Risk assets could be vulnerable once more

The speed of the US GDP growth decline could still cause a quick end to the recovery in risk assets that we’ve seen recently.

GDP growth is slowing down across the G10 nations and many, if not all, will fall into recession. But the speed of the growth decline could still cause a shock – and a quick end to the recovery in risk assets that we’ve seen recently.

We’ve already had ample warning that much of the world risks falling over the cliff edge when it comes to growth. China’s economic data was poor, but at least the PBoC was able to respond with a cut in rates. It might have only been 10-bps, but it is 10-bps that most other central banks cannot hope to deliver. Instead, the question for them is how much to hike rates. That applies to the Federal Reserve as much as others, but you only have to look at one of the first surveys for August to be released, the NY Fed Empire manufacturing survey, to see the difficult job that the Fed faces.

For this survey, the fall was a massive 42.4 points in the month. To put this into context, this survey, which has been around since 2001, has only ever seen one bigger monthly fall, and that was when the world was basically locked down because of COVID-19 in April 2020. We also saw the August NAHB survey for the housing market. It fell another 6 points, and in the last 3 months it has fallen faster than any time bar COVID-19, and that includes the housing collapse of 2008.

It is the sort of data that has a cliff-edge look to it, and if traders, investors, the Fed, and the US government all think that the two-quarter fall in GDP in the first half of the year was not a recession, upcoming data could well suggest that a recession is here. Even if it was not in evidence earlier in the year.

If things look bad in the US, they are much worse in Europe even if the two quarters of growth in the euro zone in the first half of the year seem to tell a different story. Here, the cliff edge is likely to come in the autumn/winter, with perhaps October being the most likely period as energy price surges really start to hit home in places such as the UK and Germany.

The UK faces a second consecutive huge surge in gas prices in October as energy regulator Ofgem lifts the price cap. The government may hope to offset some of this, but it is unlikely to stop a cliff-edge drop in the economy if, indeed, one has not already occurred by then.

In Germany, the government is actually charging residents more for gas rather than trying to offer financial support, but the key concern here is that if they don’t reduce gas demand, they will run out over the winter. It has taken the calculated gamble that higher prices starting in October are a more palatable price to pay for consumers than power cuts during the winter.

In the end, it may well be that consumers suffer both. Other countries face similar vulnerabilities to Russian gas supply, and one of these – Italy – also faces "unwelcome" snap elections next month and the threat that the far-right Brothers of Italy may gain a grip on power. Something else we’d also mention is the prospect of a material rise in industrial action and even the possibility of social upheaval as the cost of living strangles residents.

With all this in mind, how do we read the recovery in riskier assets that we’ve seen so far in the second half of the year? Mr. Steve Barrow, Head of Standard Bank G10 Strategy said this rebound would certainly continue given how far risk assets had fallen and how short investors had become. In addition, much of this economic carnage may already be discounted via the collapse of risk assets that we saw in the first half of the year. That’s the glass-half-full story. Unfortunately, Mr. Steve Barrow leans to the glass-half-empty view, which is that risk assets are very vulnerable again because of the cliff-edge drop off in the global economy, which will both be frightening and devoid of any monetary help by central banks because it will still be associated with very high inflation.