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If Leo Tolstoy were writing about today’s business conditions, he might have noted that happy economies are all alike but every unhappy economy is unhappy in its own way.
China’s growth prospects have been hammered by strict Covid-19 lockdowns in a bid to quell its Omicron outbreak; the US Federal Reserve risks turning an American boom into bust; Europe’s households are enduring a cost of living crisis; and the situation is worse in many poorer emerging markets, where food crises and even famines beckon.
These four different but imposing problems each stalk the global economy as it recovers from the pandemic and it is not surprising the mood is darkening.
According to Robin Brooks, chief economist of the Institute of International Finance, the confluence of these shocks suggests the world economy is already in trouble. “We’re in another global recession scare now, except this time we think it’s for real,” he says.
Financial markets have taken fright. The MSCI world index of equities fell more than 1.5 per cent in the past week, more than 5 per cent in May and more than 18 per cent since a peak in early January. Dhaval Joshi, chief strategist at BCA Research, notes that on top of a torrid time for stocks, there has been a sell-off in bonds, inflation-protected bonds, industrial metals, gold and crypto assets.
“The last time that the ‘everything sell-off’ star alignment happened was in early 1981 when Paul Volcker’s Fed broke the back of inflation and turned stagflation into an outright recession,” Joshi says.
Defining a global recession is no easy task. For individual countries, some economists define a “technical recession” as two consecutive quarters of contraction in gross domestic product. The Financial Times prefers a more flexible definition as does the US, where the National Bureau of Economic Research defines a recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months”.
At a global scale definitions become still more difficult. The IMF and World Bank prefer to characterise a global recession as a year in which the average global citizen experiences a drop in real income. They highlight 1975, 1982, 1991, 2009 and 2020 as the dates of the previous five global recessions.
While the official global growth forecasts for 2022 still seem far off this definition — in April the IMF expected annual growth of 3.6 per cent this year — this figure relates as much to the recovery in the second half of 2021 as to expectations for 2022. When the fund looks at the growth it expects during 2022, it has already cut its forecast from 4.5 per cent in October last year to 2.5 per cent in April.
Brooks reckons that the news since this forecast was published has been sufficiently bad to lower the growth projection to just 0.5 per cent during 2022, less than the expected increase in population. “Mounting global recession risk is top-of-mind for markets, which has important repercussions for investor psychology,” Brooks says.
China is the big economy that most economists are worried about and the past week has seen new data reinforcing concerns about its prospects. Accounting for 19 per cent of the world’s total output, China is now so large that when it catches Covid the rest of the world cannot ignore its pain, especially because of its impact on global supply chains and its demand for goods and services from other countries.
Severe strains are showing. With lockdowns rippling through the country, ships queue outside Chinese ports and the country’s manufacturing and retail sectors have started to contract. Retail sales fell 11 per cent year on year in April, while industrial production was down 3 per cent. China’s home sales also dropped more last month than in early 2020, when its economy went into reverse, despite the People’s Bank of China loosening monetary policy to encourage borrowing and spending. Unemployment is rising.
Kevin Xie, senior Asia economist at the Commonwealth Bank of Australia, says that China’s economic data in April was consistently disappointing. Although the outlook depends crucially on the spread of Covid, he adds, “falling employment and weakened confidence among business and households will curb spending and bode poorly for the growth outlook”.
In the US, the other global economic powerhouse, the economy is suffering from the pandemic’s legacy and, in particular, excessive fiscal stimulus that arguably ran the economy too hot and generated high inflation even with modest energy price rises. Alongside a very tight labour market, the Fed has been forced to concede an error and has now moved decisively into a phase of tightening monetary policy to slow growth and bring inflation down.
The Fed chair Jay Powell was crystal clear this week that the central bank would continue raising interest rates until it saw “clear and convincing” evidence that inflation was returning to the 2 per cent target. He was not concerned about unemployment rising “a few ticks” from the current low level of 3.6 per cent.
Powell added that he was aiming at a soft landing for the economy, but many in financial markets think that might be hard to achieve. Krishna Guha, vice-chair of Evercore ISI, warns there is a much higher than normal risk that the tough talk from officials, economists and market participants would become a self-fulfilling prophecy and generate a downturn.
“To say a softish landing is possible is not to say it is inevitable or even particularly likely,” Guha says. Although he is not predicting a US recession, Guha says, “bringing inflation under control without a recession and large increase in unemployment . . . will be challenging”.
On the other side of the Atlantic, Europe’s equally difficult problem is different. Apart from the UK, inflation stems almost universally from higher energy prices rather than an overheating economy and can be traced directly to Russia’s invasion of Ukraine.
Unfortunately for the EU, understanding the cause of Europe’s woes does not diminish its consequences. With inflation of 7.4 per cent in April, eurozone prices are rising much faster than its citizen’s incomes, imparting a hit to living standards that will limit spending and the recovery from the pandemic. New forecasts from the European Commission this week were scaled back sharply and implied stagnation in the second quarter of 2022.
The commission expects the economy to get over this difficult period and return to reasonable growth of about half a per cent per quarter by the summer, but many private sector economists think the hit to incomes will have longer-lasting effects. Christian Schulz, an economist at Citi, says that the official forecasts appear too optimistic and it is more likely there will be “virtually no growth for the rest of the year”.
If Europe’s difficulty is in adjusting to much higher energy prices, poorer countries have the even harder task of dealing with the rapid rise in the price of food, which account for more than 30 per cent of expenditure in emerging economies.
With the Black Sea ports that Ukraine uses for exporting grains shut, fears of a food crisis later this year are mounting. António Guterres, secretary-general of the UN, said on Wednesday that the conflict in Ukraine, coming on top of existing pressures on food prices, “threatens to tip tens of millions of people over the edge into food insecurity followed by malnutrition, mass hunger and famine”.
Although it has its own domestic political and economic crises, Sri Lanka epitomises the dire choices faced in many of the world’s poorest countries when it decided this week to default on its foreign debt for the first time. This, it said, was necessary to use its hard currency for importing fuel, food and medicine.
India, meanwhile, intensified the problems in other emerging economies by reneging on a pledge not to ban the export of grain this week. Wheat prices rose again and are up more than 60 per cent this year.
Naturally, as recession risks rise, the best news for the global economy would be a Russian withdrawal from Ukraine and an end to the zero-Covid strategy in China. This is not in the gift of economic ministers and officials, so instead, they will again have to fine tune their response to the difficult situations they face.
In Europe and emerging economies, this will involve alleviating the consequences of higher food and energy prices — raising benefits and subsidising food and energy in countries with sufficiently strong public finances. The US and UK could accelerate the tightening cycle of monetary policy, while China will seek to limit the negative effects of the Omicron coronavirus wave in China.
The majority view among economists is that the defence against global recession will still win in 2022. But economists are increasingly hedging their bets in the face of relentless bad news.
Innes McFee, chief global economist at Oxford Economics, says there is little question that the global economic expansion is close to a peak, that it is slowing and that policymakers will need to work out how much tightening is needed. But, he says, a recession is still unlikely for now because policymakers still have the tools to back away and stimulate if things get worse.
“Recession risks rise into next year, but they are not that high at this time,” McFee says.
Air travel chaos and cost of living worries have spurred a surge in bookings by Britons for domestic summer holidays, offering hope to a sector struggling with financial pressures and a worsening economic outlook.
UK domestic holiday businesses had feared 2022 would spell an end to the summer staycation boom of the pandemic’s first two years, when onerous travel restrictions and fears of catching Covid-19 deterred holidaymakers from international travel.
But inquiries and late bookings for domestic summer holidays have jumped since early June, after flight cancellations caused major travel disruption during the school half-term holiday and balmy weather swept across the country.
Last-minute bookings for summer holiday accommodation from Sykes Holiday Cottages, one of the UK’s leading holiday rental agencies, were up 22 per cent at the start of June, compared with the same period last year.
Just under 40 per cent of Britons said they were more likely to choose a domestic holiday instead of an overseas break than before the pandemic, according to polling conducted in mid-June and published on Friday by VisitBritain, the UK’s tourist board.
Of those choosing a staycation, 65 per cent told VisitBritain it was because UK breaks were easier to plan, 54 per cent said they wanted to avoid long queues at airports and the risk of cancelled flights, and 47 per cent said it was because UK holidays were more affordable.
“Whether families think they can’t afford a summer getaway abroad, or they’ve had their flights cancelled, or the potential of sitting with four kids for 12 hours in the airport has just scared them off, many are opting to stay at home,” said Sir David Michels, president of the Tourism Alliance, a lobby group. “That’s a net-positive for the UK tourism industry.”
Michels said he did not expect demand for domestic holidays this summer to surpass the heights of summer 2021, but it was possible levels of demand could mirror last year.
He added that sterling’s depreciation this year “certainly wouldn’t hurt” the domestic market as it would “put some people off” travelling overseas. The currency is down 9.3 per cent against the dollar and 2.2 per cent against the euro since the start of 2022.
Cottage bookings on Awaze, a vacation rental company, for June were flat compared with 2021 and up 21 per cent on 2019, while bookings for August this year were 6 per cent higher than the same month last year and 46 per cent up on 2019. July was slightly down on 2021 levels.
Graham Donoghue, chief executive of Sykes Holiday Cottages, said the UK was “continuing to ride the staycation wave despite the return of foreign travel”.
“Uncertainty around Covid restrictions has seemingly been replaced with another worry — overseas travel disruption — while an increased pressure on household budgets is leading to many turning to staycations as the better value option,” explained Donoghue.
On Thursday, British Airways check-in staff voted to strike later in the summer over pay, setting the stage for yet more air travel disruption.
Henrik Kjellberg, Awaze chief executive, said the travel chaos had “benefited” the domestic tourism market as holidaymakers looked to “avoid the stress and hassle” of overcrowded airports.
He said people had been “introduced to the charms of staycations” during the pandemic and they were “here to stay”, adding that pandemic travel restrictions had combined with a “gradual trend of people thinking more and more about their CO₂ footprint” to encourage more families to consider holidaying locally.
Meanwhile, members of the trade body UKHospitality reported a 20-30 per cent uplift in inquiries over the platinum jubilee weekend in early June from customers searching for holidays in late summer or over the school half-term holiday in October, according to Kate Nicholls, chief executive.
Nicholls said the extension of the staycation boom would provide a lifeline for independent businesses, which have been hit hardest by cost pressures resulting from supply chain issues and the war in Ukraine.
“British holidaymakers will tend to go for the less obvious options,” said Nicholls. “There’s a proportion of customers who will always go branded, but there is also a proportion of domestic visitors who are much more confident about going off the beaten track and looking for independents, looking for boutique options.”
The success of domestic tourism has become more significant because inbound tourism is not expected to rebound to pre-pandemic levels until 2025.
The task for the industry now is to convince British holidaymakers to keep returning in future summers. “If the sun keeps shining, I think it’s going to be a much fuller UK with UK residents than summers before the pandemic,” said Michels. “We’ve now had three years of lots of people holidaying at home. I don’t think this is going away.”
“The longer this trend lasts, the stickier those habits become and the more beneficial it will be for communities across the country,” said Nicholls.
Brenda McKinley has been selling homes in Ontario for more than two decades and even for a veteran, the past couple of years have been shocking.
Prices in her patch south of Toronto rose as much as 50 per cent during the pandemic. “Houses were selling almost before we could get the sign on the lawn,” she said. “It was not unusual to have 15 to 30 offers . . . there was a feeding frenzy.”
But in the past six weeks the market has flipped. McKinley estimates homes have shed 10 per cent of their value in the time it might take some buyers to complete their purchase.
The phenomenon is not unique to Ontario nor the residential market. As central banks jack up interest rates to rein in runaway inflation, property investors, homeowners and commercial landlords around the world are all asking the same question: could a crash be coming?
“There is a marked slowdown everywhere,” said Chris Brett, head of capital markets for Europe, the Middle East and Africa at property agency CBRE. “The change in cost of debt is having a big impact on all markets, across everything. I don’t think anything is immune . . . the speed has taken us all by surprise.”
Listed property stocks, closely monitored by investors looking for clues about what might eventually happen to less liquid real assets, have tanked this year. The Dow Jones US Real Estate Index is down almost 25 per cent in the year to date. UK property stocks are down about 20 per cent over the same period, falling further and faster than their benchmark index.
The number of commercial buyers actively hunting for assets across the US, Asia and Europe has fallen sharply from a pandemic peak of 3,395 in the fourth quarter of last year to just 1,602 in the second quarter of 2022, according to MSCI data.
Pending deals in Europe have also dwindled, with €12bn in contract at the end of March against €17bn a year earlier, according to MSCI.
Deals already in train are being renegotiated. “Everyone selling everything is being [price] chipped by prospective buyers, or else [buyers] are walking away,” said Ronald Dickerman, president of Madison International Realty, a private equity firm investing in property. “Anyone underwriting [a building] is having to reappraise . . . I cannot over-emphasise the amount of repricing going on in real estate at the moment.”
The reason is simple. An investor willing to pay $100mn for a block of apartments two or three months ago could have taken a $60mn mortgage with borrowing costs of about 3 per cent. Today they might have to pay more than 5 per cent, wiping out any upside.
The move up in rates means investors must either accept lower overall returns or push the seller to lower the price.
“It’s not yet coming through in the agent data but there is a correction coming through, anecdotally,” said Justin Curlow, global head of research and strategy at Axa IM, one of the world’s largest asset managers.
The question for property investors and owners is how widespread and deep any correction might be.
During the pandemic, institutional investors played defence, betting on sectors supported by stable, long-term demand. The price of warehouses, blocks of rental apartments and offices equipped for life sciences businesses duly soared amid fierce competition.
“All the big investors are singing from the same hymn sheet: they all want residential, urban logistics and high-quality offices; defensive assets,” said Tom Leahy, MSCI’s head of real assets research in Europe, the Middle East and Asia. “That’s the problem with real estate, you get a herd mentality.”
With cash sloshing into tight corners of the property market, there is a danger that assets were mispriced, leaving little margin to erode as rates rise.
For owners of “defensive” properties bought at the top of the market who now need to refinance, rate rises create the prospect of owners “paying more on the loan than they expect to earn on the property”, said Lea Overby, head of commercial mortgage-backed securities research at Barclays.
Before the Federal Reserve started raising rates this year, Overby estimated, “Zero per cent of the market” was affected by so-called negative leverage. “We don’t know how much it is now, but anecdotally its fairly widespread.”
Manus Clancy, a senior managing director at New York-based CMBS data provider Trepp, said that while values were unlikely to crater in the more defensive sectors, “there will be plenty of guys who say ‘wow we overpaid for this’.”
“They thought they could increase rents 10 per cent a year for 10 years and expenses would be flat but the consumer is being whacked with inflation and they can’t pass on costs,” he added.
If investments regarded as sure-fire just a few months ago look precarious; riskier bets now look toxic.
A rise in ecommerce and the shift to hybrid work during the pandemic left owners of offices and shops exposed. Rising rates now threaten to topple them.
A paper published this month, “Work from home and the office real estate apocalypse”, argued that the total value of New York’s offices would ultimately fall by almost a third — a cataclysm for owners including pension funds and the government bodies reliant on their tax revenues.
“Our view is that the entire office stock is worth 30 per cent less than it was in 2019. That’s a $500bn hit,” said Stijn Van Nieuwerburgh, a professor or real estate and finance at Columbia University and one of the report’s authors.
The decline has not yet registered “because there’s a very large segment of the office market — 80-85 per cent — which is not publicly listed, is very untransparent and where there’s been very little trade”, he added.
But when older offices change hands, as funds come to the end of their lives or owners struggle to refinance, he expects the discounts to be severe. If values drop far enough, he foresees enough mortgage defaults to pose a systemic risk.
“If your loan to value ratio is above 70 per cent and your value falls 30 per cent, your mortgage is underwater,” he said. “A lot of offices have more than 30 per cent mortgages.”
According to Curlow, as much as 15 per cent is already being knocked off the value of US offices in final bids. “In the US office market you have a higher level of vacancy,” he said, adding that America “is ground zero for rates — it all started with the Fed”.
UK office owners are also having to navigate changing working patterns and rising rates.
Landlords with modern, energy-efficient blocks have so far fared relatively well. But rents on older buildings have been hit. Property consultancy Lambert Smith Hampton suggested this week that more than 25mn sq ft of UK office space could be surplus to requirements after a survey found 72 per cent of respondents were looking to cut back on office space at the earliest opportunity.
Hopes have also been dashed that retail, the sector most out of favour with investors coming into the pandemic, might enjoy a recovery.
Big UK investors including Landsec have bet on shopping centres in the past six months, hoping to catch rebounding trade as people return to physical stores. But inflation has knocked the recovery off course.
“There was this hope that a lot of shopping centre owners had that there was a level in rents,” said Mike Prew, analyst at Jefferies. “But the rug has been pulled out from under them by the cost of living crisis.”
As rates rise from ultra-low levels, so does the risk of a reversal in residential markets where they have been rising, from Canada and the US to Germany and New Zealand. Oxford Economics now expects prices to fall next year in those markets where they rose quickest in 2021.
Numerous investors, analysts, agents and property owners told the Financial Times the risk of a downturn in property valuations had sharply increased in recent weeks.
But few expect a crash as severe as that of 2008, in part because lending practices and risk appetite have moderated since then.
“In general it feels like commercial real estate is set for a downturn. But we had some strong growth in Covid so there is some room for it to go sideways before impacting anything [in the wider economy],” said Overby. “Pre-2008, leverage was at 80 per cent and a lot of appraisals were fake. We are not there by a long shot.”
According to the head of one big real estate fund, “there’s definitely stress in smaller pockets of the market but that’s not systemic. I don’t see a lot of people saying . . . ‘I’ve committed to a €2bn-€3bn acquisition using a bridge format’, as there were in 2007.”
He added that while more than 20 companies looked precarious in the run-up to the financial crisis, this time there were perhaps now five.
Dickerman, the private equity investor, believes the economy is poised for a long period of pain reminiscent of the 1970s that will tip real estate into a secular decline. But there will still be winning and losing bets because “there has never been a time investing in real estate when asset classes are so differentiated”.
A consortium of Chinese state banks has lent $2.3bn to Pakistan to help the country stave off a foreign payments crisis, finance minister Miftah Ismail said on Friday.
Confirmation of the support from China, a close economic and military ally of Pakistan, came on the same day Islamabad announced a one-off 10 per cent ‘super tax’ on important industries that is intended to lead to a stalled $6bn IMF loan package being resumed.
“I am pleased to announce that Chinese consortium loan of Rmb15bn ($2.3bn) has been credited in to SBP [State Bank of Pakistan, Pakistan’s central bank] account today, increasing our foreign exchange reserves,” Ismail said in a tweet on Friday evening.
A senior government official said the arrival of the loan was “one of the signals that we’re about to return to the IMF programme”.
China had quietly urged Islamabad to repair ties with the IMF “as an essential step to improve Pakistan’s economic health and avoid a default”, the official said.
The Chinese loan will raise Pakistan’s liquid foreign reserves of $8.2bn to $10.5bn and could help shore up the rupee, which has slumped against western currencies.
Pakistan began to receive IMF payments in 2019 under a 39-month loan programme, but the fund has so far given only about half of the $6bn agreed.
In recent months, sliding confidence in Pakistan’s economy has prompted concerns it could follow Sri Lanka in defaulting on international debt.
Prime minister Shehbaz Sharif, who was elected by parliament in April following the ousting of rival Imran Khan, unveiled on Friday the new super tax to be levied on manufacturers of cement, beverages, steel, tobacco and chemicals.
“The government has decided to impose a 10 per cent ‘poverty alleviation tax’ on large-scale industries of the country,” Sharif tweeted.
Business leaders widely criticised the move and share prices on the Karachi Stock Exchange fell nearly 5 per cent after news of the tax emerged. Analysts said the decision would further fuel inflation, a central concern for households across Pakistan.
Zaffar Moti, a former KSE director, said: “This is a major setback for the economy. The government has decided to further tax those who are already paying their taxes.”
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