“The risk of a global recession is high”, Interview

What are the key takeaways from the centuries-old Pimco forum that outlines the economic outlook for the next five years?

In the medium term, we have maintained three main transitions represented by green, digital and social. But the war in Ukraine brings with it a new deal: it ends goldilocks, “golden loops” that combined growth and inflation at the right temperature, with central banks and governments having ample room to maneuver. We forecast a high risk of a recession over the medium term and believe that over the five-year horizon, shorter economic cycles, high volatility, and weakening government and monetary policy response will require finding portfolio resilience to achieve results. Today it’s a bit like “anti-goldilocks “, with weak growth, high inflation driven by energy prices, food and supply chain problems forcing monetary tightening, while the States are in deleveraging logic after the excesses of previous crises. High inflation and debt makes it much more difficult to maintain the kind of monetary and fiscal policy that we have become accustomed to in recent years.

Do you think the current tightening of monetary policy is appropriate?

Between the pandemic, China’s Covid zero policy, and the war in Ukraine, uncertainty has risen so much that it is necessary to be as modest as possible in forecasts, especially when inflation will peak. Meanwhile, central banks are forced to act. Their reaction is unanimous and very strong, often with rate hikes of 50, 75 or even 100 basis points. After that, the data will be reviewed at each meeting to decide on further actions. They will, of course, be forced to soften monetary normalization if the economic situation deteriorates.

Are we moving towards de-globalization and reindustrialization of advanced economies, which would both allow for a return to greater sovereignty and limit climate change?

Yes, the war in Ukraine has heightened the desire for “sustainability” in supply chains, which is one of the central themes of Pimco’s secular worldview. The most sensitive industries, such as the production of semiconductors, batteries and others, will be gradually repatriated. Surveys of business leaders show that supply chain sustainability is one of their top concerns and something they are actively working on.

Are you afraid that inflation, in spite of everything, will not take root?

There will likely be a transition phase with repatriation of supply sources, during which companies will have to invest and be less efficient, which will have high costs, fueling inflation. Global warming is also likely to push prices up: Facing the worst drought in seventy years, for example, northern Italy has lost nearly 40% of its crops, while hydropower generation is waning and nuclear power needs more coolant. plants.

What percentage do you estimate the risk of a recession in the US and the world in the medium term?

With tightening financial conditions as seen in the yield curves, the likelihood of a global recession in the next two years is high (ie, over 50%). This recession will be global because the rise in prices will affect all countries, and in particular the most disadvantaged, as the prices of basic foodstuffs rise first of all. While households will still be able to spend their savings accumulated over the past few years this summer, in the very short term, winter is likely to be more difficult due to rising energy and food prices, with depletion of stocks.

The likely cessation of Russian gas imports to Europe, which the IEA fears, could lead Europe to a recession?

Yes, absolutely, this is our scenario in such a scenario. The European Union fears that a complete halt to Russian gas imports will lead to plant closures and electricity rationing, which is very detrimental to economic growth. At the same time, there is a race against time to diversify supplies and reactivate other energy sources, such as coal-fired power plants in Germany. In fact, the economic downturn is global, but Europe, a neighbor in the conflict, depends on energy.

What are the most promising breakthrough innovations for future growth today?

The most important of these are “green” energy sources, which will gradually prevail over fossil fuels, electric vehicles, artificial intelligence and robotics. With sustainability and reindustrialization, automation and robotization of production lines will be critical to amortize the costs of this transition. They will also reduce labor shortages.

Do you fear a deadlock with political risks in France?

Today, political risk is global. Real household incomes are falling due to inflation, which creates social tensions everywhere. This was followed by the degradation of the political environment, the phenomenon of disillusionment and the rise of extremes. Named the main culprits, current governments are more or less successful in trying to minimize the impact of inflation. But the winter will be difficult.

What would you recommend today in terms of asset allocation?

Many investors have so far had the reflex to buy dips. buy dip. But this time around, with no fiscal and monetary support, we are much more cautious with stocks and bonds. Without a lifeline, there will probably be more bankruptcies, more defaults, so you have to be very selective. Moreover, the geopolitical risk (US/China, Russia) creates the risk of losses. On the positive side, returns have increased and can now play a role in portfolios even in Europe, where returns are back in positive territory. For bonds, markets are factoring in a rate increase that may not see the light of day given the slowdown in economic growth and the upcoming decline in core inflation (except for volatile elements such as energy and food). In this case, yields will fall and the prices of bonds that move in the opposite direction to rates will rise. Sovereign bonds should also be preferred given the prevailing unfavorable conditions. On the equities side, preference should be given to sectors that will grow even during a recession, such as wind turbines, batteries, solar panels, robots or electronic components. In the absence of general public support, these activities are such important issues that huge budgets are allocated to them (the REPowerEU plan, etc.) and will keep the activity afloat.