News in Charts: A wave of crises may be about to break

Global economic and financial risks have intensified over recent weeks and months. A wave of sovereign, currency and banking crises are now in prospect, as Fathom has been warning for some time. In this note, we discuss how these risks developed.

The COVID convulsion of 2020 triggered the steepest global recession of all time, followed by the swiftest global recovery ever. After contracting by 3 per cent in 2020, the global economy expanded by 6 per cent in 2021 as policymakers significantly ramped up their monetary and fiscal easing. Now, however, downturns are looming again in many countries. Recession is our central case in all the major advanced economies, either right away or within the next year or so.

The pandemic recession and recovery also unleashed higher global inflationcompounded by the impact on energy prices of Russia’s invasion of Ukraine. When policymakers respond to a threatened recession, looser policy is the correct medicine. But when higher inflation is the issue, and especially when inflation has become embedded in expectations, tighter policy is the answer. Recession and high inflation together create a policy dilemma. We are on the horns of that dilemma right now.

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In a sense, the current slowdown in growth is just a ripple from the storm that was the pandemic: a natural consequence of that colossal shock. All major recessions tend to see a rapid recovery, and then a pause — the timing of which tends to be a couple of years after the trough of the recession. The timing of that pause is important: it is a good predictor of financial crisis.

The intuition here is as follows. In the teeth of a major recession, policymakers are highly focused on restoring growth and preventing further damage. They will use whatever tools they have at their disposal and will have an easy time persuading others that that is what is needed. Moreover, international institutions like the IMF will be on their guard to prevent the recession from escalating in emerging economies, ready to turn on the taps of lending or other kinds of support where necessary. Financial crises are rare during recessions, for those reasons. Scroll forward a couple of years, though, through the most rapid part of the recovery and into the pause, and the frequency of financial crises peaks. It’s not the recession: it’s after the recession. The risk of financial crisis is related to the magnitude of the recession, but it peaks a couple of years later. It peaks, in other words, now.

Fathom’s global Financial Vulnerability Indicator (FVI) has been ringing alarm bells ever since the COVID recession about the coming risk of financial crisis. It suggests that the risk of a banking crisis is higher now than it has been at any time since the Great Financial Crisis of 2008/09. Moreover, the proportion of countries in each region at an increasing risk of a banking crisis has also surged, with almost 30 per cent of countries in South Asia and 20 per cent of countries in Sub-Saharan Africa having a greater than one in twenty-five chance of a crisis.

IN HOUSE

All in all, 2022 has already been a very painful year for global financial markets, with government bond yields surging and equity markets falling sharply, and the omens for the global economy are also looking increasing downbeat. If this were not enough, investors should also brace themselves for a coming wave of sovereign, currency and banking crises.

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

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