Equity markets, on the whole, performed well in the first quarter, delivering broadly small but positive gains. Nasdaq even charged ahead. Against the succession of crises we’ve been through – energy, cost of living, budget, banking and now, potentially, a credit crunch – that’s a solid achievement. Markets got a further boost this week on news that US inflation appears to be on the retreat (UK numbers will be published next week), with the lowest consumer price index (CPI) reading in two years, at just 5 per cent.
But it’s too soon to conclude that banks have the upper hand or that recession risks have melted away. US core CPI picked up slightly to 5.6 per cent and most observers remain convinced the Federal Reserve will dole out another quarter point rise at its May meeting – the central bank is not in any mood to leave its patient at risk of a relapse.
Other headwinds are whipping up again, with a downpour of dismal news from the IMF this week as it warned of poor prospects for the global economy. It forecasts that the US economy will grow by 1.6 per cent this year and 1.1 per cent in 2024, and that the UK will crawl along, contracting by 0.3 per cent this year and expanding by 1 per cent next year.
The IMF doesn’t always get its numbers right – no forecaster ever does – but no one disputes its view that better economic performance is dependent on defeating inflation, least of all the central banks. The Fed however might soon find that help is at hand in delivering a killer-cure. While there shouldn’t be any further issues in the US banking system itself – the Fed has shown it can be relied on to pump in liquidity even as it keeps interest rates raised – if banks curtail lending, the twin pincers of credit drying up and more expensive loans will drive consumers and businesses to rein in their spending, which will eventually lead to companies rethinking their hiring plans or even to job cuts.
There is little clarity yet on the extent of the potential credit tightening, or how much it increases the recession risk in the US, but it will be monitored closely by the Fed and will influence its rate policy.
In any case, caution may already have entered business thinking. The latest US job numbers show that 236,000 positions were added in March compared with 472,000 in January, a massive drop in the monthly number. The annual rate of average hourly earnings also fell, another trend that could help in the inflation battle given how high vacancy rates and wage rises in the US and the UK have, in the words of Oxford Economics, acted “as a circuit breaker helping to limit the pass-through of tougher macro conditions to broader consumer confidence” .
Meanwhile, businesses that have been spared the cost of higher borrowing over the past year as a result of holding long-maturity loans may eschew taking on debt now or draining their cash piles. Forecaster Pantheon expects business investment in the UK to fall by around 3.5 per cent year on year in 2023 as companies adopt a more defensive mindset, and Ernst & Young thinks that UK bank to business lending will contract 3.8 per cent (net) this year, from net growth of 3.7 per cent in 2022.
In the US steep falls in buyback levels in the fourth quarter could be a precursor to cuts in capital expenditure and research and development, says Goldman Sachs, although it notes that the correlation doesn’t always follow and that government subsidised trends of reshoring and green energy investment could boost corporate investment beyond the level indicated by the macroeconomic environment.
For now, recession remains a risk, the chances are businesses will be in defensive mode, and rate cuts are not likely to happen until the final quarter of this year and probably not before 2024 even if inflation weakens. However, the overall picture should come into sharper focus now that the US first-quarter reporting season has kicked off. We’ll find out how earnings have been holding up, or not. And whether analysts are right to be concerned that there is too much complacency over the additional downside risk to earnings in a credit-restricted climate or an extended era of faltering growth.
