For months, financial experts have been warning us to prepare for a recession.
While we still can’t say for sure, signs are flaring up that Europe and the U.S. might be headed for a recessionary period.
We have already talked about the existing risks of a recession in one of our previous SPOTLIGHTs. But quite a lot of things have happened since then.
With the events of the last few months (you know, record inflation, war, energy crisis, slowing growth, market collapse, etc.) we thought it was time for a little update.
So, let’s see if those recent events are putting us on the path to recession.
Are there any major signs of a possible recession today?
The short answer to this question would be, yes, and quite a few.
Here are the main ones:
- Red-hot inflation: If inflation remains high and salaries don't rise to match it (which is the case now), eventually inflation itself could lead to a recession.
Just to remind you, inflation in the U.S. has just hit 9.1%, reaching a new 40-year high. In the Eurozone, the annual inflation rate reached 8.6% in June, exceeding the 8.1% mark from May.
And, as you can see from the chart, inflation has been rising in other countries too.
- Interest rate hikes by central banks: many analysts say faster and bigger rate hikes could raise the odds of a recession. Rising rates will make it more expensive to borrow money and therefore tend to reduce the amount of money circulating in the economy. In other words: rate hikes tend to slow growth and, in some cases, create recessions.
And right now, the Fed is on an aggressive path to halt a 40-year-high inflation. It has already hiked interest rates a few times this year and is bound to do it once again soon.
The ECB, too, plans to increase rates later in July and probably again in September.
- The war in Ukraine: Russia’s war in Ukraine continues, heightening the risk of a food crisis in countries that depend on wheat exports from these two countries.
- Russia’s gas squeeze: In addition to all this, Russia has temporarily shut down the Nord Stream gas pipeline, thus reducing Europe’s gas supplies. Now many officials are worried about a full gas shut-off from Moscow that could seriously harm Europe’s economy with winter slowly approaching.
As you can see, the outlook for the world economy is, to put it lightly, very hazy.
But could that potentially lead to a recession? Here’s what analysts are saying.
Natural gas disruptions could trigger a recession in Europe
Further disruption in the natural gas supply to Europe could send many economies into recession, the head of the International Monetary Fund, Kristalina Georgieva warned.
She wrote in an IMF blog post that Russia’s war in Ukraine had significantly worsened the economic growth outlook and that the IMF was prepared to lower its forecast for 2022 and 2023.
“The outlook remains extremely uncertain. Think of how further disruption in the natural gas supply to Europe could plunge many economies into recession and trigger a global energy crisis. This is just one of the factors that could worsen an already difficult situation.”
And it seems that, out of all EU countries, Germany is facing the biggest risk of recession.
“It seems reasonable to assume that Russia will continue to look for ways to disrupt economic activity in Europe in retaliation for Western sanctions and financial and military support for Ukraine… the impact on industrial output and economic uncertainty will almost certainly push the German economy into recession in the second half of 2022,” the economists said.
The graph below shows exactly this:
As you can see, before the conflict in Ukraine, there was a 20% chance that both Germany and the Eurozone would experience a recession. Today, Germany has a 55% probability of a recession, compared to 43% in the Euro area.
Former IMF chief economist: There’s a high risk of re-running the 1980s
According to former IMF chief economist Maurice Obstfeld, there is a real risk that central banks will push rates too high while trying to fight inflation.
"You've got a real cocktail of global monetary contraction that could go a bit too far because each central bank is looking only at its own domestic situation and not thinking about the global effects," he warned.
In other words, along with many economists, Obstfeld fears that central banks run the risk of hastening the path of the world economy into a deep recession by not coordinating their rate hikes.
"We saw something like that in the early 1980s when the Fed was fighting inflation hard … We got a very deep global recession which spilled over to emerging markets in the form of the debt crisis of the 1980s and I think there is a risk of something similar now."
💡Early 1980s recession
The early 1980s recession was a severe economic downturn that affected a large portion of the world from roughly the beginning of 1980 to the beginning of 1983.
Most people agree that it was the worst recession since World War II.
He thinks that central banks are scrambling to catch up because they have been delaying raising interest rates for too long.
“They have egg on their face from having been behind the curve, and there is a little bit of a sense of panic in the air,” Obstfeld says
What does it all mean for investors?
As usual, this most likely means that investors should diversify their portfolios with safer and more stable assets to balance out their riskier investments.
Melissa Bouchillon, Sound View Wealth Advisors' managing partner and CFP, says it’s better to be prepared than sorry:
"Whether it's COVID-19, the Great Recession, or what we're experiencing right now, you never know what the next major crash will be. You must always have a portfolio element ready for when things go south.”
How to prepare for a recession?
To prepare for a recession, there are some handy tips you can follow, but we won’t reveal them just yet, we’re keeping that for an upcoming spotlight.😉
Right now, we will take a look at the most common way to preserve your wealth during a recession: portfolio diversification.
And that’s where gold and precious metals might come in handy.
It’s true that gold has been facing some pressure lately.
Last week, the gold price dropped back toward an 11-month low as investors turned to the U.S. dollar amid expectations for more aggressive rate hikes by the United States Federal Reserve.
Why did this happen?
Well, mostly because, the strong dollar seems to be currently weighing on the gold price, as are rising interest rate expectations.
So does it mean that the gold price will continue to fall?
In short, not necessarily.
As mentioned above, more aggressive rate hikes by central banks are boosting the chances of the economy entering a recession.
And there’s a general agreement, however, that during a recession, riskier assets like stocks and high-yield bonds tend to go down, while gold and U.S. Treasuries usually increase.
For example, the Great Recession of 2008 boosted the price of gold, even though it dropped in the aftermath of the Lehman Brothers' bankruptcy.
As Craig Erlam, senior market analyst at OANDA, explains:
“A break [in the gold price] below $1,700 is still very likely, with the next support level at $1,680 an ounce. [But] once the peak is in place and we see signs of inflation pressures retreating, we could see gold back in favor as the economy drifts into recession."
Will gold necessarily act this way if another global recession unfolds? We don’t know for sure.
One thing is certain, though: diversifying your investments and taking sensible precautions to manage risk can help you protect your wealth and personal finance.
