After months of focusing on central banks’ response to runaway inflation, financial markets are rattled in the realization that a global economic slowdown may now be looming.
Sentiment dampers include the war in Ukraine, huge energy and metal price hikes, aggressive central bank policy tightening led by the US Federal Reserve, and China’s policy of city lockdowns to stave off the COVID.
The International Monetary Fund and the World Bank further stoked growth fears last week by cutting the global forecast for 2022 by almost a full percentage point.
Financial analysts are also increasingly pessimistic, with Deutsche Bank predicting an “outright” US recession by the end of 2023.
Omens fly in droves and quickly.
They include warnings this week from shipping groups Maersk and Kuehne & Nagel about declining container volumes, and parcel service UPS predicts e-commerce growth will slow. Deutsche Bank, which announced its results on Wednesday, said reported credit losses could increase “significantly”.
On the data front, US new home sales hit a two-year low, weakening UK and German consumer confidence and new factory orders all point to slowing momentum. of growth.
Investors responded by pushing bond yields above recent multi-year highs, pushing oil prices down from 14-year highs and dumping currencies such as the Australian dollar and Brazilian real which had, until recently surfed the commodity boom.
“The market likes to try and move on to the next big thing,” said Craig Inches, head of rates at Royal London Asset Management. “For the past few months he has focused only on inflation, but now he is starting to focus on the recession.”
Inches isn’t in the recession camp, but says central banks’ determination to accelerate rate hikes “has got people thinking, well, what does that mean for future growth concerns. Does this mean we are headed for a harder landing?
Still, with global inflation at its highest level in decades, tensions with growth could drag on as months pass, forcing investors and policymakers to walk a fine line between the two.
Morgan Stanley strategist Mike Wilson describes a “fire and ice” scenario, where the Federal Reserve tightens policy in an economic downturn.
Last week’s stock market sell-off, particularly weakness in materials and energy, were “signs of market awareness that we are now entering the ‘ice phase’ where growth becomes the primary concern for stocks, rather than inflation, the Fed and interest rates,” Wilson said in a podcast.
Global stocks fell 8% this month, but cyclical stocks, which are closely correlated to economic growth, lost 10%.
Reading the tea leaves of recession isn’t easy, and economists use a range of indicators, including stock and bond market signals, to interpret the outlook.
The first is the US Treasury market, specifically the closely watched spread between 2- and 10-year bond yields. An inversion of this curve – when shorter-term yields exceed their longer-term counterparts – usually means a recession within two years.
The curve inverted in early April and is now around 20 basis points, levels that show that fears of recession remain in investors’ minds.
It’s probably too early to say an overhaul is underway on US interest rates likely to cap, but money market expectations for the so-called terminal rate have eased since Friday by around 30 basis points.
Similarly, futures on the eurozone interbank rate, Euribor, show that implied yields for March 2024 fell below December 2023 yields last week, and that implied yields are expected to decline until the end of the year. 2024.
This suggests that “(the ECB) will tighten too much, so they will (then) have to ease monetary policy,” said Piet Christiansen, chief analyst at Danske Bank.
Of particular note is China, where a 3.5% drop in the yuan in April raises questions about whether authorities are allowing the weak currency to support the economy.
Fathom Consulting’s China Momentum Index, unifying freight volumes, energy consumption and bank lending, is worth watching. The gauge, which would have been favored by Premier Li Keqiang, fell to 4.6% in January, compared to February 24.
The latest lockdowns will likely put further pressure on the index.
Deutsche Bank aside, few expect a US recession next year. Goldman Sachs, for example, sees a 15% probability over the next year, rising to 35% over two years.
Valentijn van Nieuwenhuijzen, chief investment officer at NN Investment Partners, pointed to the resilience of purchasing managers’ indices (PMIs), forward-looking business indicators and pent-up demand for goods and services.
“We’ve been positively surprised at how well companies have been able to protect margins and profitability…so our base case scenario remains a soft landing,” he said.
Yet uncertainty brings money back to public debt; BofA, for example, recommends a “long” position in Treasuries, essentially a bet that bond prices will rise.
US inflation peaked last month and real GDP growth is expected to peak this quarter, the bank said.
(Reporting by Sujata Rao, Dhara Ranasinghe; Additional reporting by Yoruk Bahceli and Jamie McGeever; Editing by Emelia Sithole-Matarise)
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