Recession fears have risen swiftly this year as central banks in many parts of the world continue to raise interest rates to curb the fastest inflation in decades. Intense market volatility, sour consumer confidence, and downward pressure on income growth all point to a global economy that is slowing down.

Recessions are not a matter of “if” but simply a matter of “when.” The media often portray them as a catastrophe, but the reality is every economic cycle ends in a recession, allowing any excesses to be removed and thus making way for the start of a new cycle. 

A recession in Europe is today a consensus view. The energy crisis caused by the Russian invasion of Ukraine has created a cost shock that is now effectively locked into the outlook for the next couple of quarters. Consumer bills will stay high, depleting purchasing power, fiscal deficits will take a hit, and industries are already rationing energy use.

For the UK, leaving Europe has not left behind the energy crisis across the channel. On top of that, the UK is also suffering from structural changes to its labour supply and trade relationships, and that is dragging down growth beyond these cyclical movements. That said, new leadership in Parliament is pointing to a huge fiscal stimulus that will mitigate the pain to households and reduce the depth of the recession.

Turning to China, markets have in the past looked at the world’s second largest economy as a possible anchor for global growth. However, this time any such hope really needs to be tempered given the fragile state of the economy. Moreover, the fiscal and monetary policy that has been deployed so far has not got a lot of traction.

There remain two key restraints on the Chinese economy right now; trouble in the housing market and continuing Covid-19 restrictions. After the party Congress in mid-October, things should probably start to change but no quick fix is really expected. Right now, construction and delivery of new homes is not getting done, so the cash flow is drying up, creating an adverse feedback loop. So far, the People’s Bank of China (PBOC) has rolled the equivalent of $28 billion in bank loans to support this delivery, and more intervention and funding is expected over time. So as easy as it is to be gloomy on the outlook, a catastrophic collapse in housing doesn’t seem likely at this stage.

As for Covid-19, we should expect a gradual exit from the zero-Covid policy only by next spring. The key metrics to watch will be the pace of vaccinations and wider adoption of domestic Covid-19 treatments, and a shift in public opinion. In particular, getting the over-60 population to at least an 80% booster vaccination next spring will be key in considering the removal of restrictions.

If there is a silver lining, it’s that most market participants continue to place a high probability that the US can avoid a near-term recession. Despite notching a technical recession in the first half of the year, the US outlook continues to look somewhat brighter. For the first half of the year, nonfarm payrolls averaged almost 450,000 per month, which is not typical of a recession in the making.

From the Fed’s perspective, the economy has to decelerate to bring down inflation. They are raising interest rates expressly to slow down the economy. So far, the housing market has clearly turned, but payrolls have only slowed a bit, and the moderation in wage inflation is probably not as much as the Fed is looking for. To date, we have not seen much slowing down in consumer durables either, so the economy remains beyond its speed limit and the Fed will thus keep hiking. In effect, the Fed is committed to hiking until the demand pressures driving inflation back off, so one way or another, the economy is going to slow down.

Disclaimer: This article was written by Stephen Borg, Head of Private Clients at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd, which is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.

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