More than halfway through the fourth quarter of an eventful year, global economic and investment figures are more in line with our view. Key indicators in many economies are showing signs of deterioration.
Inflation has begun to decline even though it remains at a high level. But the risks to the economy and financial sector, and the likelihood of an emerging market crisis are higher. As a result, the accelerating pace of interest rates has begun to ease. In addition, global geopolitics will become even riskier in the future.
In Europe, many indicators are showing signs of deterioration. Manufacturing and services Purchasing Managers Index (PMI) readings, including those of large countries such as Germany, France and the UK, are slowing down. All are below 50 points, the level that separates expansion from contraction. This implies that the economies of the euro zone and the UK are entering a recession.
In the United States, the real economy has still managed to expand but growth is decelerating sharply. Although GDP grew 2.6% in the third quarter, rebounding from contractions in the previous two quarters, there were signs of a broad slowdown as consumer and business spending faltered amid high inflation and rising interest rates.
US retail sales have begun to show signs of stagnating. Headline inflation has slowed modestly but is still higher than the market expected, implying a continuous trend of monetary tightening. As a result, research houses such as Bloomberg Economics see a 100% chance of a recession in the US next year.
A Bank of America survey, meanwhile, found investors' negative view of stocks is the highest since it began taking surveys in 2002.
The International Monetary Fund highlighted the rising risk when it downgraded its global economic growth forecast for next year to 2.7% from 2.9%, signalling more concerns about recession from sharp interest-rate hikes.
CHINA SHIFTS FOCUS
In some other countries, it can be seen that the political risks are worsening. In China, the Communist Party has approved a third term for Xi Jinping, and the Politburo is filled with his loyal supporters. This indicates that the chief focus of the Chinese government for the next few years will be on political and economic stability, at the expense of economic growth.
The main policy focus will be on three areas: "common prosperity" or expanding equality, not growth; "dual circulation" or focusing on domestic production instead of imports; and zero Covid, or not fully opening up the country until a further change of policy. This policy cocktail implies that the economic outlook for the next five to 10 years is for a slowdown from the current pace.
Another example of how quickly things can deteriorate was seen in the UK, after the Liz Truss government announced ill-timed plans for tax breaks, which caused a fiscal crisis as bond yields surged and the pound plunged. This left pension funds vulnerable to severe liquidity shortages, and caused the Bank of England to step in to support liquidity, despite being in tightening mode in the face of double-digit inflation. In the end, Ms Truss had to resign as prime minister just 44 days after taking office, and after her new finance minister, Jeremy Hunt, cancelled almost all of his predecessor's tax-cut plans.
Meanwhile, emerging markets and Asian countries are facing difficulties of their own. Bloomberg reports that Asian governments spent $50 billion in foreign reserves in September to protect their currencies. In Vietnam, the central bank expanded its exchange rate band to allow the dong to depreciate more easily, and has raised its policy rate by 2% to slow capital outflows. Meanwhile, Japanese authorities intervened in the currency markets for the first time in three decades, after the yen weakened to 150 per dollar.
Some of the global problems we are seeing have been caused by the US Federal Reserve's mismanagement of monetary policy. Specifically, it started raising interest rates sharply only after inflation got out of control. This has worsened conditions in the financial sector and poses two main problems: illiquidity or insolvency.
LIQUIDITY SQUEEZE
The recent turmoil in UK pension funds is a case in point. When interest rates rise, fund managers face margin calls, causing them to sell bonds to meet obligations, resulting in a liquidity shortage, until the central bank has to come to the rescue.
On the economic front, we agree with the IMF that the global economy might not slow down sharply this year. But next year, the risks will be greater, both from financial tightness and monetary policy deviation between the Fed and other central banks, which will cause greater capital outflows. In addition to the aforementioned threat, the protracted Russo-Ukrainian war also becoming a wild card for the global economic growth next year.
However, we still believe that most emerging markets' fundamentals are stronger in comparative terms, as many for years have pursued prudent economic policy that emphasises strengthening stability. The main risk, however, is that the Fed will keen pushing up interest rates until there is clearer evidence that inflation is falling. This will make emerging market economies prone to capital flow reversals.
The economic walkway is coming to an end. Businesspeople and investors need to be careful not to trip.
Dr Piyasak Manason heads the Wealth Research Department at InnovestX Securities Co Ltd
