The search for a new equilibrium

Recent weeks have shown that optimism about an imminent strong economic recovery and a pivot by the major central banks was premature. Markets, economies and central banks are still searching for a new balance, a new equilibrium, of structural transition and cyclical developments, higher inflation and interest rates, stricter monetary policy and loose fiscal policy.

The path to this new balance, wherever it may be, was always expected to be rough and volatile and not linear. In fact, major central banks are witnessing stubbornly high inflation and still very few signs that recent monetary tightening will destroy demand and hence bring down inflation. We have argued before that both markets and central banks are currently too impatient. It simply takes months before tighter monetary policy finds its way into the real economy. And it will. Or put differently, if the greatest monetary policy turnaround in years does not leave any marks on the real economy, we could also close all central banks.

However, since last summer, central bankers seem to have become increasingly afraid that they may lose their grip on inflation. This is why there is currently so little patience and rather a trend of "high or higher for longer". No single central bank wants to be on the wrong side of inflation. Longer-term inflation projections are no longer the main anchor. It is rather a combination of current headline and core inflation, longer-term inflation projections and a large portion of gut feeling. In any case, probably the biggest concern for most central bankers at the moment is relaxing too early. This is why a scenario in which central banks overshoot with their rate hikes is more likely than a scenario in which central banks start cutting rates prematurely. All of this means that the US Federal Reserve and European Central Bank (ECB) will continue to hike interest rates in the coming months.

While the global economy will still experience the full impact of the monetary policy tightening of the last year, major economies are clearly out of sync. The reopening of the Chinese economy is only gradually gaining traction and we expect it to last until the second half of the year before the recovery really takes off. The relief that the reopening of the Chinese economy should at least provide for the European economy will not be enough to stage a strong recovery. The eurozone economy seemed to have avoided a recession before we received downward revisions in German growth data. Now, a technical recession is still possible. Even though lower energy prices and the Chinese reopening could give a short-term boost to industry, the large inventory build-up as well as the ECB’s monetary tightening will weigh on the recovery. We expect a longer period of subdued growth in the eurozone.

The resilience of the US economy has been remarkable. However, we do see the first cracks in the labour and housing markets and expect a significant slowdown of the economy. Still, with the Inflation Reduction Act and rich energy supply, the US economy should experience a rather textbook-style slowdown, followed by looser monetary policy and consequently a recovery in 2024.

With economies struggling between cyclical and structural developments, governments moving from short-term stimulus to longer-term investments, stubbornly high inflation and a new era of "high for longer" at central banks, it shouldn’t be a surprise that markets and analysts are having a hard time seeing clearly at the moment. Remember Jimmy Cliff, who only saw all the obstacles in his way when the rain was gone? In the global economy, it will still take some time before the rain disappears.