The economy is still ailing from the double shock of Covid and the Ukraine war, which makes it hard to read the usual indicators. Surveys of industrial and household sentiment suggest risks of recession continue to run high. The same message can be read into bond markets: medium-/long-term yields are well below short-term rates. Such an inversion of the yield curve suggests that markets are expecting sharp downturns in the economy and inflation, to the point that interest rates will have to drop off significantly.
On the other hand, the latest actual indicators show developed economies looking fairly healthy, holding up well despite the spike in inflation and interest rates, and the more recent energy crisis in Europe.
Labour markets are booming, with levels of employment above what they were pre-Covid in most economies. The rebound in equity markets since the start of the year also sends a clear signal that expectations are improving as investors move away from a scenario of imminent recession. We still believe in a soft-landing scenario, with recessionary environments not unlikely but comparatively mild by historical standards: while the signals may be mixed, we remain confident that most economies will be able to avoid severe downturns. Robust labour markets and falling inflation will bolster household incomes, while the remaining “Covid savings” continue to support demand.
That said, while headline inflation should continue its decline, underlying inflationary pressures will likely persist, keeping central banks on the alert.
Monetary conditions are likely to remain tight, damping down the vigour of economies. Past rate hikes have already stalled activity in most property markets and are inhibiting firms’ capacity to finance investment.
Energy prices have eased, and China has opened up its economy again, two bits of good news for the world economy. High inflation and policy tightening by central banks will continue to weigh on developed economies, but the support factors already at work (labour market in particular) should help mitigate these effects and reduce the risk of an overly deep recession.
This month Fahad Kamal, our Chief Investment Officer, and Andrew Thompson, our Head of Investment Management discuss the bright start markets have had this year compared to the end of 2022.
Is this optimism around economic movements in the months ahead justified? Tune in to hear our thoughts.
