We have all the makings of a riveting tale. Heroes and villains, war, hardship, and enduring hope in spite of it all. It seems like there is no end in sight to the geopolitical strife. Every day, economists and pundits paint a picture of doom and gloom. Recession, deflation, starvation, and other worst-case scenarios dominate the headlines.
Could relief be just around the corner? Is a surprise plot twist that changes everything possible?
Let’s take a quick tour around the world to examine the global economic environment as we attempt to read the tea leaves.
The situation in Europe appears grim and we suspect a brutal winter is in store. Rampant inflation is driving up the cost of food and energy. While natural gas imports from Russia via the Nord Stream 1 have been reduced by 80%, creative alternatives to import it from elsewhere have hit roadblocks. Venezuela has paused its shipments of oil and Israel is thwarting a nuclear deal for Iran that would allow the pariah state to export energy to Europe. This will test the resolve of European States that desperately need Russian energy imports.
Meanwhile, the financial data from China shows a weak economy. Month over month and year over year, industrial production, retail sales, and home sale prices are all trending lower. The nation’s exports are still humming along, but the backdrop of a weaker global economy is likely to put downward pressure on the Yen, which bodes well for the US.
It’s clear that European and Asian economies are simply not able to cope with inflation. This is enticing capital to flock to the safety of the US dollar, in turn causing it to appreciate more than we would like. The ever-resilient dollar is likely to reach new heights in the weeks ahead, and this may harm the prospects of exporters.
In other news from US soil, most corporations are reporting earnings that show an increase in earnings per share (EPS) and revenue. Forward guidance has been upbeat and positive. Despite chatter of slowdowns and layoffs, the unemployment rate continues to hold steady at 3.6%.
We expect that the Federal Reserve will continue its tightening cycle through the end of this year and then start easing up early next year to spur demand and growth. They continue to face a very tight, if not impossible, balancing act. On the one hand, they want to get inflation back down below 2%; on the other hand, they must balance the risk of not raising rates too rapidly and damaging a fragile economic recovery.
At the Fed’s Jackson Hole meeting later this month, a 50 basis point increase has been priced into the markets, while some pundits have not ruled out a 75 basis point increase. The Fed’s sentiment seems to be to get the fed fund rate to 4% and to maintain that level for a sustained period. Looking at the bigger picture, 4% is still relatively low, and any increase above 6% would be harmful to growth and the economy in general. We are very optimistic and bullish for now but will be watching how inflation responds as the fed rate approaches that 4% mark.
A few leading indicators suggest an imminent slowdown. The Economic Cycle Research Institute’s Weekly Leading Index (WLI) has been on a downward trajectory for several months (though the rate of the decline has slowed in recent weeks.) The Baltic Dry Index has also been in a downward trend, and it doesn’t look like it will abate anytime soon.
This brings us back to the initial question. Could there be a fairy tale ending to the global economic turbulence? It may seem fanciful, but there is a ‘Cinderella Story’ scenario that has been flying under the radar.
The G20 summit has been scheduled to take place in November in Bali, Indonesia. President Putin confirmed he would attend in person, and the United States has been encouraging President Zelensky to participate as well. Currently, both nations are at a stalemate: Ukraine is unwilling to cede territory; Russia has been conducting military operations near a nuclear plant and preparing major strikes on Ukraine’s infrastructure in the coming days.
Could the G20 be the entre to a truce? If Russia and Ukraine were to come to the table and reach an agreement, it would go a long way in the fight against inflation. And if normal pre-war trade were to resume, overall economic growth and prosperity would return around the world.
Only time will tell if this can become a reality.
