This article delves into the relationship between government spending during the COVID-19 crisis, inflation in 2022, the recession in 2023 and 2024, but also the potential equities crash next year. This year the global economy has experienced a slowdown due to multiple factors, including increased interest rates, the invasion of Ukraine and the ongoing conflict between Israel and Hamas militants has introduced further uncertainty and possible growing geopolitical tensions in other regions.
The economic consequences brought about unprecedented challenges that required equally unprecedented responses from governments around the world. To combat the economic fallout of the pandemic, many governments embarked on ambitious spending programs. While these measures were intended to stabilize economies and provide support to individuals and businesses, on the contrary, these unprecedent government spending during the COVID-19 pandemic in 2020 and 2021 led to high inflation in 2022 and as the 2023 unfolded fears of a looming recession began to surface.
In the third quarter of 2023, the Euro area economy experienced setback, contracting by 0.1% on a quarterly basis, a performance that fell short of market expectations of maintaining a flat growth rate. This dip follows an upwardly revised 0.2% expansion in the second quarter, and it’s worth noting that this is the first time the Euro Area has seen economic contraction since 2020, when the COVID-19 pandemic exerted a heavy toll on economic activity. Within the Eurozone’s major economies, Germany witnessed a 0.1% contraction, Italy’s economic activity remained stagnant, and France and Spain posted modest gains of 0.1% and 0.3%, respectively. On an annual basis, the overall economy managed only a meager 0.1% growth, falling short of the expected 0.2% increase.
The European Central Bank (ECB) anticipates the Euro Area economy to grow by a mere 0.7% in 2023. However, this projection seems increasingly unrealistic as a result of several concerning trends. Tighter financing conditions, coupled with elevated prices, are exerting downward pressure on domestic demand. Simultaneously, foreign demand remains subdued, hampered by global economic uncertainties and trade tensions. Furthermore, the industrial sector, particularly in Germany, continues to face contraction, which is a worrying sign given its historical economic significance in the region. In this complex economic landscape, policymakers will need to grapple with a range of challenges. Finding ways to stimulate domestic demand and address issues related to financing and inflation will be paramount. Additionally, fostering an environment conducive to industrial growth and bolstering international trade relations will be crucial for the Euro Area to regain its economic momentum in the face of these headwinds.
All macroeconomic indicators are showing recession, let’s dive in to the data of USA and EU (China is not included, due to non-transparent data).
Gross Domestic Product (GDP) growth is in significant decline, especially if it is negative for two consecutive quarters or more, is a strong indicator of a recession.
GDP growth EU
Rising unemployment rates and a decline in job creation are signs of economic distress. High levels of job losses across various sectors can indicate a recessionary trend, but this time we won’t see severe unemployment, due to population decline.
This graph shows the unemployment rate in EU
This graph shows the unemployment rate in USA.
Reduced consumer spending indicates decreased consumer confidence and can signal an economic downturn is a vital component of economic activity, especially in consumer depended economy like USA and EU. This indicator is still resilient due to increasing consumer debt. Total household debt in USA rose by $16 billion to reach $17.06 trillion in the Q2 of 2023, according to the latest quarterly report on household debt and credit. Credit card debt saw brisk growth, rising by $45 billion to a series high of $1.03 trillion. Other balances, which include retail credit cards and other consumer loans increased by $15 billion, and auto loans by $20 billion. Student loan balances reached $1.57 trillion, while mortgage balances were largely unchanged at $12.01 trillion.
Declining business investments in equipment, technology, and expansion projects suggest that businesses are uncertain about the future economic outlook, venture capital investments dropped by 34% from the first quarter to the second quarter of 2023 which is a common characteristic of a recession.
In traditional economic theory, there is a concept known as the “quantity theory of money,” which suggests that changes in the money supply can influence overall economic activity. Decline in the money supply might signal a reduction in spending and investment, which could contribute to an economic downturn, or recession. Central banks use various tools to manage the money supply and implement monetary policy, and the relationship between money supply changes and economic outcomes can be influenced by a range of other factors, such as interest rates, fiscal policy, and global economic conditions. At the moment most of the G20 economies are reducing money supply, especially in USA as leading economy the M2 supply is declining at fastest rate since 1930s.
In summary, while a decline in the money supply might be considered one potential indicator of economic stress, it is not a definitive or exclusive signal of an impending recession, but is worthy indicator of macroeconomy, so GDP growth, asset prices and inflation will weaken.
EU money supply M2
Another key indicator of recession is significant slowdown in the housing market, including declining home sales, falling home prices, because the housing market is closely tied to consumer wealth and confidence. It is obvious that negative trend during this year and probably it will continue in the next year.
The housing market has traditionally symbolized the essence of the American dream, embodying not just a place to live but also a significant investment in the future. The real estate scene in the United States has been susceptible to dynamic changes, frequently aligning with the country’s overall economic trajectory. There’s a prevailing concern about whether the American economy might once more be vulnerable to the impacts of a housing recession, because US mortgage rates have hit a two decade high of 8% or more precisely, 23 years high.
Also this year we saw steady declining of corporate profits, which indicated reduced business activity and economic slowdown leading to a recession.
And the last indicator and also the most important is yield curve inversion (when short-term interest rates exceed long-term rates), which signaled the impending recession. This crucial indicator has been a reliable predictor of recessions in the past.
While the current surge in interest rates doesn’t immediately seem to be hindering economic activity or causing distress among borrowers, it’s crucial not to prematurely breathe a sigh of relief. The impact of higher interest rates on the economy often experiences a delay, known as the “lag effect.” This delay occurs because changes in interest rates primarily affect new borrowers, including those dealing with maturing debt who need to refinance to repay investors of the maturing bonds. Additionally, individuals with fixed-rate debt that is not maturing are not immediately impacted by higher rates. The lag effect is a result of the time it takes for the issuance of new debt to exert enough influence on the economy to slow it down.
The graph below illustrates the Fed funds rate and the time, measured in months, from the last in a series of rate hikes leading up to the next recession since 1981. On average, there has been an 11-month delay between the final rate increase and the onset of a recession. Given that the last Fed hike occurred in July 2023, assuming it was the final rate increase for this cycle, it might not be until June 2024 before a recession takes place.
As economic indicators evolve, there is a growing concern that a recession may be imminent. Despite the current lack of conspicuous signs of economic distress, the surge in interest rates is raising apprehensions. It’s important to consider the lag effect associated with higher interest rates, where the full impact on economic activity takes time to materialize. The historical data, depicted in the graph above showcasing the Fed funds rate and the time leading up to the next recession since 1981, indicates a consistent pattern. On average, there has been an 11-month delay between the final rate increase and the onset of a recession. With the last Fed hike occurring in July 2023, and assuming it was the concluding rate increase for this cycle, projections suggest that a recession might not be far off, potentially materializing around June 2024 and what it means for financial markets I will cover in the next post.
While the economy currently appears resilient, the lag effect implies that the repercussions of higher interest rates may be looming on the horizon. It’s crucial for policymakers, businesses, and individuals to monitor these trends closely and be prepared for potential economic headwinds in the coming months.