In a mid-year assessment of the global economy, Carsten Brzeski, global head of macro and chief economist for the Eurozone, Germany, and Austria at ING, warned of a further weakening of the global economy and a rapid fall in headline inflation for the remainder of the year, with a dearth of central bank rate cuts. Brzeski compared the current economic situation to halftime in a football game, emphasising the need to assess the first half of the year and sharpen economic forecasts for the second half.
He noted several key events that shaped the first half of 2023, including the energy crisis in Europe, China’s slower-than-expected reopening, and a banking crisis in the US and Switzerland that did not result in a global financial crisis as feared. Despite these challenges, Brzeski emphasised the need for a balanced perspective, stating: “The truth is probably somewhere in the middle. Should we cherish the current resilience of many economies and the financial system as things could have become much worse? Or should we moan about the missed opportunities, lacklustre growth, and a still very long list of potential risks?”
Additionally, central banks have been tightening policies, leading to gradually retreating inflation. However, Brzeski pointed out that while the situation may not be as dire as feared, it does not automatically lead to a surge of economic activity or a return of optimism.
Brzeski highlighted several structural themes that continue to impact the economic outlook, including geopolitical tensions, the war in Ukraine, demographics, climate change, the energy transition, and high government debt. While the exact effects of these factors on growth and inflation remain uncertain, they are expected to persist.
Beware ‘slowcessions’
Looking ahead, Brzeski highlighted three major calls for the remainder of the year.
China’s reopening is anticipated to continue facing obstacles, the US economy may experience a winter recession, and the eurozone will likely remain stuck in a twilight zone between stagnation and recession.
Second, Brzeski predicted that headline inflation would retreat faster than central banks currently anticipate. The cooling of many economies is expected to lower wage pressure, reduce inflation pipeline pressures, and lead to price discounts. This phenomenon of “slowcessions” poses a new challenge for central banks, as identifying and reacting to a prolonged economic slowdown is more difficult compared with a more pronounced cycle.
Lastly, Brzeski argued that rate cuts are not expected to be a story for 2023 but rather for 2024. “If we are right, central bankers will adjust to the new reality in the last months of the year, acknowledging weaker growth, broader disinflation and no further need for rate hikes,” he said.
As part of its latest Economic and Financial Analysis, ING also broadcast key calls for the global economy. The calls highlight the resilience of the US economy, concerns over eurozone growth, the trajectory of China’s recovery, the UK’s inflation problem, disinflation in Central and Eastern Europe, revised oil forecasts, foreign exchange trends, and the pressure on market rates.
Starting with the US, ING acknowledges the economy’s resilience, which has surpassed expectations. However, the threat of recession remains due to the lagged effects of previous rate hikes and tighter lending conditions. Additionally, the restart of student loan repayments could potentially serve as a financial shock for millions of Americans. ING predicts a rate hike in July but anticipates several cuts in the following year.
While the situation is not entirely pessimistic, subdued growth is the most optimistic outlook. Inflation is clearly declining, but the European Central Bank is still expected to implement two more rate hikes.
China’s hurdles
In China, the recovery has been primarily focused on consumer spending, particularly in the catering sector. However, even this area is expected to moderate in the coming months. ING suggests that the stimulus response has been modest and will likely remain so. Consequently, further rate cuts are anticipated, potentially weakening China’s yuan. ING is revising its GDP forecasts downward and expects a weaker Chinese currency.
Moving to the UK, markets are expressing concerns about the country’s inflation problem, which is perceived to be more severe than that of the US and eurozone. In response, the Bank of England has adopted a more aggressive rate hike approach. ING expects at least two more 25 basis-point hikes but believes that better inflation readings throughout the summer may allow for a pause before the winter.
In Central and Eastern Europe, disinflation continues to be observed, presenting the possibility of central bank rate cuts. However, lower inflation does not necessarily translate to faster rate cuts. ING highlights that the local story will increasingly create divergence across the region.
Factors such as a more hawkish Federal Reserve, limited speculative appetite due to uncertain market conditions, robust Russian supply, and rising Iranian supply contribute to the expectation that the oil market will not trade as high as initially projected.
In terms of foreign exchange, the dollar downtrend is currently on hold as markets await crucial data to determine the new peak for Federal Reserve rates and the timing of rate cuts. ING predicts that the EUR/USD currency pair may trade around or slightly below 1.10 in the third quarter, considering that the US data story has yet to clearly turn negative for the dollar. However, medium-term undervaluation and an anticipated drop in US short-term rates suggest a potential climb to 1.15-1.18 in the fourth quarter of 2023 and first quarter of 2024.
Finally, market rates are experiencing pressure due to increased investment in risk assets and the slower-than-desired calming of inflation. Central banks are further piling pressure on market rates. ING suggests that the US 10-year Treasury yield will not reach its desired level until it hits 4% and surpasses the prior high. Meanwhile, the 10-year Bund yield is expected to rise to at least 2.75% and possibly reach approximately 3%.
Overall, as the global economy enters the second half of 2023, economists are advising caution rather than spreading excessive optimism. While some risks have been mitigated, the structural challenges persist and continue to impact the economic outlook.
Source: Baltic Exchange
