Weekly Wrap: Risking a recession

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Written by Citadel Global Director, Bianca Botes

RISKING A RECESSION

As inflation continues to surprise, central banks around the world are well aware that their efforts to rein in inflation will have a negative impact on their economies. It is a risk that they are willing to take for the sake of price stability and to prevent deep economic damage caused by high levels of inflation over a prolonged period of time.

Key themes for this week include:

·       The risk of a recession

·       Chinese manufacturing rebounds

·       European Union (EU) stocks end the second quarter with double digit losses

·       Oil experiences first monthly loss for the year

·       Dollar back near 20-year high

RECESSION PROBABILITY ON THE RISE

While investors have long been gearing up for a recession, this week saw United States (US) Federal Reserve (Fed) Chairman, Jerome Powell, acknowledge the risk and state that it is a risk that the Fed, as well as other central banks around the world are happy to take, as the damage to economies, from high inflation, far outweighs the risk of recession that we currently face.

A recession is defined as a substantial decline of economic growth and is typically recognised as two consecutive quarters of a decline in gross domestic product (GDP), which reflects economic growth. However, the National Bureau of Economic Research (NBER) defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

What is important to bear in mind, is that all recessions are not created equal, for example, the NBER officially declared the end of economic expansion in February of 2020 as the US fell into a recession brought on by the Coronavirus pandemic. According to the NBER, this recession was the shortest on record, ending only two months later in April 2020. In stark contrast, the financial crisis of 2007 and 2008 was one of the deepest recessions on record. According to the NBER the US has been the victim of 34 recessions since 1854, and five since 1980. It is also important to note that the difference between a recession and a depression is based on the duration of economic decline, depressions last over a number of years, while recessions last for a number of months.

So, what causes a recession? Taking a lesson from history, one can conclude that a recession is almost always preceded by a period of tightening monetary policy (rising interest rates, for example) and fiscal contraction (less government spending, higher taxes, or both) and often higher energy prices.

If we enter a recession, what can we expect? Depending on the duration and depth of the recession, there can be numerous effects. Some key consequences of a recession include:

  • Business revenue and profits tend to decline
  • Manufacturing output declines
  • Unemployment rises
  • Businesses and households lose their credit worthiness resulting in mass credit impairment

Investor and analyst predictions indicate a 50% to 60% risk of recession, Fed Vice Chair, Alan Blinder, also supports these probabilities.

While these are just probabilities, based on various economic indicators and interest versus inflation projections, one thing is certain, economic uncertainty is rife and tough times are still ahead. While we take all these various elements of a recession into consideration, the most important thing to remember is, that recessions come and go, and history shows us that, so far, all recessions eventually come to an end.

DATA IN A NUTSHELL

The official China NBS Manufacturing PMI rose to 50.2 in June, recovering from 49.6 the previous month. This reading marks the first expansion in factory activity since February and at its fastest pace in six months, as major economic hubs, including the financial capital, Shanghai, lifted COVID-19 restrictions and lockdown measures. Output, new orders and buying levels rebounded, all growing for the first time in four months.

United Kingdom (UK) GDP grew by 8.70% in the first quarter of 2022, over the same quarter of the previous year, while business investment fell 0.6% quarter-on-quarter in the first quarter of 2022, compared to a preliminary estimate of a 0.5% decrease. It marks the first quarterly decline since the first quarter 2021.

The unemployment rate in the eurozone fell to a fresh record low of 6.6% in May, from 6.7% in April, and compared to market forecasts of 6.8%. The unemployment rate for women decreased to 7.1% from 7.2% and for men it fell to 6.2% from 6.3%.

The number of Americans filing new claims for unemployment benefits dropped by 2000 to 231 000 in the week ending 25 June. On a non-seasonally adjusted basis, initial claims rose by 1 060 from the previous week to 207 421, with noteworthy increases seen in New Jersey, Massachusetts, Ohio and Kentucky.

Producer prices in South Africa soared by 14.7% year-on-year in May, accelerating from a 13.9% rise in the previous month. This marks the sixth consecutive month of double-digit producer inflation and the highest reading since records began in 2013. The South African trade surplus broadened to R28.35 billion in May from an upwardly revised R16 billion in the previous month. Exports advanced 17.8% to R179.46 billion, mainly due to higher shipments of mineral products, base metals, chemical products and vegetable products.

S&P500 ON VERGE OF WORST HALF YEAR SINCE 1970

All three major US stock indices opened Thursday’s session in deeply negative terrain, with the S&P 500 heading for its worst first half since 1970, amid continuous concerns over the implications of soaring inflation and tighter monetary policy. All three major averages were also on track to post steep monthly, as well as quarterly losses, with technology stocks hit hardest.

European stocks descended on the last trading day of June and were set for their worst quarter since early 2020. The DAX slumped nearly 3%, to levels not seen in four months, pushing second quarter losses to over 11%, while the STOXX 600 dropped almost 2%, also down more than 11% on the quarter, as fears of a recession intensify due to the war in Ukraine. The auto sector was among the worst performers, shedding close to 5%, reaching levels last seen in November 2020. Meanwhile, shares of German energy company, Uniper, nosedived nearly 16%, after the company withdrew its financial outlook for 2022 on Gazprom gas supply restrictions.

Stocks in London were also in the red, shedding value for second consecutive session on Thursday, with the blue-chip FTSE 100 bottoming out below the 7 200 level, dragged down by heavyweight materials stocks. B&M European Value Retail and Burberry Group were among the biggest stragglers on the index, down 4.5% and 3.7%, respectively. The benchmark FTSE 100 lost nearly 6% in June, putting it on track to post its first monthly decline in four months.

The JSE FTSE All Share Index extended its losses for the second consecutive session on Thursday, as investors continued to assess the global economic outlook. Commodity-linked sectors were the main losers, followed by retailer, industrial and financial stocks. Domestically, South Africa’s state power utility, Eskom, said power cuts are set to continue until Friday, blaming an illegal strike linked to a wage dispute with trade unions that began last week. The JSE is on track to see a decline of 7.6% in June, its biggest decline since March 2020.

OIL CAUGHT BETWEEN DECLINING DEMAND AND TIGHT SUPPLY

Brent Crude futures fell almost 1%, to trade back below $116 a barrel on Thursday, following a seesaw week, ending the month of June with a marginal monthly decline. Investors continue to weigh fears of an economic slowdown and signs of weakening US fuel demand, with near-record prices, which are likely suppressing consumption. On the other hand, tight supply continues to pressure the oil market, amid the ongoing war in Ukraine and outages from Libya and Ecuador. Meanwhile, the extended Organisation of Petroleum Export Countries, OPEC+, remains bound to approved oil output increases in July and August and refrained from any policy discussions for September.

Platinum futures rose to a one-week high, to trade near $920 per tonne, rebounding slightly from its 20-month low of $907, hit earlier in the week, as hopes of solid demand and fears of tight supplies more than sufficiently offset the global growth concerns. Demand is expected to rise as the Chinese economic hubs reignite international travel and start to resume leisure activities after a two-month lockdown. Global platinum supply is expected to remain tight as the war in Ukraine shows no signs of abating. Platinum shipments from Russia, the world’s top supplier, have been disrupted due to the war. Meanwhile, traders assessed the latest gold import ban from Russia by the G7 leaders, waiting to see if the decision spills in the platinum market too.

Gold remained subdued at $1 820 per fine ounce on Thursday and was set to decline for the third consecutive month, facing pressure throughout the quarter from a strong dollar and rising Treasury yields, as the Fed leads its central bank peers in aggressive monetary tightening to combat rocketing inflation.

DOLLAR RALLIES YET AGAIN

The dollar index traded above the 105 mark on Thursday, hovering close to the 20-year high of 105.79 touched in mid-June, as global recession fears bolstered demand for safe-haven assets such as the dollar, while the Fed’s hawkishness also supported the currency. In addition, Cleveland Fed President, Loretta Mester, said that she will be advocating for another 75 basis point rate increase in July, should economic conditions remain the same.

The euro weakened further to trade near the $1.04 mark, edging closer to the five-year low of $1.035 hit in May, on the back of a stronger greenback. Investors’ preference toward the safer dollar grew as concerns of an energy crisis in Europe threaten the eurozone’s economy ahead of the winter. Confidence in the currency bloc also came under pressure after European Central Bank (ECB) President, Christine Lagarde, said that she believes it is unlikely that the eurozone will go back to an environment with low inflation. The ECB had confirmed a 25 basis point rate hike in July after multiple ECB policymakers called for a steeper increase.

The British pound is set to end the quarter below $1.22 and lost more than 10% in the first half of the year, the worst six-month performance since 2016, the year of the Brexit referendum. A general dollar strength, mounting recession fears, soaring inflation rates, and a fall in UK’s living standards have been weighing on the currency.

The South African rand traded weaker to around R16.40/$, the weakest level since October 2020, pressured by severe power cuts in the country, as state-owned power utility, Eskom contends with multiple plant breakdowns due to labour protests over wages. There is widespread concern that the current round of loadshedding could have long-term effects on the country’s economic growth. The currency also felt pressure from the dollars’ broad-based strength. Meanwhile, South Africa’s higher-than-expected inflation data in June points to a further interest rate hike in July.

The rand is trading at R16.39 /$, R17.12/€ and R19.84/£.