Recession in Q2? What key economic data say

In the latest weekly instalment of Simply put, we consider whether the global economy is on the verge of a recession.

Recession expectations: sentiment over statistics?

2022 is a risky year, in markets as well as the economy. In early Q1, growth was expected to be high and inflation soon to moderate. But war at the gates of Europe and the recognition of inflation by central banks has changed the picture. A growing number of investors have started to expect full-blown stagflation: inflation remaining high at the end of the year at the same time as potentially negative growth. Recession is just around the corner, some would say – with good reason – and yet a very limited number of economic statistics published so far indicate this.

Endogenous drivers

The investment world remembers that the 2020 recession was unique in that economic statistics were useless in measuring it. The lockdown period was a source of value destruction without anyone being able to measure this in real time (with the notable exception of oil prices). Is the current situation similar? The commodity shock and the rise in real interest rates are two solid sources of severe slowdown. However, these are endogenous sources of slowdown, whereas the 2020 recession was born of exogenous factors. Being endogenous factors par excellence, US real interest rates have already moved from negative levels to dangerously near positive in the space of a single month – enough to slow down an investment cycle that was already looking rather muted. In addition, there is the major argument that no central bank has ever managed to orchestrate a soft landing when a slower economy is needed to counter rising inflation.

What do the data show us?

Who can claim not to hear these arguments? Economic statistics. Given this endogenous slowdown, our conventional statistics should have a solid chance of catching it at the right time. However, to date there are only a small minority of economic figures indicating a coming recession – mainly household morale, a rather erratic indicator. The situation is delicate: while it seems likely that the global economy will experience a deep and necessary slowdown, at this stage there is no consensus of data pointing in this direction. Figure 1 shows economic surprise indices remaining at a high level; the fact that economists are starting to be disappointed by economic releases is usually an early sign that a slowdown is accelerating. The indices measuring these ‘surprises’ remain in positive territory to date and are very positive in both the US and in Europe. Admittedly, US GDP figures for Q1 disappointed, but the growth of US demand is not in question. The US consumer remains in a strong position. Barring a collapse in data during May, a recession will not take place in Q2.

FIG 1. Surprise indices focused on key dates, by percentile

Source: Bloomberg, LOIM.

Timing the start of a recession, however, is essential for portfolio management. As Figure 2 shows, the collapse of equities in 2008 did not really happen until survey data plunged. Survey data remains mostly strong in the US. In Europe, some numbers – such as the IFO – are consistent with a strong decline in the German economy. When we analyse our nowcasting indicators (see below), we find signs of a strong business cycle overall. From this point of view, it seems that at this stage the recession is not at our doorstep. First-quarter results remain shielded by the veil of the nominal economy: inflation is growing faster than growth, supporting the turnover of large companies, and explains the good results. Yet, these phenomena are temporary; inflation will not remain at 8% forever and a slowdown is likely to materialise. From our point of view, caution is therefore still warranted.

FIG 2. US ISM vs the rebased performance of the S&P500, 2007-2008

Source: Bloomberg, LOIM.

Macro/nowcasting corner

The most recent evolution of our proprietary nowcasting indicators for world growth, world inflation surprises and world monetary-policy surprises are designed to keep track of the latest macro drivers making markets tick. Along with these analyses, we wrap up the macro news of the week.

The macro situation remains surprisingly good. The commodity and rates shock are driving the cost of living and the cost of funding higher and yet leading indicators remain in the green zone:

• In the US, the Richmond Federal Reserve’s (Fed’s) survey and the Kansas Fed’s leading indicator are consistent with economic growth close to 2021 levels.
• The Chicago Fed’s National Activity Index (CFNAI), a well-regarded synthetic indicator, also remains at levels higher than those observed from 1999-2019 despite increasing costs.
• Negative Q1 growth in the US (-1.4% vs 1% expected) is not a reflection of a contraction in local demand: US consumption growth over the quarter came out at 2.7% versus 2.5% in Q4 2021 (albeit lower than the expected 3.5%).

US growth in Q2 is not at risk, according to most leading indicators published so far. The surprising macro environment also extends to Europe: in Germany, the IFO index (which gauges the strength of economic activity) has declined over the past two months. However, April showed the first sign of stabilisation: the ‘current assessment’ component came out at 97.2, expected at 95.9, up marginally from 97.1 in March. The ‘expectations’ component is currently the only one consistent with a sharp economic slowdown. The latest situations reading is actually comparable to the level at the end of the pandemic-related recession: expectations form the element that has deteriorated the most, while the current assessment does not look concerning. Inflation in Europe remains high and is progressing, which is in line with our nowcasting indicators: the tone of the ECB should become increasingly hawkish, as growth and inflation alike appear to be stronger than expected.

Factoring in these new data points, our nowcasting indicators currently point to:

• Worldwide growth remaining solid. The US and the Eurozone are still showing robust numbers, while China remains on a deteriorating path.
• Inflation surprises should remain positive, but our signals have shown a recent decline. This follows the moderation of commodity prices, however 70% of the data constituting our inflation gauge are now declining.
• Monetary policy is set to remain hawkish, mirroring the strength of activity. Recently, the Chinese indicator has shown the first sign of stabilisation, while remaining indicative of dovish surprises.

World growth nowcaster: long-term (left) and recent evolution (right)

World inflation nowcaster: long-term (left) and recent evolution (right)
   
World monetary policy nowcaster: long-term (left) and recent evolution (right)Reading note: LOIM’s nowcasting indicator gather economic indicators in a point-in-time manner in order to measure the likelihood of a given macro risk – growth, inflation surprises and monetary policy surprises. The Nowcaster varies between 0% (low growth, low inflation surprises and dovish monetary policy) and 100% (the high growth, high inflation surprises and hawkish monetary policy).

RISERVATO AGLI INVESTITORI PROFESSIONISTI

Il presente documento è stato pubblicato da Lombard Odier Funds (Europe) S.A., una società per azioni di diritto lussemburghese avente sede legale a 291, route d’Arlon, 1150 Lussemburgo, autorizzata e regolamentata dalla CSSF quale Società di gestione ai sensi della direttiva europea 2009/65/CE e successive modifiche e della direttiva europea 2011/61/UE  sui gestori di fondi di investimento alternativi (direttiva AIFM). Scopo della Società di gestione è la creazione, promozione, amministrazione, gestione e il marketing di OICVM lussemburghesi ed esteri, fondi d’investimento alternativi ("AIF") e altri fondi regolamentati, strumenti di investimento collettivo e altri strumenti di investimento, nonché l’offerta di servizi di gestione di portafoglio e consulenza per gli investimenti.
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