Investment Strategies

Can The US, Europe And China Avoid Recession?

Charles Paikert New York April 11, 2022

Can The US, Europe And China Avoid Recession?

Bankers, former policymakers and commentators cast their eyes over what is in store for the world's major economies and address concerns that a recession is on the cards.

The combined economic output of the US, the European Union and China accounts for approximately 65 per cent of world gross domestic product. But all three markets are facing perilous challenges which may or may not result in a global recession.

“This is a very different backdrop than 2020 or 2021,” Joseph Quinlan, head of CIO market strategy for Merrill Lynch and Bank of America Private Bank, said. “This year we’re learning how to build the plane at 35,000 feet.”

Specifically, the US is struggling to get raging inflation under control, Europe is facing an unprecedented energy crisis in addition to soaring commodity prices and China is battling a surge of coronavirus cases which is negatively impacting domestic growth and the already strained global supply chain.

The US is best positioned to avoid a severe economic and market downturn, according to Quinlan, ideally if the country’s Federal Reserve can engineer a “soft landing” for the economy – raising interest rates enough to slow down the economy and fight inflation without going too far and tipping the country into a recession. 

US prospects
Among the world’s “Big Three” economies, “the US has the best pole position,” Quinlan said. 

In a recent market strategy report to clients, he cited “numerous growth tailwinds” for the United States, including a fading pandemic, pent-up demand resulting in strong consumer spending, a healthy job market, the need to rebuild inventory and continuing ripple effects from two years of massive monetary stimulus.

What’s more, US equities tend to move higher when the Federal Reserve Board begins a series of rate hikes which results in nominal growth and rising pricing power.

But a number of high profile “inflation hawks,” most notably former US Treasury Secretary Larry Summers are not as optimistic.

Federal Reserve policy “remains dangerously behind the curve in ways that will lead to poor economic performance in the years ahead,” Summers asserted in a recent Washington Post opinion column.

Summers went on to blame the Fed for not raising real interest rates adjusted for inflation above the neutral level. He also pointed out that “every time inflation has exceeded four per cent and unemployment has been below five per cent, the US economy has gone into a recession within two years.”

Adequate tools?
According to John Leer, chief economist for Morning Consult, the Fed’s monetary policy “toolkit” may not be “particularly suited to address a shortfall of commodity supply.”  
In addition, the US is now facing “the risk of stagnating growth paired with inflation, so-called stagflation,” Leer said.

Nonetheless, a strong economic recovery to date leaves “conceptual room for optimism,” even as policy makers are in “uncharted territory,” he said. Results of the Fed’s attempts at a soft landing for the economy won’t be known until 2023, Leer maintained.

In the meantime, the US financial markets are sending conflicting recession signals, according to Morning Consult’s latest monthly report. 

A flattening of the spread between two-year and ten-year Treasury yields traditionally signals that investors have lost confidence in the economy’s growth outlook. However, the spread between the three-month and ten-year Treasury yields have widened, the report noted, suggesting that investors anticipate stronger growth, along with some combination of higher interest rates and inflation.

Euro pessimism
Europe’s prospects are considerably bleaker, according to Bank of America’s Quinlan.

Citing the Russian invasion of Ukraine, inflation and a worsening energy crisis resulting from the EU’s dependence on Russian oil and gas, the continent “has emerged as the weak link of the global economy,” Quinlan said.

“There are pretty good odds that if Europe doesn’t have a recession they will flirt with one,” Quinlan predicted. Leer agreed, noting the interdependence of the Ukrainian, Russian and European economies and expected shortfalls of commodities, especially wheat, in the months to come.

“The situation in Europe is much more dire,” he said. “The possibility of a recession there is greater than in the US.”

China as X Factor
China, currently mired in pandemic lockdowns while remaining frustratingly opaque, appears to be the wild card on the global stage.

“It’s always a challenge discerning numbers out of China,” Quinlan said. He is skeptical that China will achieve its projected 5.5 per cent growth target this year, and will be watching Chinese ports closely to monitor the extent of the supply chain bottlenecks caused by factory delays in the 70-plus cities undergoing lockdowns.

“The last thing a fragile global economy needs right now,” Quinlan said, “are supply side disruptions in the world’s largest exporter.”

UBS is more bullish on China, noting in a new research report Beijing’s recent pledge to use monetary tools at an “appropriate time” to bolster the economy. In addition, UBS noted, the People’s Bank of China unveiled a draft outline for a new stability fund to shore up a weakened economy. 

As a result of this expected policy support bolstering investor sentiment, UBS is retaining its “most preferred” rating for Chinese equities.

Leer, however, points out that China’s lockdowns are “exacerbating supply chain disruption” and also serve as a reminder that the pandemic is “not totally behind us.”

As a result, “it’s harder, not easier for policy makers to get inflation under control,” he said.

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