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The economy and markets
Key points to note
Believe it or not, things are getting back to normal.
It may not feel like it, but the global economy is getting back to normal. Prices are falling for durable goods as demand has dried up, but rents continue to rise, supported by undersupply and rising wages. Consumers are willing to pay high prices for long-delayed vacations. Meanwhile, tighter monetary policy is behaving as expected on parts of the economy — like housing — that are most sensitive to interest rate changes. Understandably, investors are focused on areas where conditions remain abnormal: The labor market imbalance favors workers and will tend to push wages higher. And energy prices remain highly volatile and hugely influential on policymakers, adding uncertainty to our outlook.
Some countries’ slumps will be worse than others’.
The world is not inching back toward normal in unison. Countries with lower personal income levels and more dependence on energy imports will likely suffer more severe slumps than those in which inflation is moderating and real incomes are rising. Governments or companies outside the U.S. with dollar-denominated liabilities may also be stressed by the currency’s sharp appreciation. Investors should assess whether those risks — which apply to many emerging markets as well as Europe and parts of Asia — are adequately priced into financial markets.
Inflation is likely to remain elevated, but any recession should be relatively mild (at least in the U.S.).
Private sector balance sheets still look solid, which is mostly a good thing.
We continue to be impressed with global consumers’ resilience as they save less to grow their spending well in excess of inflation. Their efforts are keeping the global economy upright. Strong hiring demand and wage growth are helping, as are the still-large stock of excess savings on household balance sheets and the legacy of low interest rates keeping debt service costs manageable. But this resilience has a downside if it encourages central banks to press harder on the brake to slow inflation. If consumers continue to be unusually resistant to rising rates, it may give central banks the green light to hike more.
Yes, it really is still all about central banks.
Markets continue to view all data through the prism of how central banks will respond, which explains why negative inflection points for equities have come just after unexpectedly strong labor market data. Central banks, especially in Europe, are hiking rates into softening economic conditions, inviting a form of stagflation should energy prices fail to come down quickly. And each time markets have begun to price in easier policy — as they did in July — central banks have pulled them back (Figure 2). With the U.S. Fed leading the charge on inflation fighting, we expect the U.S. dollar to remain strong and U.S. rates to rise somewhat further and remain there for longer than what has been priced in.
All market and economic data from Bloomberg, FactSet and Morningstar.
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