Increased probability of a global recession

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George Kessarios
Chief Economist & Fund Manager

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At the economic policy symposium at Jackson Hole Wyoming, Fed chairman Jerome Powell once more repeated that his number one goal was to bring inflation to about 2%. But in addition to what we already knew, he also said many other things that terrified markets.

For example, he said restoring price stability will take some time and requires using the Fed’s tools forcefully to bring demand and supply into better balance. Reducing inflation is likely to require a sustained period of below-trend growth.

Mr. Powell admitted that the Fed’s toolkit does not really work well when it comes to restrained supply, nevertheless this does not diminish the Fed’s responsibility to achieve “price stability”, said Mr. Powell.

In a nutshell this probably means higher interest rates for longer than we think, and sub-par growth (or a recession) for longer than markets think. And this is not what markets were expecting to hear, and they crashed last Friday.

I have been on the record saying central banks are making a huge policy mistake. And that mistake is trying to solve an inflation problem that is out of their control, by trying to reduce aggregate demand, hoping prices will fall, but sacrificing the economy in the process.

And as we have said several times, the largest portion of current inflationary pressures have to do with energy and supply shortages, which in turn have to do with political skirmishes, a war, and Covid.

And the question is, what happens when the Fed makes everyone poor enough, with aggregate demand falling off the cliff, but energy and food prices don't fall?

Case in point number 1:

Several days ago, Saudi Arabian Energy Minister said “extreme volatility and lack of liquidity mean the futures market is increasingly disconnected from fundamentals and OPEC may be forced to cut production”.

Case in point number 2:

US strategic oil reserves have dropped to their lowest levels since 1985. The most recent count is 425 million barrels, with the Institute of Energy Research expecting stockpiles to fall to 358 million barrels (a 40 year low) by the end of October, vs 621 million ballers 1 year ago. That is almost a 50% drawdown. And while we don’t have details, we know other countries have also sold reserves trying to keep gas prices low.

But what will happen if OPEC reduces supply, and the US stops selling its strategic reserve stockpile? After all, strategic reserves are there for national security reasons and emergencies.

My guess is that, at best, energy prices will stay elevated no matter how much demand falls. And there is also the possibility that oil might climb to higher levels.

The bottom line is that, based on what Chairman Powell said, a soft landing is probably off the table, and we are now looking at the possibility of a global recession straight in the eye, mostly because the Fed is going to cause a technical recession to reduce demand, but this time, without the guarantee that energy prices will fall, which is the biggest component of current inflationary pressures. And insofar as markets, this is the perfect storm.

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