The global economy is getting harder to fathom as we head into 2023, and the consensus forecast of a mild recession will be challenged in the coming months. The reason is simple. Although a mild recession is a good median forecast, it is by no means the most likely. One of the main ones is this: the ongoing war in Europe, Latin America, North America and Asia will push the world economy into a recession in 2023.
In this environment, deteriorating trade, investment, and financial market conditions would amplify the impact, such that a global recession would be greater than the sum of individual regional recessions. Alternatively, in a soft-landing scenario – where economic activity cools enough to allow inflation to fall back towards central banks’ targets – the world economy goes through a period of slower growth in the first half of the year. , but emerges with stronger momentum over the summer and into 2024.
Much has already been said about the downside risks to the outlook, so it is important to highlight three key factors that could lead to the most optimistic scenario materializing. “This is not about putting on rose-colored glasses, but about looking at recent world events with a curious eye toward the probable,” Atlantic Capital analysts commented in a recent note.
The most positive catalysts
The three factors to watch closely are the relative resilience of business and consumer activity in the United States, the extremely mild winter in Europe, and the regretful abandonment of the “Covid zero” policy in China. In the United States, final demand is visibly softening. “The tightening of financial and credit conditions caused by the aggressive tightening cycle of the Federal Reserve is forcing company executives to reassess their investment decisions and their talent needs for 2023”, comments from Atlantic Capital.
“But with so much effort spent on recruiting and training in the last 18 months, executives are reluctant to part with their precious talent pool,” say analysts at Piper Sandler. As a result, layoffs remain low and instead companies are considering cutting hiring alongside wage growth compression to keep labor costs in check.
For the time being, the December employment report reflected this mild easing in the demand for labor. The three-month moving average of job benefits softened to a respectable 247,000, hours worked returned to their pre-Covid level and temporary employment contracted for the fifth straight month. With an economy that added 4.5 million jobs in 2022 and an unemployment rate of 3.5%, the lowest level in 50 years, the labor market remains quite solid and robust.
Consumer spending activity has also shown signs of resilience. This is true even as households – especially low- and middle-income families – exercise more discretion in their purchases and resort more to savings and credit in the face of persistently high inflammation. As of the end of 2022, real consumer spending continued to rise at a good 2% pace compared to the previous year.
The December data on median hourly earnings for private sector workers is no doubt welcomed by Federal Reserve policymakers, who are looking for evidence that their fight against inflation will be successful. “The combination of a lower monthly boost in wages coupled with the lower post-Covid wage growth reading of 4.6% yoy should reassure the Federal Reserve that an ongoing slowdown in the pace of monetary policy tightening is warranted, with a probable rise in rates of a quarter of a point at the beginning of February ”, they assure from Piper Sandler.
Europe has benefited from an unexpected free pass with one of the warmest starts to winter in years
Evidence of less inflationary pressure in the coming months probably calls into question the hawkish discourse of the Federal Reserve. It could even open the door for a recalibration of monetary policy, with rate cuts before the end of the year, another boost to growth. “This could occur despite the recent statement in the Federal Open Market Committee minutes that no participant anticipated that it would be appropriate to start lowering the federal funds rate target in 2023,” they say from Atlantic Capital.
Meanwhile, Europe has benefited from an unexpected free pass with one of the warmest starts to winter in years, if not decades. While these conditions certainly do away with weather concerns, the warmer temperatures are easing fears of an impending energy crisis, as gas storage across Europe remains at elevated levels. Lower prices for natural gas, oil and electricity are easing pressure on the cost of living for European families and will support consumer spending and manufacturing activity.
Purchasing managers indices in the euro zone also point to a timid rebound in activity in the services sector. With consumers and businesses becoming less pessimistic about the outlook and regional economies ending the year better than expected, activity could be less subdued in 2023. “Even so, monetary policy tightening and communication The hard-liners of the European Central Bank, together with weak revenue growth, advise against any premature celebration, as they point to limited economic prospects for the region”, comments Piper Sandler’s team.
The Chinese authorities seem to have decided that the economic benefits of a rapid abandonment of the zero Covid policy outweigh the cost of a health crisis, and the country is experiencing an unprecedented rise in the number of Covid infections and deaths. In the short term, this will severely limit economic activity in China. But while the growth hit is likely to be significant in the near term, the government’s increased determination in favor of pro-growth policies, coupled with increased public immunity, will likely support a rebound in employment, consumer spending and manufacturing activity in spring and summer.
Overall, the implication for financial markets going forward is that while volatility is likely to remain ubiquitous in the first half of the year, better market conditions may prevail once uncertainty about the economic outlook dissipates. And, should the more optimistic scenario materialize, the realization that a higher interest rate environment is likely to persist, together with the restoration of market valuations and the validity of foreign exchange markets, should lead to more activity. of transactions.
