Eurobank Research expects Fed funds at 2.25% by April

In the US, the recent deterioration of economic data suggests that the economy is heading to a full-fledged recession with a probability of 60%- 80%, depending on how deep the housing downturn will prove over the coming months, note Eurobank economists in the latest edition of Eurobank Research, Global Economic & Market Outlook.

“We feel that our estimates are high enough to put recession in our central scenario,” noted Eurobank Research and Forecasting Director Gikas Hardouvelis.

“We expect the Fed to cut rates to 2.25% by April. The scope for further rate cuts is rather limited as inflation will remain above trend and target, putting a floor to short term interest rates,” note Eurobank researchers.

The US downturn will lead to a substantial economic slowdown in both developed and emerging economies, although the world economy may technically avoid a recession.

With inflation moderating somewhat in the coming months, the ECB will be eventually forced to follow the lead of the Fed and cut interest rates by midyear as the outlook of the euro area economy will continue to deteriorate.

“Our fundamental view is that the main themes of a US-led recession and “re-coupling” of both developed and emerging economies will continue to dominate medium term trends in global financial markets. We recommend increased cash holdings and maintain and a series of shortlong positions (suggested in 2007), which reflect our fundamental economic views.”

Over the next three months, Eurobank Research team expects US equities to underperform Treasuries, small caps to underperform large caps and value stocks to underperform growth stocks. Hence, they recommend short-long positions in these themes in order to hedge for the risk of an upcoming recession.

“We are positive on Bunds versus Treasuries and remain negative on the US dollar against the euro despite a likely improvement in the US trade deficit, as the latter will be due to a cyclical weakness of the US economy. We expect EM equities to underperform both US and European equities as a global slowdown will lead to a downward revision of (in some cases, such as China, absurdly high) corporate earnings estimates and a significant repricing of risk,” conclude Eurobank economists.