Recessions almost always take policymakers by surprise. They are focused on their computer models, and don’t look out of the window to see what’s happening. This time around they face a double surprise – a major recession, and then a recovery that leads into a New Normal. There is no going back to the Old Normal of the BabyBoomer-led SuperCycle.
As the chart shows, the consensus still believes that recession is unlikely. And even those who are worried about it, are still confident that it will be very short and V-shaped, as in 2020. Oil prices will fall, and financial markets quickly bounce back.
Nobody is really thinking about the 3rd alternative – that we move into recession, and then emerge into a New Normal world of much greater uncertainty:
- Growth will become much more cyclical as geopolitics and energy security become key issues
- Ageing populations mean that absolute levels of growth will be much lower than in the past
- And in the short-term, we now have to cope with the arrival of the 4 Horsemen of the Apocalyse
THE RECESSION IS ALREADY STARTING TO ARRIVE
US Treasury Secretaries and central bank governors are always the last people to see what is happening. Thus it is no surprise that the current Treasury Secretary, Janet Yellen, was supremely confident earlier this month:
“I have confidence in the Fed to get inflation under control without causing a recession. And I see a good strong economy that, even with inflation and the problems that the Russia/Ukraine situation is causing, I believe the economy will do well this year.”
Yet as the chart confirms, oil prices are currently well above the 3% of global GDP that normally leads to recession. And as I noted here a month ago, when the Ukraine invasion began:
“Wars launched by paranoid autocracies aren’t usually like video games with a defined (and quick) beginning and end. And Putin’s war has already led to unprecedented financial sanctions on Russia and its ruling oligarchs.”
Consumption is 70% of the US economy. And the latest data from the Univesity of Michigan’s Consumer Sentiment survey confirms the risk, as the chart shows. It is already at the 1990 level – which led to recession – and is likely headed lower.
The big difference from 1990, 2020 and today is that inflation is soaring around the world – due to supply chain chaos, and rising energy prices. So central banks are finally being forced to refocus on inflation, and raise interest rates into a recession.
This hasn’t happened since the early 1980s, and won’t be good news for financial assets.
Stocks and house prices are selling at record valuations. People were able to borrow seemingly unlimited amounts of cash, at near-zero rates. But already, the US 30-year mortgage rate has risen by 2/3rds to 4.42%, from 2.65% in January last year.
‘THE JOKERS’ MEAN WE NEED TO EXPECT A K-SHAPED RECESSION
The SuperCycle was unique in history. It was the NICE period, with Non-Inflationary Constant Expansion. Geopolitics became less important, as everyone was able to get their share of the “bigger economic pie”. But now it is going into reverse:
- China’s real estate bubble was key to the post-2008 recovery. But now it is bursting with average high-yield debt yields at a record 32.9%. The Ukraine invasion is causing further, major disruption, with widespread sanctions on Russia
- And as discussed here last week, it is leading to major changes in global energy markets. Germany is moving completely away from its dependence on Russian supplies of gas and oil
- Growth will also be much slower in the New Normal due to today’s ageing populations. The central banks’ stimulus programmes were effectively an attempt to support consumption by “printing babies” as discussed here many times. But that folly is now over.
3 OF THE 4 HORSEMEN OF THE APOCALYPSE ARE ARRIVING
And in the meantime, very sadly, we have to cope with 3 of the 4 Horsemen of the Apocalypse – the Covid pandemic, war in Ukraine, and now the threat of Famine.
The Our World in Data chart shows that nitrogen fertiliser feeds half the world’s population. And now fertiliser prices are becoming unaffordable for many farmers, due to record-high natural gas prices. Plus, Ukraine/Russian supply 29% of the world’s wheat – and their planting will now be disrupted.
We are facing a K-shaped recession. Companies and investors have a difficult time ahead. They not only have to navigate a potentially major downturn. But they also have to completely reposition their portfolios for the New Normal world that will follow.