As we enter 2023, sadly there appears to be no end in sight for the ongoing war in Ukraine – a tragic loss of life and a news story that has consistently dominated the headlines throughout 2022. As well as affecting the global consciousness, it continues to have an impact on markets and the broader energy industry due to a halt on gas flows from Russia into the European Union.
The global economy faces further challenges as it finds itself on the verge of a recession, with many countries already in recession. Aggressive interest rate hikes led by the US Federal Reserve (the Fed), energy supply concerns in Europe, and the knock-on impact of China’s zero-Covid strategy are likely to all combine to push the global economy over the edge.
Craig Hoyda, Senior Quantitative Analyst in our Multi-Asset team, takes a closer look at the global economic outlook and how governments and central banks around the world are continuing to try to combat inflation and work to reduce the impact of a global recession.
Recession has already begun for some
Recessions appear to have already begun in some of the major economies.
The Eurozone is facing major energy supply issues as most European countries are energy importers. This began as the region came out of the pandemic and has been magnified by Russian’s invasion of Ukraine. As a result, our research shows many European economies to already be in recession.
Meanwhile in the UK, the sharp rise in interest rates coupled with slowing growth from July to September suggests a more established recession is setting in.
Property problems for the US
The US economy is clearly showing signs of slowing, but growth remains just about positive for now. Consumer spending and retail sales have been resilient but pay close attention to the drop in house prices. The property market tends to be very sensitive to changes in interest rates, and it has a track record of signposting economic upturns and downturns. At present, the US property market appears to be in steady decline.
It’s likely there will be more interest rate hikes in the near term and we expect a US recession to begin in the second quarter. That said, we have more confidence in the recession’s inevitability than its timing.
A mixed picture for emerging markets
Across broader emerging markets, policies designed to bring inflation under control are drawing to a close. Asia is best placed, while parts of Latin America are also close to easing their monetary policy. But inflation is still exceptionally high in Central and Eastern Europe, while many of the more developed emerging markets are still in the midst of an inflationary crisis.
Unlike during the 2007/08 global financial crisis, we don’t expect China to come to the rescue of any other countries.
Speaking of China, authorities have peeled back Covid restrictions far faster than expected. A reopening of the Chinese economy can offset some damage done by the slowing of more developed economies. However, the road ahead remains bumpy as many elements of the Zero Covid policy remain in place as its effects are still being felt, plus underling issues with the property sector have yet to be resolved.
Has inflation finally peaked?
The good news is that global headline inflationary pressures have either already passed, or are very close to passing, their peak. Headline inflation considers the price of all goods and services, including commodities such as oil and gas.
We’re now seeing oil prices at 20% - 30% below recent highs and European gas prices are also substantially below recent peaks. This handle on inflation should become even stronger in 2023 as our global recession forecast plays out. But core inflation – which excludes commodities and is more tied to the labour market – will prove much stickier. Across labour markets, vacancy and resignation rates remain high, while wages remain low.
What’s next for interest rates?
To continue to bring inflation under control, we expect a number of additional interest rate hikes from the Fed, the European Central Bank and the Bank of England by the end of the first quarter.
But we believe central banks will be back in rate-cutting mode again by late 2023. In fact, we think the speed and extent of these eventual rate cuts is underestimated. Perhaps the market isn’t anticipating the big rate-cutting cycle we think is coming.
Looking ahead
There are many causes that could lead to a global recession in 2023. Our global growth forecasts are very low – but this is just one of many possible scenarios.
Other scenarios include inflation proving more persistent, continued slowdown in China, worsening European debt and the possibility of new vaccine-resistant Covid variants emerging. All these would lead to global recession.
The most likely positive scenario is that the ‘Fed walks the tightrope’ – being careful not to cut rates too quickly and risk hampering growth but not acting too slowly it risks deepening the recession. This scenario is probably closest to what’s priced into financial markets.
We believe there’s still a path to a soft landing where the US economy will just about avoid falling into recession. It will just require a lot of moving parts to fall into place.
During a recession there will be winners and losers – there are always investment opportunities for those willing to do their research and hold their nerve. At times like these, it’s important to remain calm and remember that you’re investing for the long term. If history tells us anything, it’s that markets can recover from periods of economic downturn.
There’s support if you need it
If you’re not sure how market and economic events may affect your investments, or are concerned about the impact, consider speaking to a financial adviser. If you’re already an abrdn client, get in touch with your financial planner. If you don’t have an adviser, you can find out more about how our financial planning services can help you.
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The information in this article should not be regarded as financial advice. Please remember that the value of investments can go down as well as up and may be worth less than was paid in. Information is based on abrdn’s understanding in January 2023.