On the Edge of Recession
Recession seems to be the dominating topic for 2023. The depth of recession and what may trigger it could be different from country to country. In Canada, rising rates have led to cooling real estate demand as mortgage payments increase. However, we are benefiting from aggressive immigration policy and higher commodity demand. The employment picture is generally solid, which would support a mild and shallow recession (if we do get one).
The Fed takes an aggressive approach
In the US, the situation is somewhat different. Higher rates have compressed valuations of growth companies that dominate the S&P 500 index and the US economy. We have seen aggressive layoffs in the tech sector, which also have ripple effects to consumption. The Fed has been very aggressive in hiking interest rates and the markets generally believe a recession is unavoidable. The central bank appears to care more about bringing inflation back to 2% than risk of recession. This means if inflation does not cool to 2% before a recession starts, monetary policy will remain tight. The odds of that scenario happening are less than 50% as we expect inflation to cool drastically in the next few months as sellers of products and services lose pricing power and consumers have turned cautious due to negative wealth effect from falling asset prices. The bad news is earnings of US corporations are unlikely to rise meaningfully to justify current valuations multiples.
Europe and Asia still uncertain
It is more interesting outside of North America. The risk of Europe running out of natural gas has abated as this winter was warmer than normal. Inventory is healthy and they are getting access to liquefied natural gas (LNG) abroad. As China re-opens, demand for goods out of Europe will likely rise and, while increased demand alone may not be enough to save Europe from recession, it could provide a soft landing, provided that inflation has indeed peaked and the ECB remains relatively dovish. In Asia, Japan has been in a slow growth/recession trend for decades as a consequence of their aging population. Japan has had a deflation problem for decades and finally saw some inflation in 2022. The Bank of Japan welcomed some inflation, and it was the only major central bank that did not hike rates in 2022. This has led to a dramatic decline in the value of yen versus other currencies.
China’s long-awaited re-opening
Last but not least, China. Due to a long enforced zero-Covid policy for literally three years, China’s economy has slowed, most noticeably in domestic demand. In 2023, demand for Chinese goods (i.e. exports) may fall marginally due to the threat of recession, but the “slack” will be more than offset by the local demand as zero-covid has been dropped. We are seeing consumers’ eagerness to spend supported by record household savings. Traffic of travel booking websites has risen dramatically as people just want to go out. It will be a very interesting year for China as it is late in the game to go through what the rest of the world experienced re-opening in 2021.
Each country has its own hurdles to overcome before the threat of recession can be said to have passed. Only time will tell which central banks have employed the right monetary policy to provide for a soft landing.
Global economies are struggling to find equilibrium between lowering inflation and avoiding recession. In the US, monetary policy is expected to remain tight and corporate earnings will likely remain low, creating a negative view for the US economy in 2023. In contract, Canada is positioned more favourably as commodity demand remains high, which supports a milder recession expectation. A mild winter has fuelled optimism for Europe, while Japan’s ongoing struggle to support its aging population has led to a decline in value for the yen. All eyes will be on China as they finally re-open, which could have mixed results as local demand for goods surges, while exports fall.
