Depression or Recession? Hard or Soft landing?

Any casual reader of the business columns today might wonder if they had stumbled into some arcane debate on pillows or mattresses. In reality, the issue exercising economists is how to interpret essentially backwards-looking economic data - such as wages, unemployment or inflation – to determine what the future course of interest rates is or should be. 

For example, the top brains at Citigroup predict a likelihood of depression, i.e. zero growth this year, a contraction of 0.2 per cent in 2025 and a slight recovery in 2026. These dire numbers follow the 0.7% decline in GDP per capita last year and fall in 2022. If true, this would be a worse run than any chapter since the Industrial Revolution, including the austerity years after the Napoleonic and First World Wars or the Gold Standard Crisis of 1929-31. A touch too pessimistic?
Goldman Sachs, on the other hand, thinks that ‘underlying inflation’ is much weaker than appreciated and that headline inflation will drop to 1.7% by Spring, end the year at 1.6% and remain below the 2% target rate long into 2025.

Both warn against monetary over-tightening, i.e. interest rates being kept too high for too long. Having been too slow to raise rates to contain the post-pandemic inflationary surge of 2021, the Bank of England is in danger of failing to lower them in time to avoid a deeper and more protracted downturn.

In fact, UK ‘core’ inflation (stripping out energy and food prices) fell to 1.9% annualised over the past six months, lower than in the USA or the Eurozone, and is now predicted to be among the lowest in the G7 - including Japan – by the Spring, as distortions from the energy price cap wash through the statistics.

The Bank’s approach to holding rates at 5.25% may yet be vindicated (two members of the Monetary Policy Committee even voted to raise them at their last meeting in December). The latest PMI surveys hint at recovery, and there are all sorts of positive data among corporate earnings, house prices and consumer behaviour that suggest the doomster economists may be caught out. The trouble is monetary policy works with an 18-24 month time lag, so much of the past tightening has yet to be really felt in the wider economy. Some think the Bank is fighting an old 1970s-style inflation war when wages spiralled out of control, misreading what was perhaps a one-off spike in prices and pay that is now dribbling out of steam. As TS Lombard, the research house, pungently put it in a recent note: “The whole 1970s narrative has been a giant head-fake”. 

Whether we head into a Goldilocks soft landing, a recessionary slow-down or a full-blown depression, our political class should not escape blame for their communard fiscal illiteracy. Both main parties sanction arbitrary fiscal strait-jackets that treat public investment as if it were evil. Yet bond markets understand perfectly the difference between ‘bad’ borrowing for consumption and ‘good’ borrowing that lifts productivity and pays for itself through the ‘multiplier’ effect.

So, hobbled by a Bank that is probably fighting the wrong war and governments that seem unable to look through party political issues to come up with any form of coherent, long-term industrial strategy, what hopes are there for investors? Curiously, opportunities abound at such times of inflection for investors who can take an objective, long-term view and ignore the ‘white noise’ of current news flow.

Valuations of so many assets that are low by historical standards will inevitably regress to their means once global investors can see through the fog that has distorted markets for so long since the pandemic (and before). Even a small adjustment to US dollar hegemony after their elections in November could see a surge of dollars into undervalued sterling assets. Despite the extraordinarily high percentage of long-term sick and economically inactive veiled among UK labour figures, our currently high levels of employment do not indicate a consumer recession. Once the heavy boot of interest rates is lifted off the neck of corporates and individuals, we could see earnings and spending recover and markets rebound. Even if, as polls predict, Labour strolls into power at the next election, markets may well surge in what Kallum Pickering of Berenberg terms ‘a low-wattage 1997 Blair election win rally’. 

Any of this would happen long before economists’ arguments catch up with the data and the debate over soft landings and recessions morphs into a new narrative. I have been in markets long enough to know that if we are not actually in a recession, then we are, by definition, heading for the next one. Just as with bedding, economists’ debates, while intellectually interesting, often tend to obscure and delay sound investment decision-making.   


Important Information

The contents of this article are for information purposes only and do not constitute advice or a personal recommendation. Investors are advised to seek professional advice before entering into any investment arrangements.

Please also note that the value of investments and the income you get from them may fall as well as rise, and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance.

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