I’ve been suggesting that the developed world was heading for recession for some time. In Europe, sky high energy prices were to be the cause. In the US it was a different argument: a recession was needed there to control inflation.
I expected recession this winter in both the US and Europe, but it now looks like we won’t get it. In the US, consumers have been drawing down their ‘covid piggy banks’ (the money cumulated during covid) to sustain their spending. In Europe, the efforts to contain demand for gas and secure alternative supplies have coupled with favourable weather and led to a sharp fall in natural gas prices. Prices for next month’s delivery are now back to the levels they were at before Russia’s invasion of Ukraine. They are still double those levels for delivery next winter but that is much lower than they were even a few months ago.
Meanwhile, the tide of news on inflation has decisively turned in the US. After a string of inflation reports that were higher than expected in the first 8 months of 2022, the numbers in recent months have been trending lower.
So, is recession cancelled or merely postponed? As far as continental Europe is concerned there is now a real prospect that 2023 will be a year of sluggish growth but without recession. Unlike their US cousins, consumers in Europe have not drawn down their ‘covid piggy banks’ as they’ve been too frightened by the prospect of high energy bills to go out and spend. Real incomes have been squeezed in Europe, but unemployment remains low and as spring approaches, they are likely to feel more confident. Consumer spending should pick up.
UK consumers can also breathe a sigh of relief and although the energy price cap will go up £3,000 in April, there is chance that the bills will fall over the rest of the year. The problem is that sharp rises in mortgage rates have hit the housing market and will gradually squeeze consumers as their mortgage rates are re-set. The UK looks more vulnerable than Europe in 2023 and beyond. Wage inflation has accelerated in the UK and the Bank of England will have to keep on raising rates.
But what about the US? There is no doubt that improvements in inflation will increase the chances of a soft landing. But in my view, the odds still favour a recession. The labour market tightness means that wage inflation is too high, and the Federal Reserve can’t ease their grip. We’ve highlighted previously that wage increases for US workers who switch jobs have been accelerating relative to their peers who have stayed put. This suggests that wage inflation is likely to accelerate. Later this month we get the Fed’s preferred measure of wage inflation – the employment cost index. If that stays high, then there will be pressure on them to raise rates further than the market expects and keep them higher for longer.
I believe that the US is on the brink of a significant weakening in the labour market, with a negative employment report likely in the next 3-6 months. Companies are seeing margins come under pressure and will resort to job cuts. Indeed, layoffs are already increasing in large firms and smaller firms are being squeezed. Consumer demand may get a temporary boost from bumper increases in social security payments this month, but the trend is for weaker spending and a weaker US economy.
