Clouds in the economy will become either a hurricane or a tropical storm – the ultimate triangle and four stock scenarios

Although a major hurricane appears less likely for the global economy than it did a few months ago, it is very likely that we will experience a severe tropical storm that will cause significant damage, says the prominent economist. Nouriel Roubini With an article by project syndicate, Adding:
Much will depend From how the major central banks They will face The final “triple”: maintaining prices, growth and financial stability at the same time.

scenarios…

In particular, according to what is known as dr Doom, There are currently four scenarios On the prospects for the global economy and the future of stock markets.
three It involves serious risks, with far-reaching effects on the markets:
most positive It is a “soft landing,” in which central banks in advanced economies will bring inflation back to the 2% target without causing a recession.
in The second case There is also the possibility of a soft landing.
Here the inflation target is met, but through a relatively mild (short and shallow) recession.
the Third scenario It is estimated that there will be a hard landing…
On this basis, a return to an inflation rate of 2% presupposes a prolonged recession, with the potential for severe financial instability (such as greater bank distress and highly leveraged factors leading to severe debt servicing difficulties).
If efforts to reduce inflation lead to severe economic and financial instability, Fourth scenario also becomes possible.
Accordingly, central banks decided to allow above-target inflation, risking derailing inflation expectations and a continuing spiral of wage prices.

economics

As it stands now, the Eurozone is already in a technical recession, with GDP contracting in the fourth quarter of 2022 and the first quarter of 2023, and with inflation still above target (despite its recent decline).
The UK is not yet in recession, but growth has slowed sharply and inflation remains stubbornly high (above the OECD average).
And the US suffered a sharp slowdown in the first quarter of 2023, even as core inflation (excluding food and energy prices) continued to rise (although it has fallen, it is still above 5%).
Meanwhile, China’s post-Covid-19 recovery appears to have stalled, calling into question the government’s relatively modest target of 5% growth in 2023.
Other emerging market and frontier economies are growing relatively weakly compared to their potential (with the exception of India), and many of them are still suffering from very high inflation.
Which of the four scenarios is most likely? Rubini wonders – right…
Although inflation has fallen in most advanced economies, it has not done so fast enough—at least not as fast as central banks had hoped—in part because tight labor markets and rapid wage growth have intensified inflationary pressures in stressed sectors. . work (such as services).
In addition, expansionary fiscal policies continue to fuel demand and help keep inflation low.
This fact, by itself, has made it difficult for central banks to fulfill their mission of price stability.
Market expectations that central banks will end the cycle of raising interest rates and even start cutting interest rates in the second half of 2023 have been dashed.
The Federal Reserve, European Central Bank, Bank of England and most other major central banks will have to raise interest rates further before they stop tightening.
However, the economic downturn will become more persistent, which will increase the risk of economic downturn and the accumulation of new debt, which will increase banking pressures,” says Dr. Doom.
According to the economist, geopolitical developments – for example the unsuccessful advance of Wagner in Moscow – continue to plunge the world into instability, deglobalization and fragmentation.
Now that China’s recovery has lost steam, there must be either aggressive stimulus policies – with ramifications for inflation around the world – or a significant reduction in the growth target for individual countries.
On the positive side, however, according to Roubini, we should note that after the failure of the banks in March and the fall in commodity prices, the risks of a serious credit crunch receded (due in part to expectations of a recession), which also led to a downturn that contributed to containing Commodity inflation.
Therefore, the risk of a hard landing (the third scenario) is less likely than it was a few months ago.
But with continued high wage growth and core inflation forcing central banks to raise interest rates further, a short and shallow recession next year (second scenario) has become more likely.
Worse, if a mild recession occurs, it will further erode consumer and business sentiment, setting the stage for a more severe and prolonged recession and raising the risk of financial and credit stress.
Faced with the possibility of the second scenario developing into the third scenario, central banks may allow inflation to remain well above 2%, rather than risk triggering a serious economic and financial crisis.

trimmings

Thus, the monetary policy trinity of the early 2000s still holds.
Central banks face the very difficult task of achieving price stability, growth stability (without recession), and financial stability, all at the same time.
What would be the implications for asset prices in these scenarios?
So far, US and global equities have reversed the bear market while bond yields have moved slightly lower – a pattern consistent with a soft landing for the global economy, with inflation edging toward its target rate and avoiding deflation development.
However, stocks are likely to see significant declines…
If central banks do not send the right signals, the resulting rise in inflation expectations will push up long-term bond yields and ultimately hurt stock prices because of the higher discount factor applied to dividend payments.
So, while the possibility of a major hurricane affecting the global economy seems less likely than it did a few months ago, we could still have a tropical storm that could cause significant economic and financial damage.Nouriel Roubini concludes.

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