Recession risks ease, but inflation fears resurface

Recession risks continue to ease as the global economy face easing headwinds and shortterm leading indicators have turned higher. Chinese PMI data for February were even stronger than expected and point to a frontloaded recovery of both the service and manufacturing sector. We look for China’s growth to rise to 5.5% this year from 3.0% in 2022 and the rest of the world should see a positive spill-over in both manufacturing as well as services (as Chinese tourists return).

On top of China’s recovery, the energy crisis in Europe has calmed down a lot, at least for now. Mild winter weather and a reduction in energy demand from discretionary measures have pushed down gas and electricity prices significantly. Oil prices have not taken off despite the Chinese recovery, partly due to the lower European energy demand. In the US, households raised consumption again in early 2023 and job growth stayed very solid pushing the unemployment rate down to 3.4%, the lowest level since the 1960’s. Mild weather may be part of the reason but even so, the overall picture looks stronger than anticipated a few months ago. Unemployment in Europe has also refrained from moving higher despite the economic slowdown, and the latest surveys suggest that consumers no longer expect unemployment to go up. There is widespread uncertainty on whether lagged effects from rate increases and eroding buffers as savings are drawn down will be enough to cool down the economies as much as needed.

Amid the stronger economic backdrop, inflation fears have resurfaced. It follows new upside surprises in inflation in both the US and the euro area, where core inflation is running at 5.6% and 5.3%, respectively. With labour markets tight and easing growth headwinds, it seems clear that central banks have more work to do. Rate markets have thus repriced expectations for rate hikes and now see another three 25bp hikes by the Fed taking the ‘peak rate’ to 5.4% and in the euro zone the market looks for another 150bp lift to the policy rate this year taking the ‘peak rate’ close to 4%. We broadly agree with the market pricing and have increased our forecast for rate hikes from the ECB to include a 50bp hike here in March, another 50bp in May, followed by two 25bp increases. However, there is clearly a high degree of uncertainty also within the ECB, and the outlook can quickly change in either direction if data starts to paint a different picture. Markets no longer price rate cuts later this year, which we always thought was premature.

On the geopolitical front, US-China tensions have flared up again, after the US shot down an alleged Chinese ‘spy balloon’ and White House officials stated they saw indications that China contemplated selling weapons to Russia. China has presented a peace plan including proposal for ceasefire on the war in Ukraine, but it has gained little traction and is unlikely to change much. We still see the conflict as frozen with no end in sight, unfortunately.

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