As global economies adjust to the withdrawal of trillions of dollars of stimulus post-Covid, inflation is remaining stubbornly high alongside ongoing conflict in Ukraine, elevated energy and commodities prices and China’s reopening from Omicron BF.7.
Central banks around the world are continuing to raise interest rates in an attempt to contain inflation. The US is leading the way as the Federal Reserve Chairman continues to hold a firm line against higher prices and persistently strong employment & wages growth. Australia’s Reserve Bank is on a similar path but to a lesser degree, given that the US is doing some of the heavy lifting for Australia as it slows global growth overall.
The pressing questions on everyone’s lips are:
- How high will interest rates go?
- Are we heading into a recession?
- Will it be a soft or hard landing?
- Are we already in a recession?
As long as core inflation stays above the major central banks’ target levels (typically 2-3%), there are likely to be several more interest rate increases interjected with a pause or two across the 2023 calendar year.
Whether interest rates continue to rise, stay level or even drop again beyond 2024 is unknown depending on economic data, the lag effect and the answers to the questions above.
Professional economists are forecasting the possibility of a recession at a higher rate than anytime over the past decade and Google searches of the word “recession” hit an all-time high in 2022. A key indicator for an impending recession is a sustained period of ‘yield curve inversion’, which is where short term Government bond rates (2 yr) are higher than the long term (10 yr) rates. This has been the case in the US since the end of last year and points to economic growth slowing in the longer term, more than in the short term, and a pending recession.
The Good News
If a recession does come, it will happen with a backdrop that includes a historically strong employment market, which would hopefully bring about a less severe, shallow recession. In Australia’s case we also have an abundance of natural resources that the world needs and we are benefiting from higher commodity prices and the strong US dollar. This may assist us avoid a technical recession altogether i.e. two consecutive quarters of negative economic growth. However, this remains to be seen and will also depend a lot on what happens in the US and other major economies around the world.
The employment market is only one piece of evidence that counters the recession narrative. There are others as well, which include:
- LVMH (parent company of Louis Vuitton, Tiffany & Co, Fendi) reported record numbers in the first nine months of last year. Consumers are spending aggressively on luxury items.
- Airline fares, up 28% versus last year represent the second fastest growing category in the inflation index (behind fuel oil), and travel demand has soared despite the cost.
These results do not necessarily feel like a recession. However, we note that the data is lagging and captures what has already happened. It’s possible the environment could be much different six months from now, emphasising that it’s not possible to predict outcomes, but that taking a long-term view is key to being adequately prepared.
From an investment standpoint, we take solace in the fact the stock market and economic cycle don’t move in unison. The worst performance of the stock market is usually observed in the 12 months leading up to a recession rather than during the recession itself. There have been exceptions, but markets generally tend to be forward-looking while economic data is backward-looking.
Let’s not forget lessons from recent history. Only two years ago we had an economic deterioration while the stock market moved higher. It’s certainly possible the same thing could happen again this year.
We are hopeful 2023 will be a smoother ride than 2022. But we are confident that together, we can navigate whatever the future holds, and we look forward to supporting you throughout the journey.
As usual, please contact us if you would like to discuss any of the above in relation to your circumstances, your financial advice and strategy areas, or your structures and investments.