Is a Global Recession Upon Us?

Amid global shocks across supply, commodities and the U.S. Dollar, central banks continue to fight hard against inflation, leading many to wonder if a global recession is imminent.

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Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's chief global economist, along with my colleagues, bringing you a variety of perspectives. Today, I'll be revisiting a topic that's front and center: concerns about a global recession. It's Tuesday, August 30th, at 2p.m. in New York.

One key market narrative right now is that the clouds of recession have been gathering globally. And the question that I get from clients every day, 'is a global recession upon us?'

A recession is our baseline scenario for the Euro area. The flow of natural gas from Russia has been restricted and energy prices, as a result, have surged. We expect a recession by the fourth quarter but, as is so often the case, the data will be noisy. A complete gas cutoff, which is our worst-case scenario. That's still possible. On the other hand, even if somehow we had a full normalization of the gas flows, the relief to the European economy would only be modest. Winter energy prices are already partly baked in, and we've got the ECB with an almost single-minded focus on inflation. There are going to be more interest rate hikes there until the hard data force them to stop.

Now, I am slightly more optimistic about the U.S. The negative GDP prints in the first two quarters of this year clearly cast a pall but those readings are misleading because of some of the details. Now, bear with me, but a lot of the headline GDP data reflects inventories in international trade, not the underlying domestic economy. Household spending, which is the key driver of the U.S. economy, averaged about 1.5% at an annual rate in the first half and the July jobs report printed at a massive 520,000 jobs. Since the 1970s, the U.S. has never had a recession within a year of creating so many jobs. But the path forward is clearly for slowing. Consumption spending was slammed by surging food and energy prices and more importantly, the Fed is hiking interest rates specifically to slow down the economy.

So what is the Fed's plan? Chair Powell keeps noting that the Fed strategy is to slow the economy enough so that inflation pressures abate, but then to pivot or, as he likes to say, 'to be nimble.' That kind of soft landing is by no means assured. So, we're more optimistic in the U.S., but the Fed is going to need some luck to go along with their plan.

The situation in China is just completely different. The economy there contracted in the second quarter amid very stringent COVID controls. The COVID Zero policies in place are slowly starting to get eased and we think more relaxation will follow the party Congress in October. But will freedom of mobility be enough to reverse the challenges that we're seeing on consumer spending because of the housing market? The recent policy action to address the housing crisis will probably help some but I fully expect that a much larger package will be needed. Ultimately, we'll need the consumer to be confident in both the economy and the housing market before we can make a rapid recovery.

The world has been simultaneously hit by supply shocks, commodity shocks and dollar shocks. Central banks are pulling back on demand to try to contain inflation. Even if we avoid a global recession, it's really hard to see how economic activity gets all the way back to its pre-COVID trend.

It's still the summertime, so I hope it's sunny where you are. You can worry about the storm later.

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