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Increasing numbers of investors are weighing up the likelihood of an imminent recession. These concerns may still be muted but they are unmistakeable, as we can see from trends in the Google search engine. Is this a serious worry at a time when economic growth forecasts remain very high for 2022 – at over 3% in Europe and the US based on the Bloomberg consensus – and very comfortable for 2023?
Two issues, which are partly interdependent, justify such questions.
The first is the surge in the price of commodities, particularly energy. Memories of the recessionary impact of the rapid rise in the crude oil price in the seventies or even in 2008 are still painful. It is a crucial point, particularly as the conflict in Ukraine does not fully explain the recent hike in prices. Were it caused solely by the war, current energy inflation could be considered an exogenous and transitory factor that could be easily overcome. But the crude oil price was already at high levels at the start of the year, before the “special military operation” began. The strength of the post-covid economic recovery, particularly in the US, largely explains the current price, and leaves little hope of a clear decline, even if the intensity of the war in Ukraine were to subside.
But although it is fair to say that the conflict in Ukraine is having only a marginal influence on the already strained oil situation, it is having a clear impact on the outlook for other commodities that are equally essential. It is causing natural gas and other vital agricultural commodities such as wheat and corn for animal feed to soar, as well as many industrial metals, including the very metals that are key to efforts to reduce dependence on oil via renewable energies, such as nickel and copper. The crisis in commodities is thus widespread and will be harder to overcome than a straightforward oil shock. This is especially the case since the chances of a swift solution to the war look slim and to the sanctions against Russia even slimmer.
The second issue has to do with interest rates. The difference between 10-year and 2-year rates is often seen as a recession indicator. There is usually a positive difference, as even when there is no chance of default, as is the case with US debt, long-term rates are on average higher than short-term rates since there is always the risk of inflation in the long term. But as central banks tighten monetary conditions, rates can rise higher at the short end than at the long end. This foreshadows an economic slowdown, which often translates into recession.
This inversion of interest rates occurred last week on the US rates curve, causing investors to panic. Could the bond markets be anticipating a recession that equity markets and forecasters have failed to spot?
Not necessarily. The Fed has stated several times, and recently reiterated , that a different rates-based indicator is more relevant: the difference between expectations for short-term rates in 18 months and current short-term rates. And there is no cause for concern on this front at the moment. The same holds true for a plethora of other methodologies used by the regional US central banks.
Of course, there is always the possibility that all indicators and forecasters are wrong. Recessions often come as a surprise. After all, tensions linked to commodity prices are very real, and likely to last. And part of the answer is dependent on the unpredictable outcome of the war in Ukraine. However, as far as 2022 is concerned, given the growth already achieved to date, an outright recession looks highly unlikely. Of course, the 2023 outlook is less certain, once monetary conditions have tightened dramatically. But by then a myriad of new risks will have appeared and a myriad more been resolved by the market.
Although it may seem wise to try to anticipate recessions, in reality it may well be absurdly overambitious. In contrast, a handy stock market adage assures us that, in statistical terms, whilst it is certainly costly to be invested during recessions, it is even more costly to miss out on rallies that start in the heat of a crisis. In the coming years, it is a pretty safe bet that wise investors who do not succumb to an excess of wisdom will be proven right by the market.
Written on 1 April 2022 – Olivier de Berranger, CIO, LFDE