Abrdn: "This mix...will push the world economy over the cliff"

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By Laura Sanchez

Investing.com - Volatility returns to financial markets this key week of central bank meetings. While European stock markets remain tense today -Ibex 35, CAC 40, DAX - as they await the Fed rate decision, comments continue to come in from experts with their economic forecasts for 2023.

In an emailed commentary to Investing.com, Jeremy Lawson, chief economist at abrdn, explains that "the global economy is on the brink of recession."

"The mix of aggressive monetary tightening led by the U.S. Federal Reserve, high energy prices and the trade crisis in the U.K. and Europe, the drag from persistent COVID-Zero measures, along with weakness in China's housing sector, will likely push the global economy over the cliff," Lawson highlights.

As the economist explains, "although our view has been belatedly shared by many analysts, the consensus is underestimating the potential severity of the recession, as well as the rate-cutting cycle that we believe will continue. In fact, recessions appear to have already begun in some economies."

"Eurozone leading indicators are in deep contraction, and we expect GDP growth to be negative from Q4 2022 onwards. True, energy rationing this winter now seems less likely, given the build-up of gas reserves. But the mild weather and lower Asian demand, which have allowed Europe to secure large quantities of liquefied {0|natural gas}}, cannot be sustained. Moreover, we do not see a close outcome to the Russia-Ukraine war, which means that there will be no pipeline gas flows. In any case, avoiding gas rationing this winter only makes the European recession less severe, although it does not prevent it," this expert points out.

United Kingdom

As Lawson notes, in the UK, GDP has contracted in the third quarter; the weakness of leading indicators and the sharp rise in interest rates means that a deeper recession is starting, or will start soon.

United States

"Although the U.S. is slowing, growth remains positive, with consumer spending particularly resilient. However, the contraction in real estate indicators gives us a more forward-looking signal. Despite signs that inflation is bottoming out, our analysis implies that controlling core inflation requires a substantial rise in unemployment. More importantly, we believe that the Fed is willing to do whatever it takes," says abrdn's chief economist.

China

In China, despite enthusiasm for a two-way shift toward easing COVID-Zero and property sector policies, the rise in COVID cases is contributing to a worsening of near-term growth, says this expert. "We do not expect a more generalized easing of restrictions until the second half of 2023. Similarly, a vigorous recovery in the housing sector is unlikely, as developer financing conditions are tight, activity prospects are depressed and there is oversupply," Lawson highlights.

Emerging markets

Across emerging markets as a whole, the macroeconomic outlook is very mixed. Asia is the best placed, while parts of Latin America are on the verge of easing monetary policy. Inflation remains too high in Central and Eastern European countries, while many frontier markets are in the throes of crisis.

Inflation and central banks

Global inflationary pressures are passing their peak, Lawson points out. "But core inflation will prove more difficult, as labor markets are too tight and companies have too much pricing power. This means we expect more near-term rate hikes, including another 1.0% from the US Fed and the European Central Bank, and 1.5% from the Bank of England, by the end of the first quarter of 2023. The risks are even greater."

All in all, Lawson explains that demand destruction during recessions should ultimately put significant downward pressure on core inflation. "The upshot is that we believe central banks will cut rates again by the end of 2023. We expect US interest rates to return to the effective lower bound by the end of 2024 and both UK and eurozone interest rates to do the same."

Risks lean toward weaker growth, but higher inflation than the consensus expects. "We have introduced a 'rigid inflation' scenario in which tightening triggers recession, but core inflation turns out to be more persistent. Even so, the policy rate is well below 2% in the average of all scenarios. We are therefore optimistic about durations for the coming year, as well as currencies such as the yen and the Swiss franc," says the expert.

"The outlook for risk assets in terms of excess returns is more unfavorable. After the recent rallies, equities and credit spreads are increasingly factoring in a mild decline. In our view, a prolonged rally will have to wait until recessions consolidate," concludes Lawson.

(Translated from Spanish)