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What happens to a recession deferred?


Natale Labia writes on the economy and finance. Partner and chief economist of a global investment firm, he writes in his personal capacity. MBA from Università Bocconi. Supports Juventus.

Given the mixed regional performance of 2023, the outlook is contingent on one thing: how high will rates go and what impact will this have on the economy?

As the northern hemisphere returns to work after a summer of floods, fires and other similarly biblical meteorological phenomena, it is worth taking stock of the year thus far to get a sense of where the global economy is going.

First, the supposedly inevitable has not happened. As forecasted in this column late last year, a recession in the US – as a consequence of sharply higher interest rates – has not transpired. 

Back in January, an average of GDP growth forecasts for the US was that the economy would stagnate or suffer a mild recession, with a full-year expansion of a paltry 0.5%, but now it looks as if the US economy will grow in 2023 by a far more resilient 1.5%, according to forecast averages by Consensus Economics.

The global economy, therefore, has been kept alive by that one factor which economists have once more learnt to doubt at their peril – the unfailing ability of American consumers to consume. 

With aggregate demand remaining relatively resilient in the US, and the labour market consistently defying predictions of higher unemployment, the US economy has refused to roll over in the face of higher borrowing costs. 

Such relatively buoyant activity has resulted in equity markets pushing ever higher. 

The tech-heavy Nasdaq is up an astonishing 34% year to date, with the generalist S&P500 showing healthy returns of 17.61%. Reflecting this economic rerating, the US benchmark 10-year yield has risen from its lows in April of 3.30% to 4.2%. 

Second, the going has unfortunately not been so good elsewhere. 

While a recession has not quite materialised in the EU and the UK, economic activity has been more subdued. Germany, the perennial powerhouse of the Eurozone, is worryingly now an outlier of how bad things can get. 

Germany entered recession in 2023 – and is now once again being called the “sick man of Europe”, a moniker it has not been saddled with since the tough days of the 1990s when it faced the ruinous costs of rebuilding East Germany post-unification.

The source of the woes of the German economy is simple; muted demand from its most critical export market, China. 

Indeed, the former Asian powerhouse is facing secular if potentially terminal economic and political challenges in the form of a crashing property sector, rising youth unemployment, skyrocketing debt and increasing geopolitical uncertainty. Recent moves to support the currency and housing market look like increasingly desperate attempts to keep the music playing as the ship sinks.

Finally, SA has faced its own set of domestic travails which have hindered it thus far in 2023. 

Largely thanks to Eskom, the economy is likely to expand a paltry 0.3% this year, far behind similar emerging markets such as Mexico and Brazil which look set to grow around 3%. 

Worryingly, last week National Treasury reported the biggest monthly budget deficit since 2004 as government spending on social welfare grants and salaries skyrockets while revenue nosedives. The spending gap will simply have to be filled by more bond issuance. 

The South African government’s 10-year cost of borrowing has consequently risen to almost 12% from 11.50% at the end of July.

Given this mixed regional performance of 2023, the outlook is contingent on one thing; how high will rates go and what impact will this have on the economy. While the effects of higher interest rates have not been felt as promptly as expected, this is not to say they can be delayed indefinitely. 

Until a few months ago, the Federal Reserve was expected to begin cutting rates this year. However, the strength of the US economy has meant there is a small possibility that rate-setters could increase borrowing costs another quarter point, to a target range of between 5.5% and 5.75% in September. 

Economists now expect the first rate cut to come in the spring next year. This is far higher for far longer than almost anyone was forecasting at the beginning of this year when an economic slowdown was meant to do the heavy lifting in terms of moderating inflation.

To paraphrase Langston Hughes, what happens to a recession deferred? Does the economy sag under a heavy load, or does it explode? Worryingly, there is a chance that given the ever-higher interest rates, when the recession does eventually come, it will not be the more gradual economic slowdown that was predicted for 2023, but something far more violent. 

The current global business cycle of productivity and investment was already looking tired in 2019. The Covid era stimulus in 2020 and 2021 postponed the eventual build-up in stock and drop in aggregate demand characteristic of a classic inventory-led recession. 

Now combined with sharply higher interest rates, the combined effects going into 2024 could be heady. While the base case for many economists is a “soft landing”, with global GDP growing to around 2% next year and inflation in the West slowly falling below 2%, this is not guaranteed. One should not be surprised to see aggressive interest rate cuts in the face of looming deflation, perhaps by mid-2024. 

For South Africa, with commodity prices falling and rolling blackouts unabated, the secular trend of large-scale deindustrialisation across the economy continues apace. 

Should there be a global recession in 2024, led by a disintegrating Chinese economy and exacerbated by a slower US, it remains to be seen how much of an economy will be left in SA by the time it reaches the other side. 

Hopefully, a soft landing in the US and Europe will give the SA economy some breathing room to address persistent energy shortages and find its feet. 

Alternatively, the climatic extremes witnessed across the northern hemisphere could well be a harbinger of economic conditions to come. DM


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