Having experienced the shortest recession in history through 2020, it now looks like we’ll be mirroring that with an extremely short period of recovery. Global growth is projected to slow from 6.1% in 2021 to 3.5% in 2022 and 2023. This is already lower than forecasts at the start of the year, and more downward revisions are already coming through. The war in Ukraine, sanctions on Russia and COVID-19 lockdowns in China are all having a meaningful impact, combined with monetary tightening already under way in the US, the UK, the EU, Australia and Canada.
Inflation concerns are a global phenomenon, but driven by different factors in different countries. Inflation in the UK is now expected to exceed 10% this year, although this headline number is lower than the real inflation most of us are feeling in our day-to-day lives.
Across the eurozone, annual inflation is reported at 8.1%, but individual countries are experiencing much higher levels. The producer price index in Italy, for instance, is at 41%. This is reflected in materially higher yields across government bond markets, but with Italy being impacted more than Germany. European Central Bank president Christine Lagarde has referred to ‘financial fragmentation’ across Europe, as some countries experience greater increases in financing costs than others.
With many price increases being driven by supply-side issues, to a large extent due to the pandemic, these increases might be expected to ease in the coming months. However, with the war in Ukraine showing no signs of ending, it seems more likely that the situation could worsen. Bank of England governor Andrew Bailey described the impact on world food prices as ‘apocalyptic’. With no material improvements expected on the supply side in the near term, higher inflation is now firmly entrenched in expectations and wage expectations. This, coupled with very tight labour markets, makes it challenging for employers to refuse higher pay demands.
At their last meeting on 16 June, the Bank of England raised the base rate to 1.25%, with some calling for a move of 50 basis points (bps) rather than just the 25bps. The market has priced in further increases, with rates expected to be at 3.5% by next summer. The cost of hedging interest rate risk has materially increased in the past few weeks.
In the US the themes are similar, and the Fed’s most recent rate hike was 50bps, slightly below the 75 basis points. The US market, like the UK, has priced in further rate rises this year and next. Concerns about a looming US recession are widespread, and there’s much debate about a ‘soft’ versus ‘hard’ landing. The Fed does have a dual mandate that focuses on price stability (inflation) as well as unemployment.
Amid the doom, there are glimmers of good news. The position of US consumers, for example, is positive, with many stimulus cheques still unspent, and cash deposits (savings) high. Even with the cost-of-living increases, the US consumer looks to have a decent buffer. As personal consumption is by far the largest component of US GDP, how consumers behave in the coming months will be meaningful for the outcome of a soft versus hard landing.
The volatility in public capital markets also impacted activity in global M&A. The first quarter of the year saw global deal volume at just over $1trn, down by 20% in both value and volume on Q1 last year. Global dealmakers do expect a further pause through Q2 as they assess the geopolitical and economic situation. The brunt of the reduction was in the large deals ($1bn-$5bn), down 40%, while mega-deals (more than $10bn) were more resilient. Private equity sponsors did, however, show an increase in activity year on year in Q1, and vendors took advantage of high valuations.
While media headlines report very little good news, it does feel like the capital markets already reflect a lot of negative sentiment. That’s not to say things cannot worsen, but parts of the global economy remain relatively strong. After the frenetic activity and volatility of H1, it feels like we may be entering a summer of ‘pause’ – for central banks, dealmakers and advisers alike.
Jackie Bowie, European head of real estate and co-head of European business, Chatham Financial – a member organisation of the Corporate Finance Faculty