Franklin Templeton expects ‘shallow recession’ in US and eurozone

Oksana Patron

23 June 2023

Although there will be no Fed rate cuts this year, a ‘short and shallow’ recession is likely in the US and the euro zone, according to Franklin Templeton’s fixed income team’s third quarter investment outlook.

Fixed income assets are predicted to continue to provide strong levels of income, with some sectors offering “some of the highest yields seen” in several years.

“Shorter-duration, high quality assets remain attractive to us on a historical basis and can provide downside risk management amid both rising interest rates and widening credit spreads. We still believe global central banks must continue to be vigilant as they strive to lower overall inflation,” the manager said in its outlook.

However, the team warned, that expectations that the US Federal Reserve (Fed) will be quick to respond to any deterioration of economic conditions with rate cuts would be disconnected from the Fed’s own guidance.

“Our base case calls for no Fed rate cuts during this year; we also still see the European Central Bank (ECB) and the Bank of Japan (BoJ) continuing to tighten monetary conditions. We expect a short, shallow recession in the United States and the euro area,” the investment outlook said.

Other important developments will include ‘likely’ elevated interest rates for longer since the Fed would be busy bringing still-high inflation back to target which is going to take time and therefore, rate cuts would be unlikely in 2023.

On top of that, the ECB also made clear it is not yet contemplating a pause in its hiking cycle.

What is more, as the US labor market imbalance softens, it would be likely to be less upside pressure on nominal wages, which in turn will limit how high real wages will rise.

“While private consumption spending is expected to slow through the rest of the year, we still think even the lower real wage and disposable income growth will help support the consumer sector, which will help prevent the US economy from slipping into a deep recession in the second half of the year.”

Finally, the US non-housing core services inflation (the Fed’s preferred measure) remained elevated and has largely moved sideways in the past six months.

This would mean service-driven inflation will also remain an influential component of overall inflationary pressures in Europe and Japan.

However, the similarity ends there as goods-driven inflation in the US appears to have re-accelerated, whereas goods inflation has peaked in Europe, while receding in Japan.