For Nouriel Roubini, the amount of public and private debt is a boulder that can lead to a long recession and further downturns in the stock markets.
In the statement that accompanied one of the last rate hikes by the Bank of England, the possibility of a long-lasting recession for the British economy was feared: a phase of economic downturn that could last until 2024. In subsequent communications, this scenario was not reiterated, but the idea that the current macroeconomic phase could lead to a “mild” but prolonged recession is quite widespread.
The last voice to join the chorus is that of the economist Nouriel Roubini, and Dr. Doom’s call is one that automatically becomes front page headlines for financial newspapers. Roubini focuses his attention on one of the great economic/financial variables that are characterising this historical phase of the global economy: public and private debt. According to the calculations of the International Monetary Fund, in 2020 the global debt came to be worth around 256% of the global GDP. Essentially, the public debt equaled all the wealth produced that year (99%).
According to the economist who predicted the US real estate crisis of 2007, the burden of debt on the budgets of governments, households, and businesses is such that a wave of restrictive monetary policy, coupled with inflation-dented demand, can lead to a long and complicated recession. The increase in the cost of debt (interest to be paid) linked to the rise in interest rates is likely to deal the final blow to the high number of “zombie” operators present on the market (businesses, families but also states), also reducing the responsiveness of fiscal policy to a period of downturn. And if you think about the speed with which central banks have turned around, then the risks grow further.
For Roubini, the stock market will pay the price once again. In the US case, according to the economist, the S&P 500 could lose up to 40% in the presence of a hard landing of the stars and stripes economy. All the leading Wall Street experts seem to have no doubts: in 2023 there will be a recession with an unknown duration.
Both the Federal Reserve and the ECB intervened with serious delays (especially the European Central Bank). On the other hand, the increase in interest rates, and therefore the cost of money, is the only possible weapon in the hands of central banks. The rest is solved by itself, with time and perhaps thousands of layoffs.
Nevertheless, what is most frightening for the moment is the possible lack of energy in Europe for the upcoming winters of 2022-2023, which could cause many European productions and industrial plants to stop.
The Fed has suggested that there may be a continued acceleration in policy tightening, raising predictions that the federal funds rate could rise to more than 3% by the end of the year and reach 3.8%, well above the previous predictions of most economists and the Fed itself. Such aggressive positioning to slow the economy means a greater risk of actually dropping it into a recession.
To further complicate the Fed’s efforts, evidence is emerging that inflation could peak and the economy is cooling on its own. Yes, inflation is still high and the May consumer price index level was disappointing, but recent producer price index data was better than expected on almost all scores. Furthermore, the rise in commodity prices begins to slow down as supply chains free up, inventories rebuild and demand cools, as evidenced by weaker retail sales. Housing demand is also slowing and, perhaps more convincingly, the Atlanta Fed currently expects GDP growth of 0% quarter-over-quarter for the second quarter.
All of this raises the question: is a “soft landing” still possible? We think so, but we worry that the possibilities now may be slim. Inflation in this cycle appears to be driven by things the Fed cannot control, such as geopolitics. Furthermore, the Fed’s efforts to tighten financial conditions through rate hikes and budget cuts may not be the cure for inflation today, as extreme levels of fiscal stimulus have provided liquidity to households and markets, not excessive lending, which probably drove the excess demand in the first place.
As we continue to assess bullish and bearish scenarios for the economy and markets, investors should keep an eye on financial conditions in the United States and beyond, as global central banks also begin to tighten their monetary policies.
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