Where is the Global Economy headed?
The current economic situation worries most of us. Every day new information is published, and it is hard to make sense of it all. In an effort to figure things out, I published a post on inflation back in July. Today – 3 months later – where are we? Will things get worse? Here are a few points that strike me as important. I hope this post will encourage you to share my feeling that things are improving.
Do we need to worry?
In many ways, the current circumstances are unique, and we find ourselves in unchartered territory. Indeed, we are seeing a constellation of macroeconomic signals that are proving exceptionally contradictory, with many signs of strength coexisting with weakness. This lack of consistency in the data complicates its reading and makes it less robust.
The U.S. economy, though facing a growing risk of recession, continues to exhibit remarkable strengths, particularly in the labor market, as illustrated by continued job creation and the lowest unemployment rate in 50 years.
Although the situation is by no means perfect, there are some very encouraging signs:
· There is evidence to suggest that the peak of inflation has been reached. Inflation is lower than it has been, and the numbers below show that inflation is starting to decline. The U.S. Department of Labor reports that the U.S. annual inflation rate is 8.2% for the 12 months ending September 2022. For comparison, the rate was 8.3% in August and 8.5% in July. There is a different trend in the Eurozone, down from 9.9% to 9.1% in September 2022, before rising to 10.7% in October. Moreover, long-term inflation forecasts remain modest.
All of these inflationary surges were primarily attributable to supply disruptions caused by the pandemic, where cyclical excesses in demand, exceeding supply capacity, led to high and problematic inflation. These imbalances will largely dissipate on their own as companies find alternative solutions to their supply chain problems. Thus, the current trend is not predictive of the future. Moreover, as China emerges from its Covid lockdown, inflationary pressures will further abate.
At the same time, the Europeans were successful in mitigating energy-related inflationary pressures associated with the war in Ukraine. In fact, gas prices reportedly peaked in August at €383.29/MGh and have since fallen to €191.17/MGh in September and €98.99/MGh in October. This decline is partly explained by record gas inventories, the result of efforts by businesses and households to cut their gas consumption by more than 16.3% compared to the previous year.
Inflation is a real squeeze on purchasing power and hits the lowest-income families harder because items such as food and gasoline make up a larger portion of their budgets, leaving less for discretionary spending.
Inflation may still have an important impact on poverty and inequality, which raises the prospect of social unrest domestically and globally.
· The U.S. labor market is strong: 6 million jobs have been added in the U.S. in 2021 and the unemployment rate is at a 50-year low. Layoffs are not increasing. An unequivocal sign of a recession would be for firms to collectively shrink their workforce and for unemployment to rise sharply.
· The U.S. household income (excluding unemployment benefits and adjusted for inflation) continue to rise. Wage growth is slowing but still rising. A booming labor market leaves households with comfortable incomes allowing them to keep spending.
· U.S. consumer sentiment, as measured by the University of Michigan, hit a record low. However, U.S. consumer spending, which accounts for 70% of the U.S. GDP, is improving. So, while Americans feel terrible about the economy, they still keep spending.
· U.S. firms remain strong, with profits at record highs. Across the S&P 500, profit margins are contracting as wages rise rapidly to attract and retain workers in a tight labor market. Yet sustained robust sales growth, even in nominal terms, is offsetting shrinking margins, leading to near-record profits. In this profitable environment and strong labor demand, companies are reluctant to resort to early layoffs.
· U.S. production, including orders for industrial equipment, a good indicator of a recession, did not decline. EU output rose 2.5% in August 2022.
Are we headed for a global recession?
The global economic slowdown was expected and desirable (these are not normal times). It is worth putting things in perspective: 2022 started on a relatively positive note. There were concerns about inflation and central bank responses, but all of it seemed manageable. At the end of March, matters began to unravel, given the Russia-Ukraine conflict and the China lockdowns. All of this certainly tipped the whole global narrative into the negative.
So, are we heading for a recession? It all depends on how much one wants to label a slowdown as a recession. If the U.S. is about to enter or has entered a recession, it is unlike any other recession on record. “I would be surprised if there were a recession without much job loss,” said Gregory Mankiw, a professor of economics at Harvard University. Indeed, since World War II, the U.S. has experienced 12 recessions, each with a dual characteristic: a contraction in economic activity and a rise in unemployment.
For many economists, the way to think about this type of recession is as a supply-driven disruption, one that should be short-lived and, most importantly, manageable. So, once these problems of supply delivery times, inventories and backlogs are resolved, supply will bounce back, as will growth.
In the early days of the pandemic, global growth in many economies was based on the export of goods. Subsequently, pandemic-related excess consumption shifted from goods to services. Yet, the service sector is twice as large as the goods sector and consumers are still catching up on vacations, restaurants, meals and the like, despite high inflation. As an example, for the last two years, tourism was totally non-existent. Now, we are seeing a recovery in this sector, which continues to grow strongly. This rebound in tourism and services is significant because these are sectors that generate a lot of job opportunities.
We have almost reached full employment in most economies. Unemployment in the U.S. is still very low and fell from 3.7% to 3.5% in September 2022. It is stable in the Eurozone at 6.6% (Germany 5.5%, stable at 7.3% in France).
What distinguishes the current recession risk from that of the 2008 banking crisis, according to Philipp Carlsson-Szlezak, chief economist at the Boston Consulting Group, is the lack of compelling systemic threats. While financial system disruption increases with a reversal of years of extremely low interest rates, it is less likely that these will paralyze banks and disrupt lending, the hallmark of a financial recession with systemic damage. This points to chances of a milder downturn than that commonly suggested when the 2008 model is used as a benchmark.
The picture is just as complex as what I described in my July post (these are not normal times). But the good news is that several signs in the U.S. economy suggest that we may have hit bottom. The inflation rate is falling. The risk of a U.S. recession may be receding. Treasury Secretary Janet Yellen recently stated that while U.S. economic growth is slowing, a recession is "not inevitable". At this point, the risk of a recession appears to be greater in Europe.