It is my belief that major developed markets economies are going to see a material slowdown and most likely a recession. Some emerging markets economies (including China) look fragile as well. In recent quarters the market narrative has changed multiple times. While admittedly GDP numbers and spot job market data (e.g. unemployment) remain solid for now, our view is that this environment may not last long.

When we look at the current state of global economies, we think a slowdown at this stage might be even more likely. While various leading indicators have been suggesting this, there are at least three key factors to support such a thesis, especially in the US:

 

  1. The aforementioned long and variable lags in monetary policy;
  2. The contraction in lending activity and the tightening in lending standards;
  3. Less support for consumption.

On the long and variable lags of monetary policy, history has always shown that monetary policy takes time to affect economies. We do not see any structural change that should make things different this time. On the other hand, as mentioned above, long-term low-cost borrowing in the pre-COVID era and in 2021 might have partially reduced interest rate sensitivity of households and corporates. This does not mean that monetary policy won’t bite, but it might take some additional time. The high yield market is a good example. Companies were able to kick the can down the road for some years.

In the lending space, we have been noticing worrying trends in recent quarters. In the US as well as in the Eurozone, not only have banks been tightening lending standards, but they have also started to reduce lending activity. Contractions in variables such as commercial and industrial loans are not very common in history. Similar patterns characterized the GFC period, for example. The higher cost of debt is also starting to affect demand for loans, especially when it comes to mortgages where we have been seeing a continuous drop in mortgage applications and transactions in the existing home market.

Consumption has been a key driver for recent strength in the US economy. Admittedly, US consumers have shown a level of resilience when it comes to spending patterns that few market participants had forecasted. The extraordinary accumulation of excess savings in the COVID period helped. In the last 12 months, households have been able to artificially inflate their spending patterns by reducing these savings and using more consumer debt. Various estimates see a strong drop in excess savings in the US, especially in the lower percentiles of the income distribution. At the same time the cost of consumer debt has reached a worrying level. Things such as delinquencies on credit card debt or auto loans are still relatively low when looking at long run history, but they are nevertheless on somewhat of a rising trend. With regards to fiscal policy, going forward, this is likely to have much less of an impact on growth in 2024.

When it comes to inflation, we continue to expect further disinflation moving forward when looking at year-on-year numbers for headline and especially core inflation. The gradual catch-up of shelter inflation with trends seen in the past quarters in the new rental market will clearly be supportive in this sense. The collapse in money supply growth over the course of this year gives us added confidence that deflation will be the bigger threat over the next 12 months.

 

 

Outside the US, the environment looks even more fragile. Higher reliance on manufacturing has already brought the Eurozone into what is a de facto mild recession. Australia and South Korea have also started to show more meaningful downside surprises in recent weeks. Finally, we continue to believe that China will continue to disappoint as it wrestles with many structural issues for years to come. We do not believe that the latest support measures enacted by the government will prove sufficient to solve the structural imbalances within the housing market where almost 20% of GDP is from construction (30% if we include also related sectors). Bear in mind, China property is the biggest asset class in the world. Piecemeal measures announced thus far are unlikely to have much of a long-lasting effect in our opinion.

 

 

These developments will provide central banks across the globe with reasons (or perhaps the need) to be less hawkish and indeed December has shown some signs in this direction at least for the Federal Reserve, while the ECB and the BOE still keep a relatively hawkish stance.

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