US and EU on the verge of recession? No, that’s why
There are encouraging signs that seem to be taking away the prospects of a recession in the United States and Europe. The comment by Alvaro Sanmartin, Chief Economist, Amchor
In recent weeks, the (slight) moderation observed in some macro data and risk factors such as regional banks in the US, the debt ceiling, the war in Ukraine, have led the market to price in a scenario for the US economy characterized from three basic elements. The first, a more or less immediate, though probably mild, recession; the second, a relatively rapid moderation of inflation; the third, consistent with the previous two, a Federal Reserve forced to start cutting interest rates well before the end of the year.
This narrative does not find us fully aligned. First, because we believe that aggregate demand in the US and the Eurozone is in very good health and that this implies that monetary policies will have to remain tight for much longer than currently discounted. Notably, we don't see any rate cuts this year in either the US or Europe, and we also think the ECB will have to hike them at least another time or two at upcoming meetings.
Secondly, because we continue to see signs of a sizeable recovery in the Chinese economy throughout the year and we believe this, coupled with a very positive emerging Asia overall, will provide further significant support to global aggregate demand in the next quarters.
Furthermore, from a medium-term perspective, we believe that once the current period of high inflation is over and once monetary policies move away from tightening, the world we will live in will not be one of zero rates and deflationary, but one where inflation risks will be reasonably symmetrical and where neutral rates will be somewhat higher than currently priced.
This is because aggregate demand in many countries seems to enjoy structurally favorable elements: households and businesses with good balance sheets, lower levels of risk aversion than the norm after the international financial crisis, greater need for public and private investment associated with the ecological transition, increase in military spending.
On the other hand, we must not forget that there are several factors that can hinder an efficient supply response to this more dynamic demand, such as the retirement of the baby boomers and therefore lower labor supply. this implies, for markets, that the assets that have done better since the beginning of the year (growth, technology, gold, duration, etc.) are likely to be the worst relative performers for the remainder of the year.
In the US, the problems seen in some US banks should not lead to a "catastrophic" tightening of financial conditions. Looking ahead, the high degree of banking disintermediation that has long characterized the US financial system reduces the likelihood that the problems currently affecting US regional banks will generate something akin to a recession. as far as the debt ceiling is concerned, it will probably be resolved without causing major problems, not to call into question the role of the dollar as a reserve currency and the reputation of US Treasuries as the risk-free asset par excellence.
The current global economic environment
While some indicators have shown signs of moderation, that doesn't mean the US economy is on the verge of recession. Conversely, the US appears to be starting to correct the huge excess demand generated after the pandemic. One sign of growing weakness in the US economy is that of first-quarter GDP growth (1.1% quarter-over-quarter annualized, a theoretical rate clearly below potential). However, even then, looking at this data, it's hard not to conclude that the US economy continues to show great underlying strength. Two examples: private consumption grew at annualized quarterly rates of 3.7% in the first quarter; the decline in inventories, meanwhile, subtracted almost 2.3 points from growth in that period.
In addition, US corporate inflation expectations continue to move in the right direction, making the possibility that the Fed can control inflation without causing a recession in the US economy more credible.
If instead we analyze the situation in Europe, the labor market and service sector data in the Eurozone not only do not indicate a recession, but would rather be compatible with a certain acceleration in economic activity. Inflation expectations in the euro area also appear to be moderating and this, as in the case of the United States, makes a scenario of a soft landing of economic activity plausible, sufficient to obtain a progressive easing of price pressures in the coming quarters.
Finally, it will also be necessary to keep an eye on the evolution of food and energy prices in the rest of the year. If these were to rise significantly, headline inflation could end the year at rates that are still too high, which in turn could lead to a chain of unwelcome events. Namely: de-anchoring of inflation expectations, significant second-round effects on wages and prices, even more aggressive rate hikes by central banks. And, then, recession (perhaps significant) as the central scenario for 2024.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/usa-e-ue-sullorlo-della-recessione-no-ecco-perche/ on Sun, 14 May 2023 05:08:30 +0000.