International economy – “no other choice”
Sydney Wealth Management | The information in this article is current as at 1 October 2022.
“No other choice”
As Northern Hemisphere nights grow longer, central bankers face the unenviable choice of allowing prices to run rampant, or risk plunging economies into recession anyway by lifting interest rates too aggressively.
While there are some signs to suggest inflation may have peaked (global supply chains blockages are beginning to ease1, firms are building inventory levels2 and many commodity prices such as oil have fallen from recent peak levels), other coincident indicators particularly in the US remain strong, such as rent and wage growth. Recently in August, US core inflation, which strips out changes in food and energy prices, surprised to the upside at 6.3% for the year versus a consensus forecast of 6.1%. However, we should note that a big driver of this change (approximately 40% in fact3) is due to the cost of rent and housing. This is expected to persist until next year because of the way this is measured in the US. Fearful of a wage price spiral, the Federal Reserve economic department’s (Fed’s) focus has shifted to reducing inflation to a 2-3% range at all costs even if this weakens the economy and causes job losses.
Although we have already seen two quarters of negative GDP growth in the US, this was more due to GDP accounting anomalies that were at odds with underlying strength in the labour market. Nevertheless, weakness in other indicators besides consumer spending suggest a material slowdown is now indisputably underway. The Markit Composite PMI for the US was 44.7 in August, with new orders falling at their fastest pace since May 2020 (the first set of coronavirus lockdowns). The overall weakness is being led by services sector (Services PMI at 43.7 vs a still positive 51.7 for manufacturing firms), implying that job losses are likely. Recession risks for the US are continuing to rise in our view.
In Ukraine the war rages on. Over recent weeks Ukrainian forces have mounted a successful offensive, retaking sizeable tracts of land from Russian occupiers. Even in the face of these setbacks, there has been a marked reluctance from Russia to negotiate an end to the conflict. Given Western support has remained intact, we expect the war and its consequences to persist for some time. The withdrawal of many Russian commodity exports, including oil and gas from global markets has helped fan global inflation. This worsened in August with Russia effectively weaponing its gas supply by halting the flow of gas to Europe in retaliation to EU sanctions.
This has seen electricity prices continue to soar as European countries race to stockpile enough for winter later this year. In some countries such as the UK, headline inflation for the year is nearing double-digit territory at 9.9% for the year to August.
UK annual inflation rate (Aug-07 to Aug-22)
Source: Bloomberg
Governments are working to support households and businesses in the face of these unprecedented energy price hikes. Energy prices have been capped for UK households at £2,500 per annum until September 20244 as part of an overall support program costing £150bn. In Germany, energy retailers such as Uniper are being nationalised to avoid bankruptcy5. This situation has triggered a broad economic slowdown as household budgets are diverted to necessities such as electricity. The Eurozone Composite PMI for August was 48.9, its lowest since February 2021, indicating a contraction in economic activity.
Somewhat counterintuitively, the European Central Bank (ECB) has compounded these challenges by lifting interest rates for the first time since 2011, adding further pressure onto households and businesses. After holding its nerve for over a year, the focus has shifted to more political goals, such as being seen to be “doing something” to reduce inflation. Given the economic damage already underway, we think the ECB may well be cutting again before long to support the economy.
In China, the well documented problems with its property market and the consequential downstream impacts on investment and consumption, continue to wreak havoc on the broader economy. Real estate investment was down 7.4% for the year to August6. Coronavirus lockdowns remain part of the Chinese landscape with rapid shutdowns of major cities being a continued source of disruption. Chengdu, a city of 21 million people7, has been the latest victim of the country’s Covid Zero Strategy, following on from Shanghai’s major two-month lockdown earlier this year. These have added to economic disruption including a slowdown in demand and investment spending. The government launched a new US$146 billion stimulus package in late August targeting new infrastructure spending (US$44 billion), energy supply security (US$29 billion) and local government funding (US$73 billion). This follows moves to lower interest rates by the People’s Bank of China, while the country’s official growth target of 5.5% for 2022 was dropped by Chinese officials after a parlous start to the year with growth of 2.5%.
Overall growth prospects have continued to weaken with US growth revised down to 1.4% for 2022 (down from 1.7%)8. Although EU growth has been revised slightly higher to 3.1% (due to positive economic surprises in the first half of 2022), aggregate demand is expected to slow sharply to just 0.9% in 20239. For many, it is becoming increasingly expensive to just “keep the lights on”, let alone meet other expenses. Recession risks are elevated in our view and growth forecasts may well be revised lower in the months ahead. This is supported by leading indicators that have turned sharply negative in recent months including the Composite PMI survey shown below.
Developed economy annual growth versus Composite PMI survey (Sep-19 to Sep-22)
Source: Bloomberg
Conclusion
In summary, risks to global growth have continued to climb. While we have seen some signs of inflation peaking, this has been countered by rising wage growth, especially in the US, and soaring energy prices, particularly in Europe. In response, central banks worldwide have continued to tighten monetary policy. With the economies of the US and Europe barely expected to grow over the coming 12 months, and China facing significant challenges of its own, the risk of a global recession is rapidly increasing in probability. We are in a turbulent period for the global economy, that suggests being cautious is well-advised.
Part 2: Key economic indicators
United States
| Economic snapshot | Last reported result | Date | 2022e | 2023e | |
| Growth (GDP) | 1.70% | Jun-22 | 1.6% | 0.9% | |
| Inflation | 8.30% | Aug-22 | 8.0% | 3.8% | |
| Interest rates | 3.12% | Sep-22 | 4.1% | 3.9% | |
| Unemployment Rate | 3.70% | Aug-22 | 3.7% | 4.1% | |
| Composite PMI | 49.3 | Sep-22 |
Eurozone
| Economic snapshot | Last reported result | Date | 2022e | 2023e | |
| Growth (GDP) | 4.10% | Jun-22 | 2.9% | 0.3% | |
| Inflation | 9.10% | Aug-22 | 8.2% | 5.0% | |
| Interest rates | 0.75% | Sep-22 | 2.3% | 2.5% | |
| Unemployment Rate | 6.60% | Jul-22 | 6.8% | 7.0% | |
| Composite PMI | 48.2 | Sep-22 |
China
| Economic snapshot | Last reported result | Date | 2022e | 2023e | |
| Growth (GDP) | 0.40% | Jun-22 | 3.4% | 5.1% | |
| Inflation | 2.50% | Aug-22 | 2.3% | 2.3% | |
| Interest rates | 1.82% | Sep-22 | 4.3% | 4.3% | |
| Unemployment Rate | 3.96% | Dec-21 | 4.1% | 3.9% | |
| Composite PMI | 53 | Aug-22 |
Japan
| Economic snapshot | Last reported result | Date | 2022e | 2023e | |
| Growth (GDP) | 1.60% | Jun-22 | 1.6% | 1.5% | |
| Inflation | 3.00% | Aug-22 | 2.1% | 1.3% | |
| Interest rates | -0.10% | Sep-22 | 0.0% | 0.0% | |
| Unemployment Rate | 2.57% | Jun-22 | 2.6% | 2.5% | |
| Composite PMI | 50.9 | Sep-22 |
