MUFG: US to Transition to Mid-Cycle Economic Downshift in 2022

The U.S. economy is moving from a post-reopening boom phase toward a moderating period, which, depending on policy prescription, may end up feeling like a mid-cycle slowdown in the second half of 2022, according to Mitsubishi UFJ Financial Group’s 2022 U.S. macro strategy outlook.

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 Federal Reserve 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,” Goncalves wrote. “This could ultimately push the economy back to pre-COVID-19 stagnation or worse — end up shortening the business cycle.”

Outlook Highlights

  • According to MUFG, 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 MUFG expects 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 MUFG’s 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 will likely bring back investors sitting on the sideline.
  • Investment-grade credit spreads will likely trade within a range of 85 to 125 basis points. According to MUFG, these spreads are weighted more toward widening over time versus tightening more because of rising rates and the company anticipates some economic deceleration in the second half of 2022.
  • MUFG’s credit team remains relatively constructive on the high yield sector and expects high-yield spreads to remain toward the tighter end of their projected range of 285 to 385 basis points.

Eric Ruff, credit desk analyst at MUFG; Glenn Schultz, head of mortgage-backed security modeling and strategy at MUFG; and Bill Matthews, leveraged finance credit desk analyst at MUFG also contributed to this report.

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