Global economies are prepared for a temporary down-turn

Recently, the IMF has issued a gloomy global forecast for 2023, as expected. For market spectators, the market situation has not been improving. This is mainly due to consequences arising from the onset of the pandemic and the Russian invasion of Ukraine occurring shortly after, with the latter complicating matters from an inflation point of view.

In light of this, measures were taken to combat any meaningful economic set-backs that could occur on the back of a sustained spike in inflation. Namely, the Fed lifted its benchmark policy rate this year from close-to-zero rates to those fluctuating around the 3 per cent region. The reason for raising interest rates is mainly in relation to consumers struggling to cope with the current inflation levels, which will eventually reduce overall economic activity. 

As a deterrent, an increase in rates was implemented to prevent things from getting worse. However, if the cost of borrowing becomes too high, companies might be discouraged from taking on new projects that may in turn stimulate economic growth, while paying mortgages might become unsustainable, to mention some of the negatives associated with elevated borrowing costs.  

An indicator of economic stability is the ability for borrowers to repay their debts. In this area, the six largest US banks—JPMorgan Chase, Bank of America, Citigroup, Goldman Sachs, Wells Fargo and Morgan Stanley—have been provisioning for loan-losses for the third-quarter earnings period, according to analysts at Bloomberg. Banks have been increasing provisioning, consecutively. 

To add to this, the KBW Bank Index was down significantly in 2022, underperforming the benchmark S&P 500 index by over 2 per cent. The fall is reflective of concerns that further loans might sour on the back of the lack of repayment ability, despite higher interest rates providing more interest income to banks. Putting it simply, the magnitude of lower loans being taken is greater than the higher interest rates, which, in turn, might negatively condition the net interest income for banks over time. 

The situation in the UK is not much better, as employment fell to historic levels going back decades. This tells us that despite the UK government’s best efforts, productivity does not seem to be increasing in the short term, thus making companies less willing to invest, train new staff, and pursue opportunity. Unfortunately, most investors only take risks when they are not afraid, thus compounding the effect of poor economic performance. 

The global labour market situation is also quite tight as employers offer higher wages to old employees in an effort to retain them, as well as to new ones in hopes of attracting talent. This activity is one of the main concerns for the Fed as it interferes with companies’ strategy in order to restrain demand and reduce price pressures through its policies.

Officials say that in their effort to try and curb inflation, subsequent job losses might occur. This is noticeable in certain markets and the possibility of recessionary market conditions cannot be ignored, as Fed chair Jay Powell recently warned. However, officials have said that inflation can be curbed without devastating increases in unemployment due to the fact that employers may think twice about cutting their workforce given current labour shortages still lingering from 2020.

All things considered, the noticeably aggressive rate-hiking cycle by the Fed has been consistent and an apt reaction to global events. The next Fed meeting, which will be held in November, will help paint a clearer picture of how difficult it will be to combat further global economic down-turns should they persist. 

Disclaimer: This article is brought to you by Shaun Frendo, Research Analyst at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd, which is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.

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