Unemployment rates also remain low and, in fact, continue to decline in some areas like the Eurozone. Tight labor markets are putting pressure on wage growth and fueling fear of a wage-price spiral, particularly in the service sector. The mixed news on growth along with the apparent imbalance in the labor market means that the fight against inflation in Europe is likely to be long and hard-fought, making it difficult to avoid a recession.
In contrast, Japan surprised with GDP growth of 2.7% in 1Q 2023—higher than expectation. PMIs as well as the recently released BoJ’s Tankan survey results—a quarterly survey of short-term economic sentiments of enterprises—continue to point to growth. The wage growth also surprised at 2.5% compared to an expectation of 1.2%. The high wage growth along with higher inflation is good news for the BoJ, which has been trying to bring inflation up to its target level by running a long-term, ultra-loose monetary policy.
China has also consistently reported high GDP growth since reopening with the most recent reading of 6.3% for 2Q 2023 compared to 4.5% in 1Q 2023. The PMIs for China continue to point to an expansion but have been lower over the past few readings. However, there are some signs the growth may be losing momentum with exports (in dollar terms y/y) declining by 12.4% compared to 7.5% in May. The tepid data are fueling expectations of further monetary and fiscal stimulus in China.
The optimistic scenario is that inflation in Europe and Australia (along with the U.S. and Canada) continues to slow and central banks can ease off on monetary policy leading to a “soft landing.” This could be supported by output growth in China which has been a source of global disinflation through its cheaper exports. Growth in the rest of Asia, including Japan and India, could also provide an impetus to global growth.
However, there are a few considerations that could derail this optimistic scenario. First, interest rates could remain too high for too long leading to a global recession. Second, inflation may remain high due to continuing labor market tightness or geopolitical events (e.g., continuing war in Ukraine, U.S./China trade tensions, or reshoring of supply chains). Third, Japan could struggle to maintain the inflation and high growth and falls back into the long-term low-growth and low inflation scenario. Finally, the underlying risks in the property market and local government borrowing could come to a head in China, leading to a major slowdown.
The inflation experience and monetary policy response has been markedly different in Europe/Australia compared to Asia. While ECB, BoE, and RBA have been trying to tame inflation and slow down the economy by hiking rates, the BoJ and PBoC are struggling to maintain growth and keep inflation high by either maintaining or loosening monetary policy. In Europe/Australia, there is a risk that higher rates remain high for too long, leading to a global slowdown. While in Japan and China, the risk is that the growth is short lived and the economies falter due to spillovers from a wider global slowdown. The risk of a global slowdown remains high and brings downside risk to the performance of international developed equities. We hold an underweight to equities, both in U.S. small-cap and international developed asset classes, and an overweight to cash and fixed income.