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Economic and Financial Market Update: Down but not out

19 August 2022

Summary:

Pessimism has grown about the economic outlook;
The economy is still likely to do well for the remainder of this year;
Loss of economic momentum will become more obvious over the course of next year;
An economic slowdown does not necessarily lead to economic recessions.

I have just returned from a fantastic three weeks in South Australia spent in the Flinders Ranges, strolling about various wineries and hanging around the Adelaide Hills. I returned upbeat but at a time when there is downbeat talk about the economy. As an example, the number of people searching for the term ‘Recession’ on Google has picked up notably in recent months. At least by this measure Germans and Americans appear more pessimistic than Australians or Kiwis.

Financial markets have picked up on the downbeat vibe and are pricing a reduction in money-market rates in 2024. More obviously so does the consensus cash rate forecasts of economists (according to a recent Reuters survey). History is on financial markets/economists side. Rate cuts have taken place within 6-18 months of each of the peaks in the cash rate cycle over the past thirty years.

And there are understandable reasons to be concerned about the outlook. The Russian-Ukrainian War is not only smashing both those countries’ economy but is hitting the global economy via higher food and energy prices. If the gas is completely turned off to Europe this winter the economic concerns become a lot bigger. Global supply-chain problems are (slowly) being fixed but they will remain a concern as long as China continues to aim for zero COVID. More generally the Chinese economy is going through a weak patch, exacerbated by worries about the level of debt in the Chinese economy. Wars are not the only reason behind rising prices, and that inflation is eating into household and business incomes in most economies. But the main reason behind the rise in economic concerns has been the sharp increase of interest rates due to the rise of inflation (and the impact that has had on housing and equity prices) with the promise of more to come.