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As of this writing, one of the most heated debates taking place within the investment community centers around the looming risk of a global economic recession. Are we likely to enter one? If so, when? How long and severe might it be?
Our take: The global economy is on the cusp of what we’re calling a “pricey” recession scenario, which could be very different from past recessionary periods. We may see a slowing in real (inflation-adjusted) economic activity, in line with the lagged impact of tighter global financial conditions. However, the nominal pulse of most economic indicators could remain elevated as inflation stays “sticky” at today’s high levels.
At the heart of our “pricey” global recession scenario lies the thorny issue of persistently high structural inflation, fueled in large part by:
In short, the cumulative impacts of deglobalizing supply chains and labor markets, driven by geopolitical realignment and compounded by decarbonization (spurring demand for commodities used in the adoption of renewable energy sources), are feeding into higher structural inflation.
The pressing question is whether the current global economic slowdown is temporary or a sign of a deeper global recession. On balance, we think it probably marks an economic “pause” rather than the onset of a protracted recession. If we are right, the global cycle should begin to bottom later this year, followed by a gradual upturn in economic activity. Decelerating global growth and easing supply bottlenecks will temporarily lower monetary policy tightening expectations. However, strong developed economy labor markets and activist fiscal policies to support global demand could keep structural inflation stubbornly higher.
It’s important to note that when global inflation is as elevated as it is these days, there are no guarantees that central banks can orchestrate “soft landings” for their respective economies. However, it’s not impossible.
For example, in the US, barring a meaningful and sustained improvement in labor supply or productivity (not our baseline), the Fed may have to reduce aggregate demand via rate hikes in a more material way to bring inflation back toward its 2% target. A Fed that successfully anchors inflation expectations, in conjunction with well-targeted US fiscal policy, might be able to put the nation’s economy on a path where the inflation rate can normalize without inflicting serious economic damage.
In our follow-up companion blog post, scheduled to publish next week, we will share our thoughts on how investors might position for the potential recession scenario we’ve described here.
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Brett Hinds
Jameson Dunn