting on the sideline.
• Investment-grade credit spreads will likely trade within a range of 85-125 basis points. We believe these spreads are weighted more toward widening over time versus tightening more because of rising rates and our anticipation of some economic deceleration in the second half of 2022.
• MUFG’s credit team remains relatively constructive on the high yield sector. They expect high-yield spreads to remain toward the tighter end of their projected range of 285–385 basis points.

Contributors to this report include Eric Ruff, Credit Desk Analyst; Glenn Schultz, Head of Mortgage-Backed Security Modeling and Strategy; and Bill Matthews, Leveraged Finance Credit Desk Analyst.

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