Asset Management Europe: Monthly Macro Insights – November 2022

Marc-Antoine Collard, Chief Economist, Director of Economic Research, Asset Management, Europe

The world economy continues to face strong headwinds. Markets remain hopeful that central banks will soon pause the tightening campaign and give economic activity a breather, although the stubborn persistence of inflation could dampen those hopes.

The pandemic and the war in Ukraine are still causing damage

While the pandemic’s impact has moderated in most countries, its lingering waves continue to disrupt economic activity, especially in China. Although the Chinese GDP rebounded in Q3, the monthly indicators for September painted a weak picture at the end of the quarter. Looking ahead, the outlook remains murky as business confidence fell and were in economic contraction territory in October both in the manufacturing (49.2) and services (48.7) sectors.

In the US, GDP posted its first quarter of positive growth for 2022 in Q3, increasing 0.6% q/q – or 2.6% annualised. However, this was in large part due to a narrowing trade deficit amid a significant drop in imports, which is unlikely to be repeated in future quarters, while private domestic demand was lacklustre as inflation is hurting household consumption and the housing sector is getting crushed under the weight of higher interest rates.

In the Eurozone, Q3 GDP growth was better than expected (0.2% q/q) as the German economy (0.3%) was surprisingly resilient despite supply chain disruptions, rising prices and interest rates, and the war in Ukraine. That said, the Eurozone S&P Global business confidence index is signalling that the manufacturing sector is in a recession. What’s more, inflation reached a record 10.7% in October and is likely to stay in double-digit territory for some time, hurting household purchasing power and keeping pressure on the ECB to continue raising interest rates.

Investors await the pivot 

Persistent and broadening inflation pressures have triggered a swift and synchronised tightening of monetary conditions, alongside a powerful appreciation of the US dollar which tightened global monetary and financial conditions. Uncertainties continue to cloud forecasts of global growth and downside risks remain elevated, while policy trade-offs to address the inflation surge have become acutely challenging.

In fact, the risk of monetary, fiscal, or financial policy miscalibration has risen sharply. As economic activity in many parts of the world starts slowing down, and financial fragilities emerge, calls for a pivot toward looser monetary conditions will inevitably become louder. Yet, there are risks of both under- and over-tightening. The former would entrench further the inflation process, erode the credibility of central banks, and de-anchor inflation expectations. Historical records caution strongly against prematurely loosening policy as this would increase the eventual cost of bringing inflation under control. On the other hand, over-tightening could push the global economy into an unnecessarily harsh recession, especially if financial markets struggle to cope with an overly rapid pace of tightening. However, the costs of these policy mistakes are not symmetric and misjudging yet again the stubborn persistence of inflation could prove much more detrimental to future macroeconomic stability.

In that context, the Fed delivered a 75 bps rate hike for the fourth meeting in a row in November. An imminent slowdown in the pace of policy tightening – to a more normal 25 to 50 bps per meeting – is likely. However, the tighter for longer stance saw Chair Powell downgrade the Fed’s prospects of achieving a soft landing, upgrading the probability he placed on a recession. Will investors agree?

Completed writing on 3 November 2022

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