Is a recession inevitable?
With inflation high, unemployment low, and rates rising, are world economies on the verge of recessionary times?
And how bad do things have to get before central banks and governments switch their focus from inflation to stimulus measures?
Stimulus seems a far-fetched scenario right now, with inflation rising globally.
The latest CPI print from the US showed US inflation accelerating to 8.6% annually in May, its fastest pace in 41 years. Four whole decades.
And just this week, our very own Reserve Bank governor – Philip Lowe – told Leigh Sales in an ABC interview that he thinks inflation in Australia will peak at 7% late this year.
The blazing inflation figures are setting central banks on aggressive interest rate courses.
The US Fed surprised markets with a 75-basis points rate increase this week, with Fed chair Jerome Powell admitting that another 50 or 75 basis point hike is likely in July.
So how can anyone be contemplating stimulus measures?
Now, Jim thinks rampant inflation and changing monetary policy are about to lead to a new regime in markets.
In fact, Jim thinks the global order as a whole is undergoing what he is dubbing an axis shift.
Recently, Jim prepared an investment strategy for the big axis shift he sees coming.
Is a recession inevitable?
The tools to combat inflation at central banks’ disposal are blunt instruments. Raising interest rates curbs inflation … but can also topple economies into recession.
With living costs rising – and rising interest rates set to make debt costlier – global economies are finely balanced.
Already we are seeing some bad signs.
In the US, consumer confidence is already slipping.
The Michigan sentiment survey fell to 50.2 in June from 58.4 in May. The sentiment survey sat at 85.5 a year ago.
As the Wall Street Journal noted:
The more consumers believe that their real earnings will keep falling, the less they’ll spend to keep the economy afloat.
It’s a similar situation in Australia.
The Westpac-Melbourne Institute consumer sentiment index fell 4.5% in June, reaching its lowest level since the peak of the pandemic.
Excluding the pandemic, the June sentiment reading is the worst since February 2009.
Which brings us back to the question: is a recession inevitable?
That’s what veteran investment strategist Jim Rickards pondered in the latest interview with Daily Reckoning’s own Nick Hubble.
We can approach this with another question.
How high do interest rates have to be to quash 8% inflation, which is what the US is experiencing?
As Jim explains in the interview, you need a real interest rate of 2% or more to crush inflation.
But who in their right mind thinks the Federal Reserve can hike interest rates to 10% without causing a recession and without causing an epochal market crash?
Clearly, the Fed is very unlikely to raise rates that high.
Jerome Powell himself said in a recent press conference that the Fed is ‘not trying to induce a recession now. Let’s be clear about that.’
But with inflation rampant, what are the Fed’s options?
Jim thinks central banks like the Fed find themselves in a tough spot:
‘Inflation will only come down when rates get high enough but rates can’t get high enough without causing a recession.’
This monetary conundrum is quite dire.
Jim cited analysis from Larry Summers, who pointed out that, looking at the data, there’s hardly ever been a case where unemployment was this low, inflation was this high, and the Fed raised rates without causing a recession.
Here is Summers speaking with investment magazine Barron’s last week:
Q: You’ve been skeptical that the Fed can engineer a soft landing, or cool inflation without causing a recession. Why?
LS: My judgment isn’t about the competence of the Fed. It’s a judgment about the difficulty of the task.
The discouraging fact is that, when you have unemployment below 4% and inflation above 4%, recession always follows within two years. And historically, when we get significant inflation, we really haven’t avoided a significant downturn in the economy.
So, what does that mean for the global economy?
For the world’s stock markets?
And how should investors prepare?
For the Daily Reckoning