Which economic outlook should we expect? It’s neither here nor there, with markets still having trouble figuring out whether it’s a soft landing, hard landing or no landing at all.
The scenario that policymakers and investors would want to see is a soft landing, in which inflation is reduced without triggering a recession. A hard landing – when increasing interest rates drive countries into recession – is the worst-case scenario. No landing means inflation would remain high and economies would keep growing.
Nobody knows what to expect, and growing uncertainty led to a 2.5% decline in global equities in February, pausing market growth seen since October and standing in stark contrast to the 7.0% increase recorded in January. Although data throughout the course of the month revealed that economies and labour markets are not feeling overly strained by rising inflation, the euphoria that had driven equities up and global bond rates down has waned.
Since October of last year, European equities have dramatically outperformed US equities. In February, European equities were the only area to record gains, rising 1.6% on the back of good consumer demand figures and indications of declining inflation.
It’s not all bad in the eurozone
But those hopes faltered when the new month got underway, as numbers revealed that European inflation was still persistently high. Consumer price inflation slowed to 8.5% in February, up from the consensus estimate of 8.2% but barely detectable from the previous month. The news boosted expectations that there will be another 50 basis points increase by the European Central Bank (ECB) later this month.
Meanwhile, investors were reassured on Friday by reports of continuing recovery in eurozone business activity, notably in the dominant services sector, offering the most recent sign that the region will escape a recession. But it also gave the ECB more confidence to tighten monetary policy more aggressively. Economists predict that this month’s ECB deposit rate rise will be another 0.5%.
The more sombre rate outlook sees government bond yields at their highest peak in years. As bond prices drop, bond yields climb. And while two-year UK gilts recorded their greatest February increase since 2005, two-year German bond yields reached their highest level since October 2008. The two-year US Treasury yield also came close to decade-high levels.
Some good news for the US economy
Losses for US stocks in February were similar to those for global markets, but Wall Street finished another tumultuous week in positive territory thanks to the news that the US services sector expanded steadily in February.
The statistics added to investor confidence that the economy – and business profits – can endure a higher-for-longer interest rate path as signalled by solid growth and decreasing prices. The release of the most recent US employment statistics on Friday will be a crucial indicator of the health of the economy and what action can be expected from the Federal Reserve next.
China’s markets and their effect on global economies
Asian markets fell by almost 6% in February, but on Wednesday – when statistics revealed that Chinese manufacturing activity had increased at its quickest rate in almost a decade – they had their best day in seven weeks, recovering from a two-month low.
The performance was better than anticipated and added to the debate over whether China’s rebound will benefit the rest of the world by boosting GDP or leading to a rise in inflation. This outcome reflects the spike in activity following the relaxation of the country’s zero-COVID policy (ZCP).
David Rees, Senior Emerging Markets Economist at Schroders, is sceptical that China’s economic reopening would have much, if any, positive effect on the world economy.
‘‘China’s services sector was the most hampered by ZCP and is likely to experience the same release of pent-up consumer demand. However, unlike other economies – certainly developed markets – Chinese households are not sitting on a huge stock of savings that can fund a prolonged period of rampant consumption.”
Schroders anticipates growth above trend in 2023, but when pent-up demand is satisfied, the ‘sugar high’ rebound will end in 2024. Rees predicts that the rebound will favour services over manufacturing. Rees continues:
‘‘Prior strong investment and soft external demand means the recovery is unlikely to spur a renewed investment cycle in manufacturing that sucks in imports from Europe and the rest of the world.”
Rising house prices in the UK
UK stock prices concluded the week with small increases. According to Nationwide, the year to February saw the largest yearly decline in house prices in more than a decade. The building society predicted that the market will struggle to pick up steam in the short term due to economic headwinds like a deteriorating labour market and rising borrowing costs.
The difficulty for borrowers was highlighted by remarks made on Wednesday by Andrew Bailey, Bank of England governor, who said that interest rates may need to increase once again to slow the cost of living. Rees said:
‘‘I would caution against suggesting either that we are done with increasing the Bank Rate, or that we will inevitably need to do more.”