There is a rare sense of optimism in financial markets. For most of the year, high inflation in the United States has persisted troublingly, Europe's energy crisis is threatening a deep recession, and China's economy is suffering from COVID-19 lockdowns and real estate declines. It is plagued by bankruptcy. Investors are currently rooting for development on all three fronts. The US annual inflation rate fell from 8.2% to 7.7% in October. European natural gas prices have fallen by two-thirds since their peak in August. China has eased some restrictions related to its “zero coronavirus” policy, and on November 11 announced measures to ease financial pressure on beleaguered property developers. Global stocks have risen 13% since mid-October on the news, as traders priced in fewer interest rate hikes by central banks, causing the dollar to fall.
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Unfortunately, investors are getting ahead of themselves. U.S. inflation is falling as pandemic-related supply chain disruptions begin to clear. A year ago, dozens of ships were anchored outside Los Angeles, waiting to unload, and semiconductors and used cars were in short supply. Now the berths are empty, there is a glut of tips, and car prices are falling. These improvements are likely to continue. And from March 2023, price comparisons with a year ago will no longer look back to before Russia's invasion of Ukraine, when oil was cheap. If this happens, the headline inflation rate will fall further.
But as inflation subsides, the battle will become even more difficult. The labor market remains so tight that American wages are growing at more than 5% annually. There are almost two vacancies for every unemployed person. The Fed's 2% inflation target is compatible with wage increases of just 3% to 4% (reflecting inflation, productivity growth, and perhaps a recovery in workers' share of economic output). Job growth has slowed, so the Fed is likely to continue raising interest rates until the labor market cools further. Some disinflation may be easily achieved today, but a recession will almost certainly be needed to get back to 2%.
Europe's energy crisis is experiencing a similarly illusory reprieve. Natural gas prices fell sharply due to high storage levels and mild weather. But despite this, Europe's economy is probably shrinking, and this is just the beginning of an energy crisis that will last at least two winters. Next year, Europe may have to replenish its reserves with Russian gas without pipelines. The weather could get colder and global liquefied natural gas prices could rise. To make matters worse, the inflation traditionally driven by energy prices appears to be taking hold. Britain's annual inflation rate reached 11.1% in October. Excluding food and energy, it was 6.5%. Wage growth is rising across Europe and inflation expectations are gradually rising, making it difficult to balance fighting inflation with supporting the economy.
China's economy has been severely damaged by the zero-coronavirus policy and the housing crash, so 2023 has the greatest potential for a pleasant surprise. Authorities announced 20 tweaks to anti-coronavirus rules and 16 measures to support real estate companies. However, on both fronts, the road ahead will be long and difficult. Rising cases mean further lockdowns may be imminent. If we can manage to bring the new coronavirus infections to zero, growth will be promoted, but if people who have had little exposure to the virus hit an “exit wave” of infections in a disorderly manner, , which could cause panic and further damage the economy. Although real estate measures have helped developers and reduced the likelihood of financial collapse, housing demand, and therefore real estate's contribution to growth, is likely to remain subdued. Global economic problems remain serious. It's not just about ignoring them. â–
