With just over 30 days to December 15, when many South Africans go on leave, it is useful to assess where we are in global markets.
Since Russia’s war in Ukraine, geopolitics and global fragmentation have become key elements to consider in assessing market worries and predicting what comes next.
High inflation and rising interest rates, and the impact these have on global economic growth, are the major concerns. China’s economic growth, which has been weak owing to drag from its real estate market, is also a major concern, especially for commodity-exporting emerging markets. Inflation has peaked and is now on its way down, but is still well above central bank targets.
The International Monetary Fund’s global growth expectation for this year remains unchanged at 3%, and is marginally down to 2.9% next year from an earlier estimate of 3%. Unsurprisingly, the eurozone’s growth expectation has been revised down this year and next year, owing to weaker growth in Germany, Italy and Spain.
“Given where US interest rates and general borrowing costs are, it is difficult to see how we won’t end up with a recession next year, however mild it might be”
On the upside, the US has continued to surprise, with growth expectations of 2.1% for this year and 1.5% next year. The disappointment has been China, whose expected growth for this year and next has been revised lower. Fiscal stimulus came in late, while monetary policy stimulus was marginal.
Central banks in many advanced economies — particularly the US Fed, the European Central Bank and the Bank of England — are now at or near the top of the interest rate cycle. Their rates will stay higher for longer before they start to come down next year. Emerging markets have started cutting interest rates earlier than advanced economies. However, this process will not be as tightly synchronised as the rate hikes were.
This is where we are. But what worries markets as we gear up for next year?
Top of the list is how the Hamas-Israel war unfolds. There are three scenarios. First, the war is confined — which is what seems to be priced in markets — but clearly we are shifting away from this situation. I think markets are mispricing by assuming a confined conflict. Second, there is a proxy war, with Iran supporting Hamas to fight Israel. This is where we are, but oil and the broader market are not pricing this currently. The third scenario is a direct conflict between Iran and Israel, which will imply a shock to oil markets well above $130 a barrel.
The second risk that worries markets is the possibility of a US recession. Here the jury is still out, as there are wide divergences in market expectations. Given where US interest rates and general borrowing costs are, it is difficult to see how we won’t end up with a recession next year, however mild it might be. There are those who believe the resilience displayed so far will continue into next year. I wonder if they are watching the numbers for home purchases, which are at levels seen only once previously, before the 1983 recession.
There are also other indicators of a looming recession, such as the percentage of people delinquent on their credit card debt, particularly the young and middle aged, and prices for medium-level homes. Car loan delinquencies are also on the rise. All this has led to a 20% contraction in banks’ willingness to lend to consumers, which historically has always foreshadowed a US recession. Fiscal policy has been the driver of resilience, but this will need to be financed. There will have to be a debt transfer from the government to the private sector in the future, and this usually hurts the private sector.
The timing of a US recession is key; it will create tailwinds for risky assets, including those in emerging markets. Both a US recession and a soft landing — no US recession and low inflation — will have somewhat similar outcomes for emerging markets. With a soft landing the rally will be smoother, while a recession carries risks for trade ahead of the rally once the Fed starts to cut.
Either way, it seems by the end of next year conditions will be better than this year. The risk is if the Middle East war expands across the region and directly involves Iran. In that case, these assumptions might be turned upside down, resulting in a global recession.
On the domestic side, the general elections next year are now top of mind. There are three scenarios: a stable coalition, a pro-reform coalition, and a populist and unstable coalition. The first and the second will likely lead to a rally in the markets, while the third will be a shock to them. What is currently priced in is a stable coalition — and thus there is a tail risk for markets.