Key views on Global Monthly - Where is the recession?
The easing energy crisis in Europe is leading to more shallow expected recessions in the eurozone and UK, while the US is also entering a moderate downturn. In the near term, consumption will continue to be weighed by falling real incomes, housing markets are correcting on the back of the surge in mortgage rates, and industry is being hampered by still-high energy prices. China’s abrupt exit from Zero Covid is a modest growth support, but also somewhat inflationary. While inflation has begun to trend lower, upside risks to the medium term inflation outlook mean the Fed, ECB and BoE are likely to continue raising rates at coming meetings. By late 2023, falling inflation and economic weakness are likely to drive rate cuts, but the recovery is expected to be tepid.
Macro
Eurozone – The economic impact of the energy crisis has been more benign than we thought before. However, most of the impact of past and upcoming rate hikes and tightening financial and bank lending conditions is still very much to be felt on the economy. We forecast a shallow, yet prolonged recession, with GDP contracting modestly during four consecutive quarters, starting in 2022Q4. Headline inflation should drop lower due to falling energy price inflation. It could be around the ECB’s 2% target by the end of this year. Core inflation is expected to be more sticky and be higher than the headline rate by the end of 2023.
Netherlands – GDP expected to contract in Q4-2022 and Q1-2023, but upward risks are posed by sturdy consumer spending and a better performance of the eurozone which bodes well for Dutch external demand. Still, growth is expected to remain lacklustre in the first half of this year, but to resume in the second half of 2023. While the recent declines in inflation are primarily energy related, the underlying trend in the broadening of inflation will continue well into 2023. However, we expect headline inflation to decrease to an average of 4.3% in 2023.
UK – While the easing energy crisis will soften the blow to household real incomes, the tax burden is set to rise significantly over the coming year. Demand is already weak on the back of record low consumer confidence, and tightening fiscal policy will compound the impact of monetary tightening. We expect more shallow recession, on falling energy prices, and despite weak demand, there is a continued risk of a wage-price spiral due to a structural shortage of workers, and public sector unrest.
US – The US consumer exhibited surprising resilience for much of 2022, but the twin headwinds of falling real incomes and dwindling excess savings are now exerting a bigger drag on consumption. Investment is also expected to remain weak in the near term. This will help inflation along its downward-sloping trend, while labour hoarding is likely to give way to a rise in the unemployment rate. This will lead to the NBER likely declaring a recession this year. Inflation is expected to fall significantly in 2023 on the back of sharply easing pipeline pressures, and be within touching distance of 2% by the end of the year.
China – Given the rapid exit from Zero-Covid, and with other signs that supporting growth has moved up Beijing’s priority list, we assume that the phased rebound of domestic demand – following a messy exit in late 2022 and early 2023 due to public health issues – will start earlier and will be a bit more pronounced, with above-trend qoq growth in Q2 and Q3. As a result, we have raised our annual growth forecast for 2023 to 5.2%, from 4.8%. Still, the road to recovery could well prove bumpy, with several headwinds and downside but also upside risks remaining.
Central Banks & Markets
ECB – The ECB slowed down the pace of rate hikes to 50bp in December. Nevertheless, the message of the policy meeting was decidedly hawkish, with the central bank saying that ‘interest rates will still have to rise significantly at a steady pace’. The ECB also announced a tapering of reinvestments for the APP portfolio. The decline will amount to EUR 15 billion per month between March and the end of Q2 2023.The subsequent pace still has to be decided. We expect the ECB to continue to hike rates, with the deposit rate peaking at 3% by May. Policy rate cuts could be on the agenda before the end of the year.
Fed – We expect the Fed to downshift to 25bp hikes at the February and March meetings, with the upper bound of the fed funds rate to peak at 5%. Subsequently, we expect the Fed to pause, assuming inflation continues moving lower and the labour market deteriorates. The risk to near-term rates is still to the upside. A higher near-term policy rate means a higher risk of over-tightening, and we expect significant rate cuts in late 2023. In the background, the Fed continues to unwind its balance sheet at a $95bn monthly pace.
Bank of England – The continued risk of a wage-price spiral in the UK led the MPC to hike rates by a further 50bp at the December meeting. We now expect a 25bp hikes in February and March, with Bank Rate to peak at 4%. Fiscal policy U-turns have significantly reduced the risk of more aggressive rate hikes, and market pricing for Bank Rate is now much closer to our own expectations. We expect the BoE to reverse course in late 2023 and start cutting rates, but at a slower pace than we previously expected.
Bond yields – Given our economic and central banks’ outlook, we think both the 10y US and Bund yields have peaked. The recession will weigh on EU rates in 2023 with the 10y Bund yield expected to fall below the 2% level in 2023. A similar path is expected for US rates. Both Treasury and Bund curves are expected to remain inverted through most of 2023 as elevated core inflation will maintain short-term rates higher for longer. Thereafter, we expect both curves to bull-steepen in the second part of the year on the back of monetary easing, with 125bp and 50bp in rate cuts pencilled in for the Fed and ECB rates respectively.
FX – We think there is more upside in EUR/USD than we had forecast for 2023 and 2024. We expect the Fed to take the upper bound of the fed funds rate to 5%. However, we still expect significant rate cuts in H2 23 and far more than market consensus (a total of 125bp compared to 50bp of cuts). This is negative for the US dollar. Meanwhile we have become less negative on the growth outlook for the eurozone. As a result of these dynamics we have upgraded our EUR/USD to 1.12 (from 1.08) end of 2023 and to 1.16 (from 1.12) end of 2024.
