The writer is chair of Queen’s College, Cambridge and advisor to Allianz and Gramercy
Inflation was the dominant economic and financial issue of 2022 for most countries around the world, especially for advanced economies that have a consequential impact on the global economy and markets.
The effects have been seen in declining living standards, increasing inequality, increasing borrowing costs, stock and bond market losses, and occasional financial mishaps (fortunately small and so far contained).
In this new year, recession, both actual and feared, has joined inflation in the driving seat of the global economy and is likely to replace it. It’s a development that makes the global economy and investment portfolios subject to a wide range of possible outcomes — something that a growing number of bond investors seem to be aware of more than their equity counterparts.
International Monetary Fund iYou will likely review soon Her economic growth forecasts again, predicting that “a third of the world will be hit by recession this year”. What is particularly notable to me about these worsening global prospects is not only that the world’s three major economic regions – China, the European Union and the United States – are slowing down together, but also that this is happening for different reasons.
In China, a chaotic exit from the wrong Covid-19 policy is undermining demand and causing more supply disruptions. Such headwinds to domestic and global economic well-being will continue as long as China fails to improve the coverage and effectiveness of its vaccination efforts. The strength and sustainability of the subsequent recovery will also require that the country more vigorously renew a growth model that can no longer rely on greater globalization.
The European Union continues to deal with energy supply disruptions as the Russian invasion of Ukraine continues. Strengthening inventory management and reorientation of energy supplies is well advanced in many countries. However, it is not yet sufficient to lift immediate constraints on growth, let alone resolve long-term structural headwinds.
The United States has the least problematic view. The headwinds to growth are due to the Fed’s struggle to contain inflation after mischaracterizing rate increases as fleeting and then initially being too timid to adjust monetary policy.
The Fed’s shift to an aggressive front-load of interest rate hikes came too late to prevent the spread of inflation in the services sector and wages. As such, inflation is likely to remain stubborn at around 4 percent, be less sensitive to interest rate policies and expose the economy to greater risk for accidents from additional policy errors that undermine growth.
The uncertainties facing each of these three economic areas suggest that analysts should be more careful in reassuring us that recessionary pressures will be “short and shallow”. They need to be open, if only to avoid repeating the mistake of prematurely dismissing inflation as transient.
This is especially important because these diverse drivers of recessionary risk make financial fragility more threatening and policy shifts more difficult, including potentially Japan. Get out of interest rate control Policy. The range of possible outcomes is extraordinarily large.
On the one hand, a better policy response, including improving the supply response and protecting the most vulnerable populations, can counteract the global economic slowdown and, in the case of the United States, avert a recession.
On the other hand, additional policy errors and market turmoil can lead to self-reinforcing vicious cycles with rising inflation and rising interest rates, weakening credit and compressed earnings, and stressing market performance.
Judging by market prices, more bond investors understand this better, including by refusing to follow the Fed’s interest rate guidance this year. Instead of a sustainable path to higher rates for 2023, they believe recessionary pressures will lead to cuts later this year. If true, government bonds would provide the yield and potential for badly missed portfolio risk mitigation in 2022.
However, parts of the stock market is still weakly bearish pricing. Reconciling these different scenarios is more important than investors. Without better alignment within markets and with policy signals, the positive economic and financial outcomes we all desire will be no less likely. They will also be challenged by the risk of more unpleasant outcomes at a time of less economic and human resilience.