Recession appears to be inching closer as PMI data turns south and housing markets falter.
- Investors are losing faith that central banks can curb inflation without stalling economic growth
- Monetary policy is a blunt tool and higher rates are unlikely to affect commodity prices
- The worst impact from inflation has yet to be felt in household spending and the housing market.
Recession has moved from being an outside chance to an odd-on favourite in recent weeks. Few economists now believe that the Federal Reserve and other central banks around the world can curb inflation without bringing growth to a grinding halt.
Fed chair Jerome Powell has said he is aiming for a soft landing, but has also cautioned that the central bank’s ability to avert a recession is limited. Monetary policy cannot unlock supply chains, it cannot resolve the war in Ukraine or bring new commodities onto the market. It is only ever a blunt tool.
Households have not yet felt the full force of rising prices. The impact of higher energy prices is likely to be felt from October onwards, for example, and it takes time for interest rate rises to be felt in mortgage costs. As such, the likely adjustments to consumer spending behaviour are only just starting to be made.
Nevertheless, the signs are there already. Wade, chief economist at Schroders, points to the “misery index”, an economic indicator that helps determine how the average citizen is doing economically, which is now in the highest 20% of readings over almost 50 years. PMI data has shown weakness in both services and manufacturing.
Wade adds that the effect of high mortgage rates is beginning to slow down the housing market. This is also being seen in the US, where the latest government data shows new home sales down 26.9% from April 2021. Given the ‘wealth effect’ of housing, this is another factor likely to dampen consumer strength over time.
The two areas of strength have been the corporate sector and employment. Company earnings continue to be relatively robust and companies have managed to pass on rising input costs. However, this gets more difficult over time, particularly – as many companies report – they are now seeing increasing wage demands. If wage demands spike, employment may start to sag.
Wade puts the probability of recession as “quite high – it's probably in the order of 35%”. However, he points out that different regions have got different risks. “While everybody's got a measure of inflation risk – particularly the US and Europe – China, as an example, has a big problem in the form of its zero Covid policy.” BlackRock also suggests that a “short and shallow” global recession now looks more likely.
That suggests that the world can still avoid recession – and even if it doesn’t, it won’t be too bad. However, while it feels gloomy to say it, even that prediction looks relatively optimistic given the current trends.