China reopening and Asia rebound could see global recession avoided in 2023

High inflation across most developed and emerging markets in 2022 led to one of the most aggressive and synchronised monetary tightening cycles observed in the past few decades. The lag in the effects of tighter financial conditions, combined with lower household income, means global growth deceleration is inevitable in 2023.

But, while the global outlook is downbeat, a closer look reveals underlying differences in growth trajectories across major economies.

A study of US recessions dating back to the 1940s shows that declines in private investment, including corporate spending and housing, were often key contributors to negative real GDP growth.

Today’s housing market has been hit by higher borrowing costs. Home-builder confidence and existing home sales have fallen to the low levels seen during the uncertainty when Covid-19 first surfaced in 2020. And given the divided federal government following the US midterm elections, additional fiscal spending to support growth could be difficult to secure.

Both developments point to a higher risk of recession in the United States. However, the proverbial soft landing might not be such a stretch if we consider the mitigating factors on the consumption front.

First, consumption makes up about two-thirds of the US economy and remained robust throughout 2022, even as unemployment benefits expired because consumers tried to maintain the levels of consumption supported by the previous government help.

This was done by tapping into savings. In the five years before the Covid-19 pandemic, the ratio of personal savings to disposable income averaged around 8 per cent. As of November 2022, it fell to 2.4 per cent. As recession risks build, the savings rate should also rise as households rein in spending. This should slow growth in real consumption in 2023.

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However, there are offsetting dynamics to consider. Despite the slowdown, there will be some support for consumer spending as cost-of-living adjustments to Social Security payments come into play. Benefits will rise by 8.7 per cent, beginning with last December’s payments, due in January 2023, to keep pace with inflation.

The Biden administration extended the pause on federal student loan payments for several months, and a robust job market continues to support consumption. If weaker growth eventually helps cool demand-side inflation, this could also allow the Federal Reserve to take a more neutral stance on monetary policy. As inflation cools, we should also see a turnaround in real income growth.

In Europe, the risk of recession is considerably higher, given the spike in energy and food prices as a result of Russia’s invasion of Ukraine. Consumer and business sentiment is also pessimistic, which is weighing on both consumption and corporate investment. The silver lining lies in the restocking of natural gas inventories, which has progressed well.

This will help the region avoid the worst-case scenario of a deep recession, especially if the winter remains mild and disruptive energy rationing is avoided. Fiscal support is badly needed to help both households and firms get through the cost-of-living crisis and, fortunately, European governments have shown a willingness to spend during these challenging times.

Economic activity in China has taken a hit given the country’s rapid reopening and a sharp increase in Covid-19 infections in recent weeks. However, with further fiscal and monetary support, the economy should see a stronger rebound in the second half of the year.

Eventually, the return to more normal levels of mobility should also enhance the efficacy of policy stimulus and prompt faster growth. More support for the real estate sector has also helped lift overall sentiment. China’s growth rebound is in contrast with the threat of recession facing the developed Western world.

For Asia, weak demand from the developed world could be challenging for export-oriented economies such as South Korea, Taiwan, Hong Kong and Singapore. This could be partially offset by continued domestic demand and recovery in the service sector as more economies learn to live with Covid-19 and the tourism sector reopens.

Economies that are more reliant on Chinese tourists, such as Hong Kong and Thailand, are poised to benefit from the mainland’s reopening as well. However, this could also lead to a rise in inflation, especially if pent-up demand from Asian consumers is met with a slower supply-side response.

Taken together, the Western world’s slowdown is balanced by a more optimistic outlook in Asia. Nevertheless, the start to 2023 still warrants a more conservative stance for asset allocation, at least until we see a definitive end to the monetary tightening cycle and global economic growth bottoms out as the year progresses.

Clara Cheong is a Singapore-based global market strategist at JP Morgan Asset Management