Will recession be the price of defeating inflation?
Insights

Will recession be the price of defeating inflation?

Inflation drivers are pointing down, eliminating the need for, but not the risk of, a mild recession.

There are very big improvements in the drivers of inflation in the US economy that the market really hasn’t recognised. These improvements have been achieved without a recession. So, if there is a recession, then we expect it will be very mild, and the US may be able to get away without a recession at all.

 

As a consequence, the Federal Reserve (Fed) are going to cut rates much earlier than people think, with our forecast of a reduction of more than 1% in 2024.

 

Similar factors are at work in the UK and Eurozone, but the economic indicators are lagging or lacking and so our confidence in our forecasts is lower, especially in the Eurozone.

 

The increasing chance of an economic soft-landing and lower interest rates mean that we are less negative on equities. However, the expected shift in inflation and interest rates expectations will benefit bonds most directly.

UK core inflation dips but remains an outlier

Source: Columbia Threadneedle Investments and Bloomberg as at 4 September 2023

The US has seen big improvements in the drivers of inflation without a recession

While higher oil prices might reverse the collapse of headline inflation, core inflation is headed down. It has been running at lower rate over the past six months and just 2.4% annualised over the last three months. So, you could argue that the US is already at its target.

 

There are good reasons to believe that that improvement is sustainable, with rent, a key component, heading lower. However, we do still need a decline in wage inflation, which has clearly peaked but remains too high. Wage inflation needs to be at 3-point-something to be consistent with the Fed’s target of 2% inflation.

 

A key factor in this reduction in inflation has been a contraction in corporate profit margins, which has offset some of the inflationary wage pressures. That leaves the way clear for the Fed to start cutting interest rates next year. Lower inflation would reverse the squeeze on real wages and so boost the consumer.

 

However, there are a series of significant events around the start of October that are going to make the US economy look quite wobbly:

 

  1. Student loan repayments restarting
  2. Big auto strike ongoing
  3. Expect a government shutdown due to legislative gridlock.

 

While these one-off factors might tip the US economy into a mild recession, they do not change our main forecasts, indeed a mild recession will only act to damp down wage inflation.

Margin Squeeze in the US

S&P 500 ex-Energy Quarterly Earnings Change (%y/y)

Source: Columbia Threadneedle Investments and Bloomberg as at 24 August 2023

Europe faces a major weak patch

Europe’s largest economy, Germany has been pushed into recession by the weakness of its key manufacturing sector, which has been reflected in its consumer sector. While the consumer sector in southern countries, like Spain, is buoyant, the relative scale of these economies means that Germany drags the overall figures down.

 

We see scope for similar factors to come into play in the Eurozone, to lower inflation and sustain the consumer, as we have in the US. Therefore, we forecast no more than a mild recession overall, with the ECB shifting to cutting interest rates next year as inflation comes under control.

 

However, the Eurozone is clearly lagging the cycle led by the US, so adjustment and recovery have further to go. The diversity of the Eurozone’s economies also makes economic indicators more difficult to read, to confirm that these positive factors are in progress. As a consequence, our confidence in this forecast is lower.

North-South divide in retail spending

Volume of retail sales %yoy

Source: Columbia Threadneedle Investments and Bloomberg as at 23 August 2023

UK is an outlier on inflation, but improvement on the way

The UK has been an outlier on inflation, as core inflation continued to rise in 2023, while it peaked in the Eurozone and fell sharply in the US. The latest figures at least confirm that core inflation has peaked, albeit still lagging the progress in Europe and especially the US.

 

However, the reason I think that UK inflation is going to improve, both absolutely and relative to other countries is that weak Sterling has been a major contributor to the poor inflation outcome in 2023. My estimate is that it takes three months for moves in the currency to start affecting inflation and a year for the full effect to come through. We can see that clearly in manufactured goods as well as imported food prices. So, the reversal of last year’s sterling weakness will take 2% off inflation by end of this year and cut another 1% by the end of 2024.

 

A modest pick-up in unemployment will cap domestic inflationary pressures. So, I’m quite optimistic about the outlook for UK inflation. This means that the Bank of England will be able to cut interest rates in 2024.

 

A peak in mortgage rates will ensure that the problem in the housing market will be contained, compared with previous cycles. I forecast an average house price fall of 10% – half of which has already happened.

Boost to inflation from weak £ in 2022 set to reverse

Source: Columbia Threadneedle Investments estimates. The data assume an impact on sterling – measured by an equal geometric weighted average versus the euro and US dollar – whereby a 3% appreciation reduces the CPI by 1% gradually over 12 months with a 3 month start delay. Sterling is assumed to be constant at its level on 24 April through the rest of the year. Estimates and forecastsare provided for illustrative purposes. They are not a guarantee of future performance and should not be relied upon for any investment decision. Estimates are based on assumptions and subject to change without notice.

A shift of inflation and interest rates expectations would directly benefit bonds

We like bonds and we expect them to deliver positive returns as inflation falls and interest rate cuts follow in 2024.

 

Our expectation of a soft landing, with a mild recession is the key reason to be a little bit less cautious on equities than we have in the past. We see the contraction period is over and we’re seeing a turn in expectations. That’s much earlier than would normally be expected. I think we’re seeing a significant improvement in the outlook for earnings in the US.

 

We continue to like Japanese equities as the economic outlook improves and corporate governance means that shareholders will see more of the gains in profitability.

Food price inflation set to tumble

Source: Columbia Threadneedle Investments and Pantheon Macroeconomics as at August 2023. Note : Both series seasonally adjusted by Pantheon

2 Oktober 2023
Steven Bell
Steven Bell
Chief Economist, EMEA
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Will recession be the price of defeating inflation?

Important information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). For marketing purposes.

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk.  Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

 

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act and relies on Class Order 03/1102 in marketing and providing financial services to Australian wholesale clients as defined in Section 761G of the Corporations Act 2001. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

 

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

 

In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.

 

In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.

 

In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.

 

In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

 

In Switzerland: Issued by Threadneedle Portfolio Services AG, an unregulated Swiss firm or Columbia Threadneedle Management (Swiss) GmbH, acting as representative office of Columbia Threadneedle Management Limited, authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA).

 

In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA).  For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

 

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies. 

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Important information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). For marketing purposes.

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk.  Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

 

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act and relies on Class Order 03/1102 in marketing and providing financial services to Australian wholesale clients as defined in Section 761G of the Corporations Act 2001. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

 

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

 

In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.

 

In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.

 

In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.

 

In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.

 

In Switzerland: Issued by Threadneedle Portfolio Services AG, an unregulated Swiss firm or Columbia Threadneedle Management (Swiss) GmbH, acting as representative office of Columbia Threadneedle Management Limited, authorised and regulated by the Swiss Financial Market Supervisory Authority (FINMA).

 

In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA).  For Distributors: This document is intended to provide distributors with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

 

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies. 

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