The recession emerges from the shadows

By Investment Desk | 25 Jul, 2022

A late but forthright shift in central bank guidance, coupled with decisive monetary policy action, has coincided with a natural slow-down in economic activity. This has raised the prospect of an outright recession across major developed economies. Recent bond market moves also signal that the probability of a recession has risen materially. Although the risk of a stagflation scenario is lurking in the background, if central banks successfully manage to constrain demand, the recent evidence of inflationary pressures receding may transform into a realistic base scenario of significantly lower prices in late 2023.

There are obvious threats to this lower inflation scenario from energy and food, emanating largely from the impact of the war in Ukraine. However, action has finally been taken by the major central banks to re-equilibrate the supply-demand imbalance, which has been the core reason for the inflation shock.

What has changed adversely in the macro outlook?

If we look at the US, they are in a technical recession right now, with the Atlanta Fed’s GDP now forecast for Q2 cut to -1% (following a drop in Q1). This was prior to more disappointing news on the final day of June, which will inevitably lead to a further cut in growth. The dark clouds that are gathering over the US will inevitably blow across the pond to Europe, adding to the woes over here.

The downside evidence is accumulating:

Key indicators:

  • Lower consumer sentiment.
  • Household savings have fallen sharply.
  • Real income is being squeezed as inflation rises even with higher wage growth.
  • Lower spending trends are gradually emerging.
  • The cost of borrowing is rising for households as mortgage rates head higher in line with key official interest rates.
  • The reverse in the stock market and other risk markets such as crypto will undoubtedly be an added burden in coming months.
  • The corporate sector is also beginning to show signs of weakening.
  • Tighter financial conditions as major central banks tighten policy.

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