Rate tightening slowed global growth, risks remain

Citi Chief Global Economist Nathan Sheets joins Yahoo Finance Live to discuss ongoing concerns about a global economic slowdown.

Sheets says throughout 2023 central banks were “vigorous” with rate hikes, which he notes “slowed the global economy” but not as sharply as investors anticipated. He cautions headwinds persist from tighter policy, and is keeping watch on how banks restricting credit to households and firms unfolds. Sheets also highlights the “so-called tightening of financial conditions” resulting from hikes. However, he observes markets have remained resilient so far.

Although Sheets believes central banks will likely be “reducing the amount of policy restraint” in 2024, he says this depends on seeing the pace of inflation continuing to dissipate. Overall, he notes aggressive tightening has moderated growth but financial stability risks remain.

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

Editor’s note: This article was written by Angel Smith

Video Transcript

JULIE HYMAN: Global economy managed to defy expectations of a sharp slowdown in the last year. Markets celebrated the unexpected momentum driving the S&P 500 to close above 5,000 for the first time ever today. But our next guest warns there are still some lingering concerns.

We’re joined by Nathan Sheets, Citi chief global economist. Nathan, thank you so much. Really good to see you and thanks for joining us. So as we look at the potential risks that remain in the economy, and this is something you wrote about for Barron’s recently, it seems like monetary policy still sort of tops on the list in terms of the tightening that’s happened and the effect it could still have. So what are you watching to see signs of that?

NATHAN SHEETS: Yeah, central banks have been very vigorous over the last year or two in terms of their rate hikes. And you know, I think it has slowed the global economy, but not nearly to the extent that we expected. My sense is that there’s still some of the headwinds associated with that tightening that are in play.

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And some of the key issues I’m watching is to what extent do banks continue to restrict credit to households and firms? We’ve certainly seen some of that. And then if firms can’t get that credit or households can’t get as much credit, what does that mean for spending and investment in the economy more broadly?

I think we’re also thinking hard about the so-called tightening of financial conditions that has come along with these higher rates. And on the one hand, you could say financial conditions are tighter because the 10-year Treasury yield is now over 4%. It’s much higher than it was two years ago when the Fed started hiking.

On the other hand, as you were highlighting, equity markets are now over 5,000. And it really is extraordinary, the resilience of the equity market in the face of these rate hikes. And I think that’s another key question for the Fed and the economy.

With the equity market this strong, that means people’s balance sheets are stronger. And the so-called what economists term wealth effects that support consumption remain in play. So there are a lot of different channels and we’re watching them. So far, there’s been some restraint, but not nearly to the extent that we expected.

JOSH LIPTON: Nathan, there are some economists– I want to get your take on this– they have kind of an optimistic view. And they say, listen, global economic growth will improve this year. And in part, foundationally, they’re making that argument, Nathan, because they’re looking at central bankers.

They’re looking at policymakers all around the world, Fed, ECB People’s Bank of China and they say, listen, they’re all going to likely ease monetary policy this year as inflation cools. So they stay optimistic. What’s your take on that?

NATHAN SHEETS: You know, I think it’s true that central banks most likely are going to be reducing the amount of monetary policy restraint, but that is contingent on what you also mentioned, ongoing and further progress with inflation. And I think that’s really the key question in my mind is what is the– and again economists would call it the last mile of getting inflation back down to 2%. So far, it’s been pretty smooth and the Fed has made a lot of progress.

But now we’re struggling with a different kind of inflation. It’s more about the tight labor market, high-wage growth, and rapid services inflation. And how rapidly does that come off? And then that in turn is going to determine how rapidly central banks are cutting. But if central banks, as you suggest, are bound and determined to avoid recession, they certainly have the tools to ensure that there is no recession by cutting rates.