Macro forecasts: charts and commentary

US

Inflation rose further over the past three months, to the fastest pace in over 40 years. Energy was the dominant factor, as global wholesale prices surged higher amid the ongoing conflict in Ukraine. However, core inflation also remained stubbornly high, as prices in the service sector increased more rapidly, reflecting strong demand and labour supply shortages.

We expect inflation will rise further in the near term, before falling back steadily through 2023. The ongoing inflationary impulse led the Federal Reserve to embark on a rapid tightening of policy, most recently raising policy rates by 75bps.

With the focus on bringing inflation down, we expect policy to move into restrictive territory in the coming months. Final domestic demand in the US remains robust. However, with the inflationary backdrop, alongside a rapid re-pricing in rate expectations and sharp falls in asset prices, we have marked down growth for 2022 and 2023 to below trend, and judge that the risk of recession (albeit likely mild in nature) within the next 18 months is now close to 50 per cent.

Figure 1. US

Euro zone

The short-term outlook continues to be dominated by the supply-side shock emanating from the conflict in Ukraine.

Growth has slowed and risks are clearly to the downside, especially if Russian energy supply is further restricted or if sanctions are increased. But the euro zone economy has also shown some resilience, perhaps because there was more “catch-up” to come through following the Omicron disruptions at the end of last year.

The other main driver of prospects is high and – in some cases – still rising inflation which is squeezing household real incomes significantly and pushing consumer sentiment to all-time lows.

The ECB has had another bout of clumsy messaging but is poised to raise policy rates slowly and steadily. Whether they will push rates up to the 1 per cent projected for end-2022 by markets looks less certain.

Figure 2. Euro zone

UK

The combination of the highest inflation for 40 years, sharply slowing growth, war in Europe and political turmoil is not conducive to the emergence of a feel-good factor. And although we continue to believe that a global recession can be avoided, that threat appears most credible in the UK.

Q2 is an almost certain negative and the outlook for Q3 (and beyond) is not good. Confidence is hitting new lows and Britain’s exports have not picked up in line with the post-COVID recovery in global trade flows – Brexit effect?

The Bank of England is torn between acting “forcefully” to tame inflation and adding to the growth headwinds and economic pain. For now its anti-inflation credentials are driving policy decisions, but that could change in H2 as growth slows further.

Figure 3. UK

China

A series of policy errors has damaged growth, but little will change ahead of the 20th Party Congress in October, when President Xi will break with precedent and stay for a third term.

Zero-COVID Policy will remain indefinitely, but is doomed: lockdowns seem inevitable, although a disastrous Q2 will mostly reverse, leading to a big rebound in Q3.

China’s policymakers are now focused on cushioning the damage from the property market downturn, with defaults and pressure on local government finances being countered with stimulus, particularly expanding infrastructure. Measures include tax refunds, subsidies, and special local bonds for rail, roads, and power projects. PBOC rate cuts will be small, and CNH weakness will continue, as inflation remains low – the only way the 5.5 per cent GDP growth target will be reached is by moving the goalposts.

China’s ties to Russia, and ESG concerns will likely lead to sanctions and outflows.

Figure 4. China

Japan

In Japan, “Living with COVID” has finally begun, begetting a tailwind from services for growth, boosted by travel subsidies.

Exports are at strong levels but no longer increasing, and manufacturing – particularly autos – is hampered by supply chain issues. These should improve in H2, but there is two-sided risk given China’s policy error and adherence to ZCP.

PM Kishida’s “New Capitalism” is an effort to boost productivity and Green Investment; in the short term, a weak currency can boost growth and large-cap equities, as well as household wealth given offshore portfolio holdings.

The BoJ continues to largely ignore 2 per cent inflation and a trend in core inflation close to 2 per cent, as it is just 0.8 per cent y/y. Change to YCC could happen soon and would lead to higher yields and some yen strength, but this may only happen at the end of Kuroda’s term in early 2023, leaving the BoJ an outlier and the yen vulnerable.

Figure 5. Japan

Canada

The recovery in Canada has been stronger and faster than initially expected. Significant tightening in the labour market has pushed unemployment to a record low of 5.1 per cent.

Wage growth has picked up and is broadening across sectors but remains negative in real terms. Pressure for further wage rises is unlikely to abate any time soon.

Inflation is very high, increasingly broad-based and therefore the primary focus for the BoC. The BoC has hiked 125bps so far in 2022 with the market pricing nearly 200bps of further hikes before year end. High levels of debt make for a difficult balancing act for the BoC, increasing the risk of recession if the economy is more sensitive to rate rises than expected.

Figure 6. Canada