International economy – “the recession the world had to have?”
Inflation has dominated economic discourse over the past twelve months but in key economies including the US, it now appears to be decelerating. Global supply chains blockages are easing[1], firms are building inventory levels[2] and many commodity prices such as oil have fallen from recent peak levels. Stickier inflationary measures remain troublesome for policymakers, however, with wage growth and the labour market holding strong most notably in the US. The emphasis across the board from policymakers is that inflation remains too high, and they need to act to keep inflation expectations from households and businesses in check. The fear is that a failure to do so could lead to workers demanding higher wages and businesses increased prices, embedding a higher level of inflation permanently. This motivated a further 1.25% in rate hikes for the December quarter by the US Federal Reserve (the Fed) while the ECB has taken its main refinancing rate from 0% in July to 2.5% in early December, a major shift in such a short period as we can see illustrated below.
Market central bank policy rate (Dec-21 to Dec-22)
Source: Bloomberg
In Ukraine, the war with Russia continues. In recent months, Ukrainian forces have mounted a successful offensive retaking sizeable tracts of land from Russian occupiers including the major city of Kherson. There remains 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. This includes elevated energy prices from the withdrawal of global supply.
The damage has been most directly observed in Europe with elevated electricity and heating costs threatening both household and business spending. The US by contrast has been supported by the use of its government-managed energy reserves to limit energy costs for households and businesses.
Concerted efforts to hike interest rates are beginning to appear in the economic data. The decline of retail sales growth (after stripping out price effects) has the Eurozone at recessionary levels and based on recent US data (nominal retail sales falling 0.6% in the month of November) the latter may not be far behind.
Annual retail sales volume growth (Dec-17 to Nov-22)
Source: Bloomberg
Overall growth prospects continued to weaken during the quarter. Expectations for 2023 growth in particular see the US flirting with recession (0.4% growth vs 0.8% expected at the end of September) with Eurozone growth now expected to decline 0.1% (versus expected growth of 0.2% previously)[3]. Recession risks remain elevated in our view and growth forecasts may well be revised lower in the months ahead.
Commentators love to focus on the labour market to judge the economy’s health. It is true it can be a useful barometer and a relatable one to the average person. However, it can be highly flawed in judging where the economy is next headed. This is because unemployment usually begins to rise materially after a recession has already begun. Indicators such as the Conference Board Leading Economic Index by contrast tend to flag spells of weakness before a recession begins. As we can see below this (the teal line) has been decelerating since last year, suggesting a material slowdown and possible US recession.
US labour market composite annualised growth spread versus CB Leading Economic Index (Nov-02 to Nov-22)
Source: Bloomberg
Even the bond market has soured on US prospects. The yield curve has inverted in recent months which historically has been a reliable leading indicator for US recessions. Inversion occurs when investors bet on weaker growth in the future and results in long-term bond yields falling below short-term yields. This year we have seen the US 10-year yield falling below the 2-year and even the 3-month rate (when the lines in the chart below fall into negative territory) suggesting high recession risk for the year ahead.
US yield curve spreads and US recessions (Dec-1997 to Dec-2022)
Source: Bloomberg
China is in many ways the last hope for a positive global growth thesis in 2023. Until recently China has been stifled by the government’s “Zero Covid” policy. While Chinese authorities had gradually begun to ease restrictions a series of nationwide protests and public discontent accelerated the move leading to the policy’s rapid abandonment. This has led to some predictable consequences with a surge in cases and presumably deaths (although Chinese authorities offer limited information on this front) as well as rising worker absenteeism due to illness[4]. The latter impact is seizing up supply chains with businesses struggling to source labour consistently. This may trigger shortfalls of some products in export destination countries down the line and have an inflationary impact while also dragging on Chinese growth by lowering productivity.
The Chinese economy remains on an unsure footing with retail sales volumes lagging other economic indicators. There has been sizeable speculation about additional stimulus by the Chinese government although the exact policies remain unclear[5]. The Chinese experience to date has been far less supportive of consumer spending. It would be a stark surprise to see that change materially. We can instead envisage a scenario where China announces policies that stimulate business investment, but do little to generate underlying growth due to weak consumer demand. Its overall impact will also be negatively affected by the slowdown we are seeing in global growth which would reduce demand for Chinese exports. One of the few areas that may benefit, depending on the scale of the stimulus, is resource demand (e.g. iron ore, copper) although we note these sectors have already rallied in anticipation leading us to question just how much upside remains.
Conclusion
In summary, risks to global growth remain material, having worsened towards quarter-end. Central bank mandates to tighten rates appear undaunted in both the US and Europe with consequent negative impacts on growth. Inflation is showing signs of decelerating but from extremely high levels compared to recent history and not yet enough to warrant central bank support. The risk of a global recession continues to climb in our view. China’s emergence from coronavirus restrictions may pose a material tail wind although it is not without its own travails. Overall, we have a negative outlook in the near term and continue to advise caution.
Part 2: Key economic indicators
United States
| Economic snapshot | Last reported result | Date | 2022e | 2023e | |
| Growth (GDP) | 1.90% | Sep-22 | 1.90% | 0.30% | |
| Inflation | 7.10% | Nov-22 | 8.00% | 4.00% | |
| Interest rates | 4.37% | Dec-22 | 4.50% | 4.70% | |
| Unemployment Rate | 3.70% | Nov-22 | 3.70% | 4.40% | |
| Composite PMI | 44.6 | Dec-22 |
Eurozone
| Economic snapshot | Last reported result | Date | 2022e | 2023e | |
| Growth (GDP) | 2.30% | Sep-22 | 3.20% | -0.10% | |
| Inflation | 10.10% | Nov-22 | 8.50% | 6.19% | |
| Interest rates | 2.00% | Dec-22 | 2.50% | 3.10% | |
| Unemployment Rate | 6.50% | Oct-22 | 6.70% | 7.10% | |
| Composite PMI | 44.6 | Dec-22 |
China
| Economic snapshot | Last reported result | Date | 2022e | 2023e | |
| Growth (GDP) | 3.90% | Sep-22 | 3.00% | 4.80% | |
| Inflation | 1.60% | Nov-22 | 2.10% | 4.80% | |
| Interest rates | 2.36% | Dec-22 | 4.30% | 4.30% | |
| Unemployment Rate | 3.96% | Dec-21 | 4.10% | 4.00% | |
| Composite PMI | 47 | Nov-22 |
Japan
| Economic snapshot | Last reported result | Date | 2022e | 2023e | |
| Growth (GDP) | 1.50% | Sep-22 | 1.40% | 1.20% | |
| Inflation | 3.80% | Nov-22 | 2.40% | 1.80% | |
| Interest rates | -0.10% | Dec-22 | -0.10% | 0.00% | |
| Unemployment Rate | 2.57% | Sep-22 | 2.60% | 2.50% | |
| Composite PMI | 50 | Dec-22 |
