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Recession watch: triggers, outlook and what next for central banks
Anne Vandenabeele
Stephen Green
October 31, 2022
While recession risk is clearly elevated around the world, they are notoriously hard to predict with any accuracy, in terms of timing, duration or impact.
Rather than forecasting exactly when global markets might fall into recession this time, the following Q&A with economists Anne Vandenabeele and Stephen Green examines what is triggering current conditions, the outlook for inflation and interest rates and the role of China as the world economy slows.
Is the global economy entering a recession and what are the likely triggers?
Anne Vandenabeele: The short answer is yes. We think there is going to be a significant slowdown next year but keep in mind there are many factors at work, so there is uncertainty around exactly what recession might look like.
We expect this slowdown to be driven by recession in the US and Europe, caused by sticky inflation and higher interest rates, and a Chinese economy that remains weak. Japan will follow these three, so activity in the world’s largest economies will be flat or contracting. The trigger for this is all about inflation and interest rate hikes in response to it. Inflation started post-pandemic with goods prices leading to supply chain bottlenecks, then the commodity and energy shock caused by the war in Ukraine, and finally service price inflation rising fast, driven by strong wage growth, especially in the US.
In response, central banks have raised rates incredibly fast – 300 basis points (bps) in the US or a 12-fold increase in borrowing costs. That will clearly start to bite and the US housing market is already in recession. Mortgage rates have risen so fast that pending house sales have started to drop and houses are sitting on the market for a long time. That will start affecting company earnings, capex, employment spending and so on, particularly if the US Federal Reserve (Fed) pushes through another 150bps in rate rises over the coming months.
Could we actually be facing stagflation rather than inflation?
Anne: Stagflation as a term was used a lot in the 1970s and 80s when we had a combination of low growth and high inflation, and there is a lot that rhymes with that situation today. Whether we end up there again depends on a few things, such as whether inflation proves persistent and whether central banks can ultimately live with higher inflation to revive growth.
For service companies, labour accounts for most of their costs so when wage growth is strong, service inflation follows and can stay elevated.
In the US, we think wage growth will stay high even as the Fed raises rates and unemployment goes up. The reason behind this is a huge shortage of workers, with at least four million people lost from the labour force due to various reasons, including long COVID, less immigration, early retirement or seeking a different work/life balance, so there are a lot of mismatches pushing prices up.
If wages continue to climb even as the unemployment rate rises, the question is what central banks do in that environment? Do they ease policy to contain recession and lower financial volatility, or keep raising rates like then Fed chair Paul Volker did in the 1980s to lower inflation?
Easier policy, whether monetary or fiscal stimulus as has been talked about in Europe, would, all things being equal, keep inflation high and that is also part of the equation.
My overall view is that inflation will be more persistent as a lot is coming from wage, which tends to be stickier. But I also think central banks will be quick to ease policy to limit any damage from recession or resulting volatility – that’s what they have done in the last 20 years.
One last thing to stress: we will get through this; recessions end and we need to think about this when we plan our investments.
Risk factors you should consider before investing:
- This material is not intended to provide investment advice or be considered a personal recommendation.
- The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
- Past results are not a guide to future results.
- If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease. Currency hedging seeks to limit this, but there is no guarantee that hedging will be totally successful.
- Risks may be associated with investing in fixed income, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.
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