Slowdown or recession? This question, which we asked three months ago, is now on everyone’s lips. The recession scenario has continued to gain ground. This is because the concerns that have been present since the outbreak of the war in Ukraine have grown stronger. Only the forecasts for business development are somewhat reassuring, as they are generally still positive compared to the previous year. But they are likely to fall in the third quarter.
Inflation at record highs
This will depend in particular on the mood of consumers. Inflation is not likely to reassure them, quite the contrary. In the eurozone, inflation is going from record to record. In June, it is estimated at 8.6% year-on-year, 50 basis points (bp) higher than in May, which in turn was 70 bp higher. Energy prices are still rising due to sanctions and retaliations related to Russia. Governments are still seeking to intervene in these markets to contain the rise and create reserves for the coming winter. Oil prices have stabilised at a high level, while gas prices in Europe (Dutch TTF) have risen again due to reduced deliveries from Russia. And energy is no longer the only driver of price increases. Food is also contributing, driven by cereals and oils, again due to the war in Ukraine.
These conditions argue for an urgent rate hike by the ECB. Despite the increased pressure, the central bank is caught between a rock and a hard place. In an urgently organized maneuver, it has to put in place a mechanism to prevent southern countries whose debt is well above their GDP from having to pay too much for their loans compared to Germany, which is the benchmark. Without this measure, a rate hike would probably have had disastrous consequences. The ECB may therefore not be able to adjust rates as much as the fight against inflation would require. A first hike is still expected on 21 July, and pressure is building for a 50 bp hike, rather than a 25 bp hike. This would be equivalent to the end of negative rates.
The Fed is a little better off, as shown by its three rather aggressive moves, and its determination to continue tightening. However, the Fed’s focus on fighting inflation, including food and energy, is making a recession increasingly difficult to avoid. So much so that Fed Chairman Jerome Powell first considered that “recession is certainly a possibility”, only to reinforce his speech, inviting the acceptance of a higher recession risk. In mid-June, the figures published for the month of May came as a shock: instead of the expected slowdown, inflation reached a new 40-year high of 8.6% year-on-year. However, excluding energy and food, it fell slightly to 6%.
Consumers are not confident
Consumer sentiment is at a 16-month low, according to the Conference Board. Expectations for the future have even fallen to the lowest level in nearly a decade. This points to a slowdown in the second half of the year. The University of Michigan’s index even fell by 8 points in a single month to 50 points, a score not seen since the early 1980s.
Such weak numbers have at least somewhat lowered estimates of the pace of Fed rate hikes. However, for the next meeting, a large majority still expects a further 75 bp increase.
The US already in recession?
According to the Atlanta Fed’s GDPNow calculations of 1 July, the US is already in recession: after a first quarter of 1.6%, GDP between April and June is estimated to have fallen by 2.1%. In just a few days, its forecasts have changed radically: on 27 June, they were still pointing to an increase of 0.3%. Weaker consumer spending and a drop in domestic investment caused the fall.
The eurozone should fare slightly better, according to UBS forecasts. After a 0.6% increase in the zone’s GDP in the first quarter, Germany and Italy are expected to come closest to zero growth in the second half.
Finally, the PMI indices on both sides of the Atlantic have sometimes bottomed out over several months, but they have all remained above the 50-point mark. The analysis of the situation by companies thus leaves some room for hope.
