11th October 2023

As it stands today one of the most anticipated recessions ever has yet to materialise. In fact, economic growth, with the exceptions of Germany and Italy, has broadly been positive across the board, although outside the US recent gains have been much more modest in nature. As we are all painfully aware the Western world has undergone one of the fastest monetary tightening phases in history, as Central Banks continue to do battle with the elusive opponent that is inflation. On that front there has generally been more positive news. Inflation in the UK unexpectedly fell to 6.7% in August, below a 7% forecast and core inflation (ex. energy and food) dropped to 6.2%. This therefore allowed the Bank of England to hold interest rates in September, although further rate rises were not ruled out. Whilst inflation in the US picked up to 3.7% in the same month, largely driven by a higher oil price and the impact of year-on-year base effects, core inflation fell to 4.3%, its lowest level since September 2021. This led to the US Fed also holding interest rates in September, though with the suggestion that there could be another hike later this year. The Eurozone’s ECB pushed ahead with its interest rate rise but indicated that this rise was likely the last, given the fragile economic outlook. China, on the other hand, has been flirting with deflation and a debt laden property market headache. The great reopening that was expected as the country emerged from its brutal series of covid lockdowns has failed to appear. This poor economic backdrop has led to interest rate cuts and stimulus measures being implemented. Yet, as we have noted before, one positive here is that China’s deflation could help the West’s inflation, as they offload excess inventory and export goods at knockdown prices.

There are so many conflicting macro variables at play today that it is not a time to be envious of central bankers. Higher debt servicing costs (for consumers, governments, and corporations), falling savings levels, higher oil prices and weakness in the global manufacturing sector, along with other indicators, all suggest a recession is on the horizon. However, tight labour markets and real wage growth has kept the consumer spending, as can be witnessed by Taylor Swift’s summer tour, that had an estimated $5bn impact on the US economy.

Interest rate rises have a lagged effect, generally 12 months or more, and so the impact of more recent hikes has yet to be felt fully. Our view remains that as these feed through and if we start to see weakness in labour markets (where some cracks are appearing), as companies try to protect margins by cutting staff, this will presage an economic downturn. Whilst we cannot know when, or even if, that will come to pass, it would likely put downward pressure on interest rates, a feature markets are already anticipating for mid to late 2024. There is clearly a risk that inflation proves stubborn, not helped by high wages and recent rises in the oil price, but we do believe that we are at least near the end of the monetary tightening phase in the US and Europe.