The signs of a world recession have begun to appear, especially in the eurozone. Excessive increase for the umpteenth time will accelerate the world entering the brink of a recession.
By
ARI KUNCORO
·6 minutes read
SALOMO TOBING
Ari Kuncoro
The decision on the magnitude of the increase in the benchmark interest rate of the United States central bank or the Federal Reserve (the Fed) in the upcoming meeting on Dec.13-14 will catch the world's attention as the signs of a world recession have begun to appear, especially in the eurozone. Excessive increase for the umpteenth time will accelerate the world entering the brink of a recession.
However, the prospect of a recession, especially in the US, remains unclear because amid indications of a decline in economic activity, several indicators show signs of expansion. Another impact of the Fed's interest rate increase is the appreciation of the US dollar, which is considered to be too strong, especially due to the caution of international investors who adopted a "cash is the king" stance. The strengthening of the US dollar is an additional burden for import payments as well as principal repayments of developing countries and emerging markets because almost all global transactions are still denominated in US dollars.
Early indications of a global recession can be seen from the decline in oil prices which has reached US$70 per barrel. Initially, oil prices stayed in the range of $80-90 per barrel. However, weakening world demands due to anticipation of a recession and a decline in economic activities due to China's COVID-19 mitigation policies has kept prices in the lower range of $70-$80 per barrel.
In Europe, the first signs of a recession are more pronounced than in the US. In the United Kingdom, for example, production has slumped in the contraction zone for four consecutive months (below 50) due to a declining public demand and rising interest rates for working capital loans. The purchasing managers index (PMI) rose slightly to 46.5 in November from 46.2 in October.
Economic growth in the third quarter of 2022 was recorded at minus 0.2 percent. Meanwhile, inflation remained in the double-digit zone, even rising from 10.1 percent in October to 11.1 percent in November.
In the eurozone, the PMI numbers also remain in the contraction zone. Despite an increase from 46.4 in October to 47.1 in November, this index has contracted for five consecutive months. It is still better than the UK because the economic growth in the Eurozone, although slow, is still in the positive zone. It was noted that there was a slowdown from 0.8 percent in the second quarter to 0.3 percent in the third quarter of 2022. The positive impact of the improvement on the PMI was that inflation declined from 10.6 in October to 10 percent in November.
Various forecasts indicate a recession will occur in mid-2023.
Early indicators in the US are still ambiguous. Various forecasts indicate a recession will occur in mid-2023. One important indicator that points toward it is the PMI number. The PMI index unexpectedly reversed from an expansion zone of 50.4 in October to a contraction of 47.7 in November.
Another sign of recession is the inverted yield curve, namely the yield for government bonds with short-term tenors is higher than those with long-term tenors. Investors, due to high uncertainty, have switched to short-term financial investment instruments. The yield for the two-year treasury bond was recorded at 4.384 percent compared to 3.692 percent for the 10-year treasury bond.
Contrary to the signs of a recession, annual US economic growth in the third quarter of 2022 reached 2.9 percent after experiencing negative growth of 1.6 and 0.6 percent in two consecutive months. The consumer price index (CPI) fell to 7.7 percent in October from 8.2 percent in September. In other parts of the world, China, as a manufacturing hub, has also begun to ease its zero Covid policy. These two countries as the locomotives of the global economy have the potential to stimulate world economic activity again.
Direction change
In the run-up to the Fed's meeting, the developments have sparked debate whether its policies have been too hawkish. From various headlines in the US, it seems that the Fed will change (pivot) to soften, giving a signal for the next hike in December of 50 basis points, followed by 25 basis points in early 2023. This signal of softening has been responded to with similar signals by a number of central banks around the world; including the Bank of England (BOE), the European Central Bank (ECB) and the Bank of Canada (BOC).
Even so, the signal could be different from the realization later. The potential increase in inflation in the US still exists. In addition to a relatively high growth, data on employment opportunities also show a scarcity of labor supply. The unemployment rate was relatively low, remaining unchanged at 3.7 percent in September and October. This is the argument that supports the Fed to remain hawkish.
World oil prices fell sharply due to concerns over the prospect of a world recession, strengthening the argument for the Fed to be more lenient in reducing inflation. Fuel prices at gas stations in the US have returned to a near $3 per gallon. Inflation data based on the CPI has not yet been released. Alternative information shows annual inflation for the November wholesale trade index recorded 7.4 percent, down from 8.1 percent last month. This provides hope the Fed will be able to pivot onto a path of lower basis point increases than it has so far.
The US dollar index reached its peak of 114 at the end of September 2022, but dropped to around 104 with the Fed's signal of softening. Although the US dollar remains strong with the index still above 100, this gives the currencies in other parts of the world some breathing room. The euro currency strengthened again from a low of 0.9584 US dollars per euro in late September to 1.0051 US dollars per euro in early December.
Meanwhile, the British currency, the pound sterling, strengthened from 1.0681 dollars per pound to 1.2667 dollars per pound. The rupiah also strengthened to a range of Rp 15,500 and Rp Rp 15,600 per US dollar in the first week of December from the range of Rp 15,700-Rp 15,800 since early November.
The domestic implication is that imported inflationary pressure has the potential to decrease. Policy flexibility to control inflation expectations and exchange rate expectations will be greater than the scenario if the Fed does not soften and the dollar index is too strong.
The annual inflation in November declined to 5.42 percent from 5.71 percent in the previous month. In addition to the opportunity for economic recovery, the downward trend in inflation is also very important as an additional cushion for domestic purchasing power to deal with global uncertainties in 2023.
ARI KUNCORO, Rector at the University of Indonesia.
(This article was translated by Hendarsyah Tarmizi)
