Global Economic Slowdown – Recession on the Horizon?

We in the U.S. aren’t alone in our economic concerns. Most of the trends that are negatively affecting our current economic picture and outlook are also, to varying degrees, affecting much of the rest of the world. Growth rates are decelerating, and inflation rates are worryingly high. The ramifications of a buildup in demand without a corresponding increase in supply for many commodities and other goods has increased pricing both globally and domestically. 

Recently, the International Monetary Fund (IMF) adjusted their global economic growth outlook, which of course meant an adjustment in their outlook for individual country growth rates as well. We have found in the past that the IMF’s ability to accurately forecast the world’s economy has been poor. 

Like most governmental agencies, the IMF seems to be consistently behind the curve when adjusting their outlook. They seem to be late in raising or lowering their outlook as compared to the private sector. Nonetheless, it is still instructive to know what organizations like the IMF (and the Federal Reserve, for that matter) think about the economy, as their outlook can influence money flows. 

Below is data from the IMF regarding expected GDP (real) growth and projected consumer price changes:

Some thoughts as to the IMF’s latest estimates: 

• The expected economic growth and inflation deceleration that we have been calling for this year is reflected in the IMF’s view. Globally, the IMF expects GDP growth to slow by 41% between 2021-2023. In the U.S., growth rate deceleration is expected to be 60%. The outlier to this view is Japan, which is expected to show a growth rate acceleration of 43%. 
• From an inflation standpoint, the IMF’s outlook is calling for global inflation rates to decelerate to 4.1% by 2023—an inflation deceleration rate of 35%. In the U.S., the expectation is for inflation rates to decelerate by 69% by the end of 2023 to 2.3%. Once again, Japan is the outlier to this global view, which is expected to see a limited uptick in inflation pressure to 0.9% by the end of 2023. 
• The IMF attributes the global growth slowdown (particularly in Europe) to the Ukrainian war, along with global supply channel disruptions. Their report doesn’t highlight government fiscal actions as a major reason behind the rise in inflation pressure. Directly from the IMF report we find: “The war in Ukraine has exacerbated two difficult policy trade-offs between tackling inflation and safeguarding the recovery and between supporting the vulnerable and rebuilding fiscal buffers.”
• Comparing the IMF’s forecast for the U.S. economy against ours, we find that our forecast for GDP growth at 2.5% is lower than the IMF’s revised data, while our outlook for inflation is lower at 4.0% vs. the IMF’s expectation of 5.3% inflation. Our outlook for “nominal” GDP growth of 6.5% in the U.S. is significantly lower than the IMF’s forecast of 9.0%. We suggest the IMF is on the path to continue to rein in their growth forecasts going forward. 

What isn’t shown above is the changed outlook from the IMF’s previous report in January. According to data reported in The Wall Street Journal,¹ as compared to their previous estimates the latest forecast includes the following:  

• 2022 global growth expectation is 0.8% lower than the report in January and a full 1.3% lower than their report of October 2021. So, not only does the IMF believe we will see slower growth this year as compared to 2021, but that estimate continues to contract. 
• Additionally, the report shows 2023 estimated growth to be slower than earlier estimates.  So, the slowdown isn’t temporary, and the degree of slowdown continues to worsen. 
• The report estimates that the Ukrainian economy was expected to contract by a whopping 35% this year. Russia’s economy will also contract but by a lesser 8.5% this year and 2.3% next year. Of course, these numbers are very fluid, as the outcome of the war is uncertain. 
• Global inflation trends are also being aggravated by the war in Ukraine. Before the war, Russia and Ukraine grew 28% of the world’s wheat exports, while Russia and Belarus supplied 40% of global exported potash and other critical fertilizer components. This, of course, is adding to global food costs. 
• This noted disparity of food costs is adding to the further divergence between developed and lesser-developed economies’ growth and income prospects. 
• China, a long-standing major global growth engine, is expected to grow more rapidly than the world in general. The IMF report suggests China’s economic growth will slow to 4.4% this year, well below the goal of the Communist leadership’s growth target of 5.5%. A renewed COVID outbreak is negatively affecting China’s economic profile. 

Stagflation All Around

A solid conclusion of the IMF’s view is that stagflation, the economic condition of contracting growth and higher-than-normal inflation, isn’t just a U.S. condition but appears to be global in reach. If we look at the estimated growth changes between 2021 and 2022, and compare those variances to projected changes in inflation pressure, we find: 

It appears by these estimates that the IMF expects Europe, the emerging economies and the world in general to experience a more intense stagflation problem for the remainder of this year than we should expect here in the U.S. If this occurs, it could severely limit what the world’s major central banks are able to accomplish. Should they fight a decline in growth prospects? Yes. Should they fight stubbornly high inflation rates? Yes. 

As can be seen, the world’s central bankers are in a tight bind and need to walk a tight-rope policy environment where a mistake (too accommodative or too restrictive) could throw the world’s economy into a recession or fuel already-high inflation pressures. The bind the world’s central bankers now find themselves in has been created by public policy errors on both the monetary and fiscal sides. 

I have written extensively in the past that I believe the Fed made a major error last year in the maintenance of quantitative easing (QE) activity. Additionally, the Biden administration’s trillion-dollar spending package that was released in 2021 has proven to be ill-timed. This package, which had a stated goal to lift the economy out of a growth drought, did little but ramp up final demand levels at a time when the world’s ability to increase supplies of many items was limited. 

The result? Higher inflation all around. I suggest today’s global inflation problem wasn’t a result of “greedy” businesspeople or Putin’s war in Ukraine, as some in Washington would suggest you believe. It was a result of bad political and monetary decisions made in the world’s capitals. The prospect of global stagflation, which I carry at a 40% chance of being the dominant economic fundamental going forward, has done nothing but intensify of late. The IMF’s outlook does nothing but solidify this outlook and intensifies the probability that stagflation may indeed be the economic byword for 2022.

Stagflation trends are not just present here in the U.S.—they are global in their reach.

Recession – Odds Increasing

All this brings us to the conclusion that the odds of the U.S. economy falling into an outright contraction—a recession—seem to be rising. Dr. Bob Dieli is an old colleague of mine, as we both worked at the Northern Trust company in Chicago, where I was a portfolio manager and Bob was a staff economist. Bob is now the writer/editor of the economic forecasting newsletter No Spin Forecast and likes to say that in a stagflation environment, the “flation” eventually gives way to the “stag” portion of the equation. In other words, stresses build, and inflation trends soften as economic growth softens.   

Sentiment polls are important. They are measures of people’s willingness to transact. If people feel good about the economic environment, they are more willing to buy something or to make an investment—to create a transaction, if you will. The trends of both consumer and small-business sentiment polls have been deteriorating over the last few months, as consumers and small-business leaders alike have been worried primarily about the effects of rising inflationary pressures. 

Additionally, the consumer “misery index,” a combination of unemployment rates (which are low) and inflation (which is high), has been worsening. This is an indicator that consumers are becoming less willing (and in many cases, less able) to transact. On a global scale, 100% of the measured misery indexes are now registering above their rolling five-year averages, according to Ned Davis Research. We have seen this broad-based reading of the global misery indexes three other times in the past 22 years, all of which coincided with the start of economic recessions. 

Is there a difference this time around for the misery indexes? This time around, the breadth of the index readings is being driven by inflation pressure and not unemployment, which was the case in the previous three readings. This is important, at least for a period. A deteriorating jobs market (rising unemployment) tends to be a precursor to a recession. Rather than a deteriorating jobs market that we saw in the three previous periods of an upward push in the misery index, this time, the index is being driven by an upward push in inflation. However, as noted previously, the “flation” side of the stagflation equation eventually gives way to the “stag” side of the problem. While the misery index isn’t a significant worry today, we need to carefully watch for signs of deterioration in the labor market. If that occurs, the probability of recession may increase.

We use three fundamental indicators of rising recession probability: 

• 2-10 Year Treasury Yield Curve has inverted. While it isn’t inverted today, the yield on the 2-year U.S. Treasury note did trade higher than the yield on the 10-year note—historically, a precursor to an upcoming recession. This indicator tends to front-run recessions by 12 to 18 months. Importantly, the fed funds to 10-year Treasury yield curve has not inverted. If typical, not only does the 2-10 year Treasury curve invert prior to a recession, but the fed funds to 10-year inverts as well. This hasn’t occurred. 
• Results of both the manufacturing and services sector PMI indexes – currently do not suggest an upcoming recession, as both indexes remain well above the neutral “50” read. 
• Six-month rate of change of the Leading Economic Indicators (LEI), which traditionally have shown an annualized six-month change of at least -3% prior to the onset of a recession. The six-month LEI change, while flattening, isn’t near a -3% read as of yet. 

Only one of these three indicators is flashing “caution” at this stage. With this in mind, we carry a 20% probability that the U.S. will experience recession this year, the lesser probability outcome of our three economic main calls. 

Final Word

With all that being said, we continue to carry a 20% probability that yes, we will experience a recession sometime in 2022. Remember, the U.S. economy has experienced recessions 12% of the time since the end of World War II, according to the National Bureau of Economic Research. We think, along with building global stagflation stresses, the probability of recession this year is higher than normal but still not our “core” call. 

¹“IMF Sees More Dire Economic Picture,” April 20, The Wall Street Journal

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