This Week: Interest rates being hiked despite global recession evidence

Global growth is stalling. The Bloomberg Economics Global GDP tracker, which is based on seven high frequency underlying indices, just hit 0%. Besides during the Covid period, it has been a pretty good indicator of global GDP growth. In short, there is growing evidence that we are currently in a global recession.

Analysts are increasingly concerned about growth next year too. Growth forecasts have fallen as inflation forecasts have picked up. Consensus now expects just 0.9% growth from the US next year and 0.2% from Europe.

The changes to forecasts for real GDP and inflation have nearly offset each other – implying very stable forecasts for nominal GDP despite the prospect of a material slowdown in real GDP growth. The implication being that company top line growth, and government revenue growth, is likely to still be around 5% despite a material slowdown in global GDP.

How do markets perform during recessions? So far, the S&P 500 is down 23% from its peak and it has been 182 weekdays since the last peak.

The average drawdown during a recession is 34% - although it is worth noting that there is a large dispersion of returns during recessions.

On average it takes around 340 weekdays for the US market to bottom if the decline is associated with a recession.  That would imply around eight months to go to the bottom if the current market cycle follows the average.

There’s probably not much value in being too precise but given that we are pencilling in a recession for the US, that implies another +/- 10% pullback over the coming six months. 

Central banks hike. Despite the raft of data pointing to a global slowdown, and the potential for inflation to decline materially, several central banks hiked rates last week. The Fed hiked by 75bps taking the upper bound of the Fed funds rate to 3.25%, the highest rate since 2007.

So far it has been the steepest set of increases in 40 years, with more still expected to come. The market is pricing the Fed funds rate to get to 4.75% by May next year.

The Fed is guiding that it will be aggressive too. Based on the dot plots, 12 out of 19 FOMC members expect the Fed funds rate to be between 4.5% and 5% by the end of 2023.

The BOE and ECB are priced to be aggressive too. The BOE hiked last week to 2.25% despite clear signs of a recession building in the UK. UK rates are priced to get to 5% by March next year.

There is an alternative. The US 10-year inflation-linked bond is now yielding 1.3%, the highest yield since 2011. US Treasuries are at 3.7%, also the highest since 2011.

More signs of inflation rolling over. Outside of Europe, there are clear signs of reducing price pressure on companies.

US PPI inflation in August was 8.7%, down from a peak of 11.7% in March. Japanese inflation was at 9%, down from 9.4% in June. Most impressively, Chinese PPI inflation was all of 2.3% in August, down from a peak of 13.5% in October last year. China will be once again exporting disinflation to the rest of the globe.

German PPI was a complete shocker though. At 45.8% it was well above the consensus forecast of 36.8%. 

In addition to lower PPI prints nearly across the globe, shipping costs continue to tumble. Container shipping costs were down 10% last week alone and are now at the lowest rate since December 2020. Shipping costs are now down 57% year-on-year.

A look at the European gas market. Germany has been able to increase gas storage over the past few months back to 2012 levels and current storage is above the 6-year average. Both the UK and Germany are close to max storage, but the UK has much less capacity than Germany.  The net result is that the UK has less than 5% of annual consumption stored while Germany has over 20%. This hasn’t changed the prospect of recession though.

SA inflation declines.  August inflation in SA was 7.6%, in line with the Bloomberg consensus and down from 7.8% in July. At spot prices there is a R1.10 over recovery for the petrol price and we expect a meaningful petrol price cut come the first week of October. Plugging this into our model sees inflation continuing to decline, reaching just over 6% by year end. We expect it to be within the band in May next year and below 5% by July. This is in line with the MPC forecasts.

Despite the material downward revision to the MPC’s inflation forecast, authorities hiked by 75bps last week. The market expects much more: it’s pricing in another 200bps of increases over the coming year despite the consensus forecast that inflation will continue to decline. That would take short-term real rates at that point to around 400bps, an extremely tight monetary position. It is much more likely that we are nearing the peak of the interest rate cycle in SA. 

Global government bond issuance normalises. The Covid-related surge in government bond issuance is well behind us. Twelve-month issuance from governments across the globe is back in line with pre-Covid levels. The net result is fiscal tightening as global short rates have been pushed up. Faster nominal GDP growth has seen global debt to GDP actually decline over the past couple of years. 

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