Seeing through clouds: low pressure economy ahead

The stormy weather continues - stock markets and central bankers saying the same thing: more turbulence ahead.

 

Most economic headlines are focused on inflation and the record pace of interest rate increases in two decades. Both have immediate and direct effects on many businesses - from the cost of materials to the cost of capital.   Businesses have to deal with these challenges today and many finance directors and management accountants are focused on helping their business clients overcome them.

 

It is natural to focus on the problems right in front of us.  However, now more than any time since the onset of the global financial crisis of 2008-09, it is also important to see past the early clouds.  Contingency planning and early preparations are needed when the conditions get worse - not dissimilar to the ships crossing stormy oceans. Below are the top three risks that we are keeping an eye on at HedgeFlows:

 

Low- and high-pressure economies are economists' analogies to weather conditions used to characterise business cycles. In a low-pressure economy, a so-called recession, unemployment increases, demand sags and growth slows down.  In the context of currently high inflation, however, the relevance of the low-pressure economy is its frequent use by monetary authorities as a tactic to combat inflation. This time is no different. Governments and central banks around the world are choosing to sacrifice growth in the next 2-3 years for the sake of combating the high inflation does not turn into a persistent expectation and, thus, an even bigger problem for years to come.  This combination of high inflation and poor growth, stagflation, is hardest for businesses that produce and sell discretionary products or capital goods. High interest rates and slow growth are also a huge burden for those with working capital or investment needs.

 

Many headlines continue to focus on the tragic war in Ukraine, with few signs of what could stop it on the ground in the near future. Nevertheless, one should not ignore broader risks stemming from Russia's play in the energy market.  Europe is racing to wean itself from Russian oil and gas, preparing such extreme and previously unpopular measures as restarting coal plants. Some analysts anticipate that oil prices can double even from here - if Russia retaliates against the latest round of sanctions by cutting crude oil supply abruptly. It is likely that we may see gas and energy shortages and rationing in European countries this winter.  This will test the resilience of political drive and social cohesion in Europe and may lead to political turmoil in countries most affected by the energy crisis. From further strikes and supply chain disruptions to more financial market volatility, there are numerous knock-on effects of this situation.

 

Currencies often act as a valve through which economies of respective countries adjust to how business cycles, monetary policies, and other factors impact them.  For instance, larger countries may “export” their inflation as their currency becomes stronger vs those of their trade partners as we are currently witnessing with the US dollar. Equally importantly, investor sentiment often drives slower but more powerful trends where exchange rates react to the relative attractiveness of a country to foreign investors. This usually affects emerging market economies more but as argued in the recent research by Bank of America, the risks for Pound Sterling are not negligible either.

 

At HedgeFlows we believe that helping businesses prepare for otherwise unexpected events also helps them prepare for new opportunities and grow with confidence even through turbulent times.