Despite the recent doom and gloom around a looming recession, it may not be as bad as we think. Mark Nash explains why.
"The report of my death was an exaggeration," Mark Twain quipped after newspapers mistakenly published his obituary. We can probably say the same about the prognosis of recession swirling in the financial markets now.
There is no doubt the backdrop for growth is challenging. China's stringent zero-COVID policy continues to disrupt supply chains, and the Russia–Ukraine war has pushed up commodity and food prices.
However, recent indicators from the world's two largest economies have not been encouraging.
The US economy unexpectedly contracted in the first quarter, while a survey of purchasing managers signalled a deceleration in business activity. Meanwhile, China's growth engines are stuttering, with industrial production and retail sales declining in April, reflecting the COVID-19 lockdowns.
Consumer behaviour
A full-blown recession is unlikely as the labour market is still very tight, and the reopening of the world will also spur demand.
Consumers have amassed a war chest of savings during the pandemic, and governments have not stopped spending as they seek to address the cost-of-living crisis stemming from high food and energy prices. Even the travails of some retailers could be due to overly optimistic demand projections rather than a lack of purchasing power.
Another factor we need to account for is a switch in consumer behaviour as the world emerged from lockdowns.
At the height of the pandemic, many developed countries saw increased consumer durables spending, straining supply chains and boosting inflation. Now, we are seeing an increase in spending on services, which may rise further in the summer months as travel and tourism pick up, resulting in spending on airlines, hotels, and restaurants.
This shift in consumer behaviour from goods to services can mask demand and confuse policymakers. The strength of commodity and energy prices that we see now could reflect underlying demand and scarcity. Energy prices could rise further if China stops enforcing its strict COVID-19 policy, releasing an extra uplift to the global economy.
Inflation conundrum
China’s slowdown will be due, primarily, to its COVID-19 policy. Therefore, there is some chance that it will end up looking slightly better than current expectations. Global growth would get a considerable boost if China reduced restrictions, eased financial conditions, and opened its economy.
I expect inflation to ease in the year's second half as central banks focus more on lifting real rates than growth. The statistical base effect and weaker growth in China and Europe may help subdue headline numbers in the coming months, which could trigger a risk rally.
However, inflation could be stickier than the market generally expects and may remain above target as we head into 2023.
Financial conditions in the US have tightened as inflation concerns pushed yields up and most of the world reeled under weaker growth, strengthening the dollar. But the strength of the world's main reserve currency may begin to fade if growth also picks up elsewhere, prompting the Fed to increase rates.
Yield curve
Many investors point toward the flat/inverse nominal bond yield curve as a predictor of recession. But the real yield curve, which is still upward sloping, suggests the central banks need to tighten more.
Considering heightened geopolitical tensions and the threat of higher energy prices, the next few months will be crucial.
Mark Nash is Head of Fixed Income Alternatives at Jupiter Asset Management. The article are the sole views of the author.
This article was originally published in FM Report.