Known unknowns: Three-minute macro
We're in an environment ripe with significant uncertainties that reduce visibility and make it difficult to have high conviction. Banking fragilities continue and the debt ceiling drama will be harmful to growth, no matter how it resolves. Meanwhile, we’re keeping an eye on European equities, which we think are losing their shine.
Why the debt ceiling debacle matters, whether it resolves or not
It’s tempting to say the debt ceiling debacle is a mere distraction—after all, economists have been writing about it almost annually since 2011 (with increasing jadedness). But each time it resolves, we move on and the gyrations turn into little blips in our long-term charts. Even if Washington comes to an "agreement," the issue still speaks to several key themes we need to monitor closely.
This year’s maelstrom is occurring in the midst of a pivotal inflection point in the U.S. economic story—just months (moments?) before we expect the United States to fall into a recession. That makes the debt ceiling problem worse from a growth perspective, but it makes it somewhat easier for the macro strategist: Indeed, this new “event risk” isn’t likely to alter the core fundamentals of the macro environment. Instead, it entrenches the economy even more deeply into three core and existing themes. So perhaps the best approach is to step away from the what-ifs and focus on why this event is thematically problematic.
- Rolling uncertainty shocks: Add the debt ceiling debacle to the other known unknown of the fragile banking system and the visibility of risk is particularly low these days. This is no-big-bets territory for investors as the timing and outcome of several events are almost unknowable.
- Increased politicization of the macro environment: Numbers we can quantify but people are harder to predict, and the growing geo- and domestic political risks mean an increased reliance on scenario analysis as opposed to standard quantitative analysis. From Russia-Ukraine to questions of central bank politicization, the rise of political pressures on the macro environment contributes to our core view that the current environment merits investor caution.
- Fiscal headwinds in the U.S. persist: While the drag on growth is less severe than it was in 2022, government activity is still detracting from the U.S. economy—with or without a debt ceiling drama. And with elevated inflation and higher interest rates, it’s our subjective expectation that the pressure to keep government spending contained will persist, no matter who's in power. That only reinforces our view of a near-term U.S. recession and ongoing weak growth in the United States beyond that.
U.S. fiscal policy contribution to GDP growth (%)
The most important data point: credit activity
As we navigate the uncertainties of political battles and their (very real) impact on the economy, the other major known unknown baring down on the U.S. and global economy is the ongoing bank “walk” of falling deposits and the slow roll of small U.S. bank failures: Will there be more of them? Do any banks’ weaknesses represent systemic risk? What happens next? But sometimes the bravest (and most responsible) answer is to admit we just don’t know what precisely lies ahead. Instead, the best approach is to focus on what is quantifiable.
For those of us watching the economy, the critical data point remains the ongoing, and now worsening, tightening of lending standards, which is being exacerbated by banking system fragility. Not once in the past 30 years have we seen credit standards tighten to the degree they have now without a recession unfolding shortly thereafter. The April 30 Senior Loan Officer Opinion Survey just adds to our conviction that the United States will see a recession in the latter part of 2023. Even if the banking system wobbles resolve themselves, that tightening is sufficient in and of itself to produce a sizable drag on growth. Should we see further bank failures, that will compound the growth problem further. In short, the options on the table appear to be a recession or a worse recession. Either way, caution and a focus on long-term investing opportunities remain the right approach to this very uncertain economic environment.
Credit activity is a critical data point
U.S. loan officer surveys lead GDP
Source: U.S. Federal Reserve, Bureau of Economic Analysis, Manulife Investment Management, as of May 19, 2023. SLO refers to senior loan officer. Gray bars indicate U.S. recession.
Europe is losing its shine
In a world filled with challenges, European stocks were a relatively good spot to hang out over the past six months or so. European equities outperformed handily between September 2022 and April 2023 as market concerns about a major energy crisis dissipated and the potential for government money-fueled growth produced upside risk that was scarcely available elsewhere.
But the shine on Europe is starting to fade, and we have trouble seeing this region as a continued macro trade winner. In short, Europe looks like it will be suffering through more stagflationary dynamics than had been expected or hoped for. On the growth side, Europe isn’t getting much boost from the much-hyped China reopening, which has been domestically centered and no major boon for global (or European growth). Drops in major confidence surveys this month—like the ZEW Indicator of Economic Sentiment—corroborate this disappointment. Perhaps even more problematically, inflation is looking sticky—consumer surveys and wage agreements are showing at best a stagnation and at worse a deterioration in inflationary conditions.
The European Central Bank was already out-hawking the Fed and is likely to continue to do so. So while Europe may still look relatively better to its global peers, we have to acknowledge the macro story is weaker.
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