Morgan Stanley
  • Thoughts on the Market Podcast
  • Sep 19, 2022

Tracking the Coming Slowdown

Transcript

Welcome to Thoughts on the Market. I'm Seth Carpenter, Global Chief Economist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the rising risks of global recession and what might be ahead.

About a year ago, I wrote about the brewing storm of recession risks around the world. Some downbeat economics news has come in since then, but the worst of the global slowdown is ahead of us, not behind us. We have an outright recession as our baseline forecast in the euro area and the U.K. The Chinese economy is on the brink with such weak growth that whether we have a global recession or not might just turn out to be a semantic distinction.

First, Europe. It's hardly out of consensus at this point to call for a recession there, but we have been forecasting a recession since the start of the summer. The energy crisis caused by the Russian invasion of Ukraine has created a cost shock that is now effectively locked into the outlook for the next couple of quarters. Consumer bills will stay high, sapping purchasing power, fiscal deficits will take a hit and industries are already rationing energy use.

For the UK, leaving Europe has not left behind the energy crisis across the channel. And the UK is also suffering from structural changes to its labor supply and trade relationships, and that's dragging down growth beyond these cyclical movements. That said, new leadership in Parliament is pointing to a huge fiscal stimulus that will mitigate the pain to households and reduce the depth of the recession.

Now turning to China, markets have looked at China as a possible buoy for global growth, but this time any such hope really needs to be tempered, China's economy is in a fragile position. In our forecasts growth this year will be about 2.75%, below consensus and well below the potential growth of the economy. And then we think there'll be a rebound in growth next year, we're only looking for a modest 5.25% next year. Those sorts of numbers are not the real game changers people hope for. So far, the fiscal and monetary policy that has been deployed has not got a lot of traction.

There are two key restraints on the Chinese economy right now; trouble in the housing market and continuing COVID restrictions. After the party Congress in mid-October things should probably start to change, but we're not expecting a quick fix. Right now construction and delivery of new homes is not getting done, so the cash flow is drying up, creating an adverse feedback loop. So far, the PBOC has rolled out about 200 billion renminbi bank loans to support this delivery, and we expect more intervention and funding over time. So as easy as it is to be gloomy on the outlook, a catastrophic collapse in housing doesn't seem likely. As for COVID, we are now expecting only a gradual exit from COVID zero next spring. The key metrics to watch will be the pace of vaccinations and wider adoption of domestic COVID treatments and a shift in public opinion. In particular, we think getting the over 60 population to at least an 80% booster vaccination rate next spring will flag the removal of restrictions.

If there is a silver lining, it's that we still think the U.S. avoids a near-term recession. Despite notching a technical recession in the first half of the year, the U.S. outlook is somewhat brighter. For the first half of the year nonfarm payrolls averaged almost 450,000 per month, that's hardly the stuff of nightmares. But we don't want to be too cheerful. From the Fed's perspective, the economy has to slow to bring down inflation. They are raising interest rates expressly to slow the economy. So far, the housing market has clearly turned, but payrolls have only slowed a bit, and the moderation in wage inflation is probably not as much as the Fed is looking for. To date, we have not seen much slowing in consumer durables, so the economy remains beyond its speed limit and the Fed will keep hiking. How much? Well, depends on how strong the economy stays. So there really isn't much upside, only downside. The Fed is committed to hiking until the demand pressures driving inflation back off, so one way or another, the economy is going to slow.

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From Europe, to China, to the U.S., global economies are facing unique challenges as the brewing storm of recession risks seem to still indicate a slowdown ahead.

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