What a year it has been. A mere twelve months ago, financial markets across the globe, including those in Israel, the United States of America, and Europe, were trading near all-time highs. Aside from the rising inflation that was caused by disruptions in supply chain, the global economy was firing on all cylinders as it was recovering from the Covid epidemic. On the surface, everything appeared to be going swimmingly, but underneath, conditions were steadily deteriorating.
In order to gain a better understanding of what has been happening and where we are headed in terms of the economy right now, it is beneficial to take a look at the primary market that serves as a benchmark for the rest of the world, which is the United States. There is some truth to the old adage that “when America sneezes, the world catches a cold.” Although this expression was used in reference to the United States’ domination on the global arena for a number of years during the course of the 20th century, it is just as pertinent in the present day as it was back then.
The first indicator that jumps out is the overall degree of indebtedness. Due to government-created economic shutdowns and compensation schemes, the debt level in the United States, the United Kingdom, and many other countries has reached record heights. The US national debt, in particular, has surpassed $30 trillion at the beginning of the year, putting a further strain on the economy. This is certainly not a good development as debt will have to be serviced for decades to come. Having said that, since the American dollar is the world’s reserve currency, possible borrowing problems for the US government may be irrelevant in the near future. However, China and other countries have begun to challenge the justification for the American currency’s special function.
The economic challenges intensified further at the end of February when speculations of a potential invasion of Ukraine by Russia turned into reality. This event alone sent shockwaves around the globe as energy commodities rose in the months that followed, driving inflation rates to multidecade highs in the United States, the European Union, the United Kingdom, and other nations. The ensuing sanctions have further exacerbated the situation as country after country was forced to give up consuming cheap Russian gas and oil.
As inflationary pressures increased, central banks were compelled to intervene in order to bring it under control. Jerome Powell, the chairman of the Federal Reserve of the United States, stated that they will do everything possible to return inflation to an acceptable level, even if it means harming the economy. In the meantime, capital markets took notice of the rhetoric and responded with one of the worst sell-offs of the year, further driving major indexes into bear territory.
However, the US economy was able to stabilise the situation. Experts cite strong consumer expenditure as one of the factors that keep the economy going relatively strong, at least for now. According to available data, consumers are spending 10% more than the previous year, and when compared to pre-pandemic levels, the number jumps to an astonishing 40%.
Unfortunately, this status quo is unlikely to be maintained in the foreseeable future. The reason being is that with nominal wages lagging price increases, it is abundantly evident that household expenditures have been significantly higher than their means. So, how could this be even possible? As reported by Barron’s, Americans saved an extra $1.3 trillion during COVID, which supported the spending spree. But it looks like the tide is turning. According to data from the Bureau of Economic Analysis, the personal savings rate has already dropped from 20% to nearly 2% since the beginning of 2021. At the same time, as reported by Federal Reserve, the total amount of consumer loans has jumped by $300B during the same period. In addition, rising interest rates will further impact consumer spending, and that in return, will have a negative effect on the economic activity. Eventually, the economy will demonstrate it by undergoing a slowdown, creating an environment for recession.
The property market, and the expense of mortgage payments in particular, is another indicator of a weakening economy next year. The mortgage payment for the median new home sold in the U.S. during October of this year would now take nearly 50% of the monthly income of a household earning the median income. The worrying aspect here is that even though Federal Reserve indicated a possibility of a slowing pace in interest rate rises, the latest employment data indicates high demand among businesses for new workers, and this will likely result in monetary policymakers hiking interest rates in similar increments.
A similar situation could be observed in Israel, where the number of mortgages taken out has been in decline in recent months as interest rates reached a decade high. At the same time, almost half of borrowers are spending up to 40% of their monthly income on mortgage payments.
Business community’s mood also reflects an upcoming upheaval as several corporations have announced mass layoffs in recent months. Microsoft, Amazon, and Tesla have all revealed employment freezes or layoffs for their corporate headquarters, citing greater economic instability and the possibility of a lengthy recession. Similarly, media and entertainment companies such as entertainment giant Disney and Gannett have been dealing with dismissals. Amazon and FedEx have recently revealed plans to lay off employees ahead of the holiday season, which is traditionally a very busy time for enterprises involved in the sale and distribution of consumer products. So, clearly, the fear of a recession for the leading companies is real, and by cutting its costs the corporate America is preparing for a slowdown in consumer spending.
Last but not least, experts are concerned about the risks related to the geopolitical situation caused by the Russian invasion of Ukraine and its continuing influence on the global economy. From December 5 members of the G7 and the European Union capped the price of Russian oil exports at $60 per barrel. With many European countries already battling soaring energy prices, further prolonging of the conflict can increase chances of local and even global economic recession.
As to the stock markets, their direction will be largely dictated by the development of the global inflationary environment. This factor and the severity of the US recession will determine the performance of bond and stock markets in 2023.