If there’s one dominant theme in our inbox at the moment — beyond the usual cacophony of ESG and crypto nonsense — it’s how everyone seems to be freaking out about the chances of a looming recession.
The US yield curve inverting was obviously one big trigger. People that want to better understand the pros and cons of the yield curve’s soothsaying abilities should check out this FT piece from 2019. The arguments have changed remarkably little since then. (If you fancy a different perspective on the yield curve, our data viz wizard colleague Alan Smith set it to music here.)
But whatever the yield curve is doing, there are clearly rising fears that uncomfortably high inflation will push central banks, led by the Federal Reserve, into jacking up interest rates faster than anticipated just a few months ago. Hell, even Lael Brainard has now got her hiking face on.
Deutsche Bank became the first big bank to predict a recession last week, with its top economists David Folkerts-Landau and Peter Hooper arguing:
Two shocks in recent months, the war in Ukraine and the build-up of momentum in elevated US and European inflation, have caused us to revise down our forecast for global growth significantly. We are now projecting a recession in the US and a growth recession in the euro area within the next two years.
The war, which has transitioned into a stalemate that is unlikely to be resolved any time soon, has disrupted activity on a number of fronts. These include upheavals in markets for energy, food grains, and key materials, that have in turn further disrupted global supply chains. We assume that the critical flow of gas from Russia to Europe will not be cut off, keeping the crisis from substantially deepening costs to the European and global economies, but that remains a downside risk.
Inflation in the US and Europe is now pushing 8%, well in excess of what was expected as recently as December. More troubling, especially in the US, are signs that the underlying drivers of inflation have broadened, emanating from very tight labour market conditions and spreading from goods to services. Inflation psychology has shifted significantly, and while longer-term inflation expectations have not yet become unanchored, they are increasingly at risk of doing so.
The Fed, finding itself now well behind the curve, has given clear signals that it is shifting to a more aggressive tightening mode. We now expect the Fed funds rate to peak above 3-1/2% next summer, with balance sheet rundown adding at least another 75bp-equivalent in rate hikes. With EA inflation likely to be sustained at 2% or more, we see the ECB raising rates 250 bps between this September and next December.
This tightening is expected to yield negative growth in the US for two quarters during the fall-winter of 2023-24 and to reduce EA growth to modestly above zero that winter. Growth is seen recovering thereafter as inflation recedes and the Fed reverses some of its rate hikes. We acknowledge huge uncertainty around these forecasts, but also note that the risks to the downside and of a deeper downturn are considerable.
At first FT Alphaville sniggered a little at the two-year forecasting horizon, but the floodgates have opened. Recession fears are clearly rising. Usual caveats etc, but take a look at how Google searches for “recession” have spiked worldwide of late.
Outside of actual recessions in March 2020 and the financial crisis, this is the biggest uptick since the yield curve last inverted in 2019, and the eurozone shenanigans in 2011:
In addition to the factors listed by Deutsche Bank, Barclays’ economists highlight how the new Covid outbreak in China “can no longer be ignored”, given 30 out of China’s 31 provinces are now affected, and Shanghai — which alone represents almost 4 per cent of China’s economic output — has been in full lockdown since March 28. Here’s Barclays:
Downside risks to global growth are rising, as China’s lockdowns expand, Europe moves towards sanctioning Russian energy, and the Fed signals more aggressive tightening. At the same time, high inflation will likely pressure the ECB next week to signal its willingness to act, while France elections create political risk.
Ed Yardeni, a veteran Wall Street analyst who has for the most part been on the optimistic side, now pins the odds on a 2022 recession in Europe at 50 per cent, and in the US at 30 per cent.
Yardeni thinks inflation will begin to moderate in the second half of the year, but highlights how every voting and non-voting member of the Fed’s interest rate setting board has become a hawk lately. That has created expectations of a series of larger-than-usual 50 basis point rate increases that could produce a recession. Here’s Big Ed:
The war in Ukraine has heightened the odds of higher-for-longer inflation, tighter-for-longer monetary policy, and recession in the US and Europe, which we peg at 30% and 50%, respectively . . . The global economy is stagflating, indicators suggest . . . Will reining in inflation take just a nudge from the Fed or an all-out recession-triggering shove?
AV’s gut feeling is that as long as labour markets remain strong and consumption buoyant then a recession is unlikely. With inflation still likely to moderate later this year, that might mean some Fed doves-turned-hawks revert to type. Other major central banks like the ECB, BoJ and the People’s Bank of China are not likely to be aggressive anyway, given their respective challenges.
However, none are as influential for the financial system as the Fed. If the US central bank does embark on a string of 50 bps hikes we are fast going to find out just how resilient the global economy is to higher rates.
Source: Economy - ft.com
