Five signs the world is heading for a recession

Around the world, markets are giving warning signs that the global economy is on the brink of a precipice.

The question is no longer whether there will be a recession, but when it should arrive.

Last week, the intensity of those red lights increased as markets grappled with the reality – once speculative, now certain – that the Federal Reserve will continue its most aggressive monetary tightening campaign in decades to wrest inflation out of the US economy. . Even if it means triggering a recession. And even if that comes at the expense of consumers and businesses far beyond US borders.

There is now a 98% chance of a global recession, according to research firm Ned Davis, which brings some sober historical credibility to the table. The company’s recession probability reading has only been as high twice before – in 2008 and 2020.

When economists warn of a downturn, they typically base their assessment on a variety of indicators.

Here are five key trends:

The mighty US dollar

The US dollar plays a huge role in the global economy and international finance. And now, it’s stronger than it has been in two decades.

The simplest explanation goes back to the Fed.

When the US central bank raises interest rates, as it has been doing since March, it makes the dollar more attractive to investors around the world.

In any economic climate, the dollar is seen as a safe place to park your money. In a tumultuous climate — a global pandemic, say, or a war in Eastern Europe — investors have even more incentive to buy dollars, often in the form of US government bonds.

While a strong dollar is a nice perk for Americans traveling abroad, it creates headaches for just about everyone else.

The value of the pound sterling, the euro, the Chinese yuan and the Japanese yen, among many others, has fallen. This makes it more expensive for these nations to import essentials such as food and fuel.

In response, central banks that are already battling pandemic-induced inflation end up raising rates faster to bolster the value of their own currencies.

The dollar’s strength also creates destabilizing effects for Wall Street, as many of the S&P 500 companies do business around the world. According to a Morgan Stanley estimate, every 1% increase in the dollar index has a 0.5% negative impact on S&P 500 earnings.

The US economic engine

The main driver of the world’s largest economy is shopping. And America’s shoppers are tired.

After more than a year of rising prices on almost everything, with wages not keeping up, consumers retreated.

“The difficulties caused by inflation mean that consumers are using their savings,” EY Parthenon chief economist Gregory Daco said in a note on Friday. The personal savings rate in August was unchanged at just 3.5%, Daco said — close to the lowest rate since 2008 and well below the pre-Covid level of around 9%.

Once again, the reason behind the pullback has a lot to do with the Fed.

Interest rates have risen at a historic pace, pushing mortgage rates to their highest level in more than a decade and hampering business growth. Eventually, the Fed’s rate hikes should vastly reduce costs. But in the meantime, consumers are getting a double whammy of high loan rates and high prices, especially when it comes to necessities like food and housing.

Americans opened their wallets during the 2020 lockdowns, which propelled the economy from its brief but severe pandemic recession. Since then, government aid has evaporated and inflation has taken root, driving prices up at the fastest pace in 40 years and undermining consumers’ purchasing power.

Companies tighten their belts

Business is booming in all sectors for most of the pandemic era, even as historically high inflation eats into profits. This is due (again) to the tenacity of American buyers, as companies were largely able to pass on their higher costs to consumers to dampen profit margins.

But the earnings bonanza may not last.

In mid-September, a company whose fortunes serve as a kind of economic gauge gave investors a shock.

FedEx, which operates in more than 200 countries, unexpectedly revised its outlook, warning that demand was waning and profits were likely to fall by more than 40%.

In an interview, its CEO was asked if he believes the slowdown was a sign of an impending global recession.

“I think so,” he replied. “These numbers, they don’t bode very well.”

FedEx is not alone. Apple shares tumbled on Tuesday after Bloomberg reported the company was scrapping plans to ramp up production of the iPhone 14 after demand fell short of expectations.

And just before the holiday season, when employers would normally increase hiring, the mood is now more cautious.

“We haven’t seen the usual September spike in companies posting temporary help,” said Julia Pollak, chief economist at ZipRecruiter. “Companies are falling behind and waiting to see what the conditions are.”

Wall Street heads for worst year since 2008

Wall Street has been hit with lashes, and the stock is now on track for its worst year since 2008 – in case anyone needs another spooky historical comparison.

But last year was a very different story. Stock markets boomed in 2021, with the S&P 500 up 27%, thanks to a torrent of cash pumped in by the Federal Reserve, which triggered a double-barrelled monetary easing policy in spring 2020 to keep financial markets from collapsing.

The party lasted until early 2022. But as inflation set in, the Fed began to pull out the proverbial punch bowl, raising interest rates and undoing its bond-buying mechanism that supported the market.

The hangover was brutal. The S&P 500, Wall Street’s broadest measure, is down nearly 24% for the year. And you are not alone. All three major US indices are in bear markets – at least 20% below their most recent highs.

In an unfortunate turn of events, bond markets, normally a safe haven for investors when stocks and other assets tumble, are also in freefall.

Again, blame the Fed.

Inflation, along with a sharp rise in interest rates by the central bank, has driven down bond prices, which causes bond yields (that is, the return an investor earns on his government loan) to rise.

On Wednesday, the 10-year US Treasury yield briefly topped 4%, reaching its highest level in 14 years. That rise was followed by a sharp drop in response to the Bank of England’s intervention in its own spiraling bond market – which amounts to tectonic movements in a corner of the financial world designed to be stable, if not downright monotonous.

European bond yields are also rising as central banks follow the Fed’s lead in raising rates to support their own currencies.

Bottom line: There are few safe places for investors to put their money right now, and that is unlikely to change until global inflation comes under control and central banks loosen their grip.

War, soaring prices and radical politics collide

Nowhere is the collision of economic, financial and political calamities more painfully visible than in the UK.

Like the rest of the world, the UK has struggled with rising prices that are largely attributable to the colossal shock of Covid-19, followed by trade disruptions created by Russia’s invasion of Ukraine. As the West cut Russian natural gas imports, energy prices soared and supplies dwindled.

These events were, in and of themselves, bad enough.

But then, just over a week ago, the newly installed government of Prime Minister Liz Truss announced a sweeping tax-cut plan that economists on both sides of the political spectrum found unorthodox at best, diabolical at worst.

In short, the Truss government said it would cut taxes for all Britons to encourage spending and investment and, in theory, soften the blow of a recession. But tax cuts are unfunded, meaning the government must take on debt to fund them.

That decision triggered a panic in financial markets and put Downing Street in an impasse with its independent central bank, the Bank of England. Investors around the world sold off UK bonds in droves, plunging the pound to its lowest level against the dollar in nearly 230 years. Just like since 1792, when Congress gave legal tender to the US dollar.

The BOE staged an emergency intervention to buy UK bonds on Wednesday and restore order to financial markets. He has stopped the bleeding for now. But the ripple effects of the Trussononomics turmoil are spreading far beyond the offices of bond traders.

Britons, already in a cost-of-living crisis, with inflation at 10% – the highest of any G7 economy – are now panicking over higher borrowing costs that could force millions of monthly mortgage payments from owners to increase by hundreds or even thousands of pounds.

The result

While the consensus is that a global recession is likely to occur in 2023, it is impossible to predict how severe it will be or how long it will last. Not every recession is as painful as the Great Recession of 2007-09, but every recession is, of course, painful.

Some economies, notably the United States, with its strong labor market and resilient consumers, will be able to weather the blow better than others.

“We are in uncharted waters for the next few months,” economists at the World Economic Forum wrote in a report this week.

“The immediate outlook for the global economy and for much of the world’s population is bleak,” they continued, adding that the challenges “will test the resilience of economies and societies and exact a punitive human price.”

But there are some silver linings, they said. Crises force transformations that can ultimately improve living standards and make economies stronger.

“Companies need to change. This has been the story since the beginning of the pandemic,” said Rima Bhatia, economic adviser at Gulf International Bank. “Companies can no longer continue on the path they were on. This is the opportunity and this is the bright side.”