By Mike Dolan
LONDON, December 2 (Reuters) – Some sort of recession 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, an overvalued dollar snob and a volatile year for equities that will struggle to go much beyond current levels in 12 months.
Energy prices, Ukraine and the reopening of China remain the biggest wildcards. Although with money assets at its highest in more than a decade, the current trend to push all assets slaughtered for the year a little higher could last until 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 let investors think about the the chances of a fabled “soft landing” – which somehow brings inflation back without a major slowdown – or a prolonged scorched-earth policy by central banks if growth persists is maintained high price.
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 the 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 at the Reuters Next conference on Thursday, IMF Director Kristalina Georgieva said the odds of a slowdown to less than 2% in global growth were indeed increasing – but she still put only a 1 in 4 chance of it actually happening.
And the IMF is far from alone.
head of the federal reserve Jerome Powell Wednesday insisted that a WE a “soft or soft” landing remained possible, with inflation falling without a dramatic rise in unemployment.
In the comments that survey world markets – Something that in itself is an indirect easing of the financial conditions supporting the economy – the president said the Fed didn’t want to “tighten too hard” just to “crush the economy and then clean up”.
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 houses, like BlackRocktend to disagree.
But not everyone thinks a soft landing is out of the question.
Jan Hatzius, chief economist at Goldman Sachs is one of 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 to come.
JP Morgan’s Bruce Kasman says his “baseline” is the Fed lagged effect contraction ends up dragging the US economy into recession at the end of 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.
CHART-Global Yield Curveshttps://tmsnrt.rs/3iiwN59
GRAPH-Global Economic Surpriseshttps://tmsnrt.rs/3Y1IQ7B
GRAPH-US Financial Conditionshttps://tmsnrt.rs/3W0ERGz
GRAPH-Pandemic economies evaporatehttps://tmsnrt.rs/3FsNPHb
(by Mike Dolan, Twitter: @reutersMikeD; editing by Lisa Shumaker)
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