Here were some of our key takeaways from the discussions:
Shallow or deep recession: We picked up a consensus among participants that the most likely near-term outcome for the US economy is a recession. It was highlighted that recessions are processes and not events, with some believing that one may already be under way, following the negative credit impulse dynamics post March’s banking stress episode. The president of a very large US bank in attendance described that delinquency rates in credit cards have already crept up to pre-covid levels and loan defaults are building up. Views were quite diverse on whether this would be a shallow or a deep contraction, a key differentiating factor being the ability of the Fed to preserve financial stability. The vulnerability of regional bank balance sheets to commercial real estate lending is key to watch (see Is commercial real estate the next shoe to drop? for our views).
Market pricing too benign: Investors in attendance expressed that current market pricing of the Fed’s interest rate outlook, with several cuts baked into the second half of this year, seemed unlikely to materialize. Most expected steady interest rates through year-end instead. Notably, central bank authorities in attendance sounded quite hawkish, highlighting the risk of cutting too early, only to need to pause if inflation proves stubborn. In this context, most investors we spoke with see equity prices as too optimistic currently relative to the economic conditions that are likely to transpire. A weaker US dollar ahead also seemed a consensus view, though not a high conviction one. (see The dollar is dead; Long live the dollar for our views).
Debt ceiling angst: While everyone hoped that “we’ll get out of it as we always do”, anxiety dominated debt ceiling conversations. Many highlighted a realistic possibility of a breach and default. The most quoted number was a 35% probability of technical default, with some analysts even deeming this too low. A former Treasury Department official mentioned that we may be reaching the ceiling earlier than expected given the likely late tax receipts coming from states such as California, Missouri, and Kentucky, plus possibly lower receipts on the back of capital gains losses from last year (see Another debt ceiling debate for our views).
Emerging market resilience: Many in attendance underscored the resilience of the large emerging markets in the context of the lower global liquidity tide and the recent banking stress in the US and Europe. Most large emerging markets were viewed as having conducted monetary policy responsively and proactively – in many cases hiking well ahead of the Fed – and benefiting from well-regulated and supervised banking sectors. All this out of necessity, considering the inflationary and banking crises episodes they’ve experienced in the past. Of note, analysts from the Institute of International finance described how capital flows to emerging markets picked up markedly following the release of the March US CPI report. Vulnerabilities were highlighted in lower-income and frontier markets (see Mind the differences for our views).
Geopolitical depression: Discussions on the global geopolitical outlook were uniformly downbeat. Most participants saw a secular rise in tensions. In terms of US-China relations, observers expect US executive action on outbound investment restrictions to materialize soon, as well as an expanded export controls regime. The US House Select Committee on China led by Rep. Mike Gallagher (R-WI) should be closely watched, with an in-depth report due to come out by year-end. Even if it doesn’t translate into immediate legislative action, it may set the tone for US policy in coming quarters. The overall direction of the relationship could be altered by a range of contingent issues such as Chinese military action along the Indian border, or the death of Dalai Lama. Despite all the noise around French President Macron’s visit to China, US and European views on China were viewed as likely converging over time, with some differences as illustrated by Europe’s talk of de-risking versus de-coupling (see Are US outbound investment restrictions coming? Or our views).
Raging-simmering fire in Ukraine: Virtually nobody in attendance saw an end to Russia’s war in Ukraine any time soon. The war was viewed as having changed Europe forever, reinvigorating its arms industry and drastically altering its energy security approach. Putin is seen to be relying on exhaustion as a strategy with an eye on cracks widening in US support to Ukraine. Most participants, however, thought Europe and the US would likely stand behind Ukraine “as long as it takes”. The likelihood of direct arms support by China to Russia was seen as very low, only possible under a scenario in which China was convinced that Putin could fail. A weak/collapsed Russia was believed to be unacceptable to China (see One year on, an end to the war remains elusive for our views).
Latin America, a trusted partner, with challenges: Many participants suggested the region has the potential to become part of the solution to a variety of global problems, from climate change to renewable energy and critical minerals, benefiting from a position of geopolitical neutrality. Yet most highlighted the risk that this may become a missed opportunity given Latin American leaders so far haven't developed a plan to take advantage of these trends. Low growth and fiscal struggles seen as remaining in place. US engagement in the region seen as timid and haphazard (see Global Tumult Has Investors Turning to Latin America, Do They Like What They See? for our views).
In conclusion, the messages we picked up in Washington DC on the global economic and geopolitical outlook were undoubtedly sobering. That said, we believe investors can act to navigate the current environment, as illustrated by our Messages In Focus “Manage liquidity as rates peak”, “Buy quality bonds”, “Diversify beyond the US and Growth”, “Position for dollar weakness”, “Diversify with alternatives”, “Invest in real assets”, and “Go sustainable”. For more information, see our latest House View update Inflection point or breaking point?
Main contributors: Solita Marcelli, Alejo Czerwonko
Content is a product of the Chief Investment Office (CIO).
Original report - Takeaways from the IMF-World Bank spring meetings , 17 April, 2023.