Recession Warning Bells Still Ringing, But (Much) Less Loudly Than Previously

The fast reopening of China’s economy, falling European gas prices, and easing U.S. inflation signal a global recession may be shallow and short contrary to fears just weeks ago. Yes, warning signals are still flashing as last year’s rise in inflation and interest rates sting, but a big rally in world markets indicates optimism is returning.

The International Monetary Fund lifted its 2023 global growth outlook and a painful euro area recession that was once seen as almost sure is less of a concern. Citi sees a 30% possibility of a global recession in 2023, down from 50% in the back half of 2022.

“The earlier worries of a recession being baked into the cake have been dialed back and that is positive for risky assets,” said Rabobank’s head of rates strategy Richard McGuire.

Here’s what some closely-monitored market indicators say about recession risks.

1/ GOLDILOCKS

MSCI’s World Stock Index has gained 8% so far in 2023 (.MIWD00000PUS) and the risk premium on junk bonds, or sub-investment grade debt, is at its lowest since the second quarter of last year.

That’s triggered by the so-called Goldilocks view that the global economy will cool just enough to curb inflation, but not so much that earnings will fall. Corporate earnings are expected to pick up from last year’s low base as inflation subsides.

Excluding volatile energy firms, MSCI world-listed companies’ earnings per share growth is expected to increase to 4.2% in 2023, from 1.8% expected for last year, according to Barclays, then to 9.3% next year.

But rallying stocks do not mean the world will dodge a recession, instead that China’s post-COVID economic reopening should curb the slowdown. MSCI’s index is still down 14% from its January 2022 high.

2/ LAYOFFS

Some of the world’s biggest companies including IBM, Meta, Microsoft, and Amazon are slashing thousands of jobs. But most of the job cuts are from beaten-down tech companies that hired aggressively during the pandemic, Goldman Sachs economist Ronnie Walker notes.

“These characteristics suggest that the companies conducting layoffs are not representative of the broader economy,” Walker said.

Indeed, U.S. job growth increased sharply last month while the jobless rate hit its lowest in more than 53 years. Job creation in 2022 was also much stronger than previously forecast, triggering hawkish comments from Fed chair Jerome Powell.

3/ DR. COPPER

Dubbed “Dr. Copper” for its track record as a boom-bust indicator, the metal has gained around 8% in 2023 to around $9,005 a tonne as China’s economy re-opens.

Copper has also seen its price ratio to gold increase steeply from January’s three-month lows. If investors buy copper and dump gold, they are not too rattled about the outlook.

But copper prices have fallen back recently, indicating some caution as investors re-evaluate expectations for the speed and scale of China’s recovery.

4/ HARD DATA, SOFT DATA

Eurozone business activity made an astonishing return to growth last month and Chinese growth has slowed less than predicted. Global data is delivering pleasant surprises at the highest rate since May, Citi’s index shows (.CESIGL)

The bulk of economists still expect a U.S. recession, but businesses and some banks have reduced the probability of one.

Others note that future growth indicators such as manufacturing activity, consumer confidence, and housing market data remain bleak.

“A lot of leading indicators and surveys look quite abysmal at face value, although many of them are stabilizing or even bouncing back,” said Patrick Saner, head of macro strategy at Swiss Re. “In the context of inflation, though, core services is what matters and that is underpinned by a still very strong labor market that isn’t showing many signs of slowing.”

5/ OUTLIER

Not everyone shares the optimistic outlook, with bond markets still poised for recession. German, the U.S., and other government bond yield curves are sharply inverted, meaning short-dated borrowing costs are much larger than long-dated ones.

Historically, that’s been a strong sign that a recession is looming. Both the three-month/10-year and the two-year/10-year yield curves are at their most inverted since the early 1980s.

Traders, meanwhile, expect the Fed will raise rates to 5%-5.25% and then implement at least one rate cut by year-end.

And economists surveyed by Reuters predicted global growth would barely clear 2% in 2023, a level associated with substantial downturns historically, and signaled the risk that it could be even slower.