LONDON, Dec 2 (Reuters) – A recession of sorts next year is quickly becoming a consensus – so much so that financial markets could find themselves whipped if they don’t materialize.
The crux of most outlooks for 2023 is a year of contraction in activity at some point, disinflation and interest rate spikes. The result of the investment is a bias for bonds, a move away from the overvalued dollar and a volatile year for equities that will struggle to significantly exceed current levels in 12 months.
Energy prices, Ukraine and the reopening of China remain the biggest wildcards. Although cash is at its highest in more than a decade, the current trend of pushing all year-to-date assets a bit higher could last well into early next year.
So far, so simple.
But neither the hard economic numbers coming in nor many high-level policymakers have yet fully bought into the recession idea.
And leaves investors wondering about the chances of a fabled ‘soft landing’ – which somehow brings inflation back without a major downturn – or a prolonged scorched earth policy by the banks power plants if continued growth keeps prices high.
Corporate surveys and historically prescient yield curve inversions in bond markets suggest that contraction is now the best guess – even globally where sub-2% growth in the global economy equates to a recession.
Many economists now assume that the eurozone and UK economies – the hardest hit by the Ukraine-related energy shock and squeezing cost of living – are already in the throes of recession.
Yet this week’s upward revisions to U.S. third-quarter output, still-tight labor markets there, and the unshakable assumption of a Chinese boom after reopening a new year from strict lockdowns of the COVID all speak differently.
Apart from Japan and emerging market indices, economic surprises for major economies remain broadly positive, suggesting at least excessive gloom in the forecasting world.
And it’s striking how many policymakers still think recession will be averted.
CRASH AND CLEANING
Speaking to the Reuters Next conference on Thursday, IMF chief Kristalina Georgieva said the odds of a slowdown to less than 2% in global growth were indeed increasing – but she was still only putting a chance out of 4 that this actually happens.
And the IMF is far from alone.
Federal Reserve chief Jerome Powell insisted on Wednesday that a “soft or soft” landing for the United States remains possible, with inflation falling without a dramatic increase in unemployment.
In comments that lifted global markets — something that itself is an indirect easing of financial conditions supporting the economy — the president said the Fed didn’t want to “tighten too hard” just to “crush the economy and clean up afterwards”.
Powell’s more hawkish wing at the Fed is also skeptical of a recession narrative. St. Louis Fed President James Bullard said Monday that the recession was not inevitable and suspected that expected disinflation was instead responsible for the yield curve inversion.
European Central Bank chief Christine Lagarde still talks of weaker eurozone growth next year – but not a contraction.
And its hawkish wing also thinks recession fears are overcooked.
“If you look at Germany, where the economy is doing better than feared, it is not a foregone conclusion that we will have a recession,” the head of the Dutch central bank said in Paris on Monday. , Klaas Knot, insisting that weaker growth did not mean a slowdown.
Many large investment firms, such as BlackRock, tend to disagree.
But not everyone thinks a soft landing is out of the question.
Goldman Sachs chief economist Jan Hatzius is among the optimists.
“A prolonged period of below-potential growth can gradually reverse overheating in the labor market and depress wage growth and ultimately inflation, providing a possible but difficult path to a soft landing,” Hatzius told the end of last month.
All of this calls into question the growing consensus. And you would think avoiding a recession should be cause for celebration for the market.
But there’s a huge difference in market positioning between a “soft landing” — ticking all the disinflation and peak rate boxes while avoiding an implosion in corporate earnings — and persistent growth that supports inflation. and simply forces central banks to apply the brakes harder for years.
JP Morgan’s Bruce Kasman said his “baseline” is that the lagged effect of Fed tightening will eventually push the US economy into recession late next year. But he also said it was “a mistake to rule out a soft landing scenario”.
However, he assigned a 28% probability to a third scenario. This is where growth persists into next year and is supported by central banks suspending rate hikes in the first quarter – but inflation is not returning to its comfort zone.
In this case, Kasman concluded: “With high inflation entrenching, policy rates will (then) have to rise significantly further and a global recession will set in in 2024.”
This may just be the nightmare scenario of 2023 for the markets.
The opinions expressed here are those of the author, columnist for Reuters.
by Mike Dolan, Twitter: @ReutersMikeD; Editing by Lisa Shumaker
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The opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed to integrity, independence and non-partisanship by principles of trust.
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