The global economy is in a stagflationary environment. This is new for all groups: Uncertainty for consumers, businesses, governments, central banks and market participants has increased significantly. Long-established relationships between economic parameters (growth, unemployment rate, inflation, interest rates, asset prices) have been called into question. The situation is exacerbated by the impact of the war in Ukraine, which threatens fundamental aspects such as energy and food security, peace, social stability and the geopolitical world order. Market participants are in search of a new strategy: In any case, TINA (There is no Alternative to Risk Assets) no longer applies.
The key question is whether a regime change is taking place from an environment of low inflation to one of persistently high inflation. The tipping point, which cannot be determined in advance and from which inflation expectations will also start to rise persistently, comes closer with each additional month of high inflation rates. In the coming days, the focus will be on the flash estimate for consumer price inflation in the euro zone in June (Bloomberg consensus: 0.7% p.m. / 8.5% p.a.). Uncertainty about the actual nature of inflation dynamics is high.
Restrictive monetary policy
To prevent an inflationary spiral, more and more central banks are accelerating the exit from their expansionary stance. While the first-round effects on inflation cannot be prevented – the surge in energy prices is causing large price increases in many areas – the secondary-round effects can be slowed down by weakening demand (the labor market). The goal is to achieve moderately restrictive interest rates as quickly as possible. Fed Chairman Powell last week repeated the message of his press conference the week before. He emphasized that the central bank’s primary focus is on restoring price stability. Powell also opined that a soft landing for the economy (no recession) will be very difficult. By its nature, a recession that prevents an inflationary spiral would be less severe than an inflationary spiral. This is because in the latter case, key interest rates would have to be raised very sharply to above high inflation rates. This would result in a severe recession.
Falling economic indicators
Even before key interest rates have reached a restrictive level, the outlook for economic growth has deteriorated further. Surprisingly high inflation rates have reduced purchasing power and led to a sharp drop in consumer sentiment. In the US (University of Michigan) and the UK (Gfk), all-time lows were reached in June; in the euro zone (European Commission) sentiment was only lower during the 2012/2013 sovereign debt crisis. At the corporate level, the flash estimates of purchasing managers’ indices for some developed economies (US, Eurozone, UK, Japan, Australia) for the month of June showed a decline in the aggregate total for the third month in a row. The report points to currently weak real economic growth and downside risks for the third quarter. Of particular concern is the sharp drop in the new orders component below the 50 mark, indicating shrinking demand.
Signs of weakness on the labor market
To date, the labor market has been firm. Unemployment rates are very low in the developed economies. The OECD aggregate is only 5.02% for April. The first signs of weakening are provided by the slight trend increase in initial claims for unemployment insurance in the US and the slight decline in the employment component in the flash estimate for the June PMI (to a still high level). Historically, weakening trends in the labor market increase the probability of recession when the unemployment rate has reached a low level. Of interest this week is the employment component of US consumer sentiment (Jobs Plentiful minus Hard to Get) for June which has already fallen twice in a row from the all-time high in March. Furthermore, the global purchasing managers’ indexes for June and economic confidence in the euro zone are in focus.
Gas supply stop
The turmoil on commodity markets has led to a sharp rise in commodity prices which is currently being passed on to many other prices. But the even greater risk is posed by actual supply cuts. Already, some developing countries are facing a food crisis. “We will continue to provide financial, humanitarian, military and diplomatic support and stand with Ukraine for as long as it takes,” reads a draft statement from the recent G7 meeting. Gas supplies to Europe have already been cut because of the further escalating conflict between the West and Russia. A gas supply freeze would lead to a strong contraction of the gross domestic product in Europe.
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Prognoses are no reliable indicator for future performance.