May 13, 2022

News in Charts: An update on Fathom’s Global Outlook, Spring 2022

by Fathom Consulting.

The views expressed in this article are the views of the author, not necessarily those of Refinitiv Lipper or LSEG.

It’s seven weeks since Fathom finalised its Global Outlook, Spring 2022, summarised in ‘Fake it till you make it’. In this note, we review recent developments in the context of those forecasts, and preview some of the analysis that will feature in our upcoming Global Outlook, Summer 2022.

Inflation has continued to soar. Many forecasters are still struggling to understand the process at work, with the core measure surprising on the upside for six months in a row in the UK, and for all but one of the past seven months in the euro area. Only in the US are there tentative signs that the consensus is starting to get on top of the numbers, with forecast errors averaging close to zero over the past three months. Fathom warned in March 2020 that the pandemic risked being net positive for inflation. By the middle of last year, we forecast that US inflation would continue to rise through the second half of the year, peaking early in 2022, albeit closer to 7.0% than the 8.5% recorded in March. In our Global Outlook, Spring 2022, we concluded for the first time that there had probably been some loss of credibility among central banks. We assigned a 70% weight to a scenario that we labelled ‘Extended transitory’, where the persistence of inflation had moved a quarter of the way back to levels seen in the 1970s, and a 30% weight to a scenario where it moved all the way back.

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Since then, we find that in many cases market pricing has moved closer to the mean paths we set out in late March, particularly regarding the US interest rate outlook, and the pricing of equities.

The first fan chart below, for the US federal funds rate, is identical to the one we published in March, save for the fact that we have updated market pricing. The short end of the US yield curve has steepened dramatically, with investors now expecting something very close to the mean path we had set out for this year. Beyond this year, market pricing is towards the upper end of the range of possible outcomes as we saw it. It may be that investors see a lower risk of recession in the US than we had factored in. Equally, market pricing for US ten-year government yields has also shifted higher. Perhaps reflecting in part this repricing of the interest rate outlook, the S&P 500 has fallen more than 10% since we finalised our Global Outlook, Spring 2022. Back in late March we saw an 80% chance that the S&P500 would fall through 2022 as a whole.

IN HOUSE

IN HOUSE

As we finalised our forecast in March, we saw close to an evens chance of recession this year in most major economies, including the US, the euro area and the UK. At the time, our forecasts were more bearish than the consensus among other economic forecasters, and more bearish than most official forecasts.

The US economy contracted, unexpectedly, in the first quarter. Looking at the expenditure components, this was driven by a marked deterioration in the contribution from net trade, with exports falling and imports rising strongly. More positively, growth in household spending remained firm, at 2.7%. Forward-looking, survey-based indicators of household spending, particularly in Europe, have deteriorated since the beginning of this year. In the euro area and the UK, confidence in households’ own financial situation is now at levels that, in the past, has led invariably to recession within a matter of months.

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Meanwhile, COVID cases in China rose sharply in early April, leading to strict lockdowns in several major cities, including Shanghai. China is the only large economy that continues to pursue a ‘zero-COVID’ policy. With the Omicron variant able to spread far more rapidly than the original strain, even among well-vaccinated populations, policies of total suppression risk producing considerable economic hardship. Surveys of business activity in China have fallen sharply over the past two months, and appear consistent with economic contraction.

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Just at the moment that investors have shifted towards Fathom’s assessment of the outlook for higher interest rates, particularly in the US, we find ourselves asking whether it will turn out that in fact we assigned too high a weight to the prospect of much higher interest rates in our Global Outlook, Spring 2022 — and too low a weight to the prospect that interest rate reductions might be on the cards before the year is out. In other words, are we reaching something close to ‘peak hawkishness’? The case for this rests in charts like the Euro area consumer confidence chart above. Large increases in consumer prices, that have not yet been matched by higher wages, mean that real incomes have fallen sharply in many economies, threatening recession. If the post-COVID economic boom does turn to bust, might a period of rapid disinflation negate the need for higher interest rates? This, alongside the potential consequences of China’s zero-COVID policy, will be one of the main themes of our forthcoming Global Outlook, Summer 2022.

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