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Global economy weakens amid inflation battle, war and pandemic

Stubbornly high inflation has Wall Street worried that the Federal Reserve will respond by raising interest rates until the US falls into recession, taking the weakened global economy with it.

While analysts say the US economy grew in the third quarter, signs of trouble are mounting both here and abroad. Higher mortgage rates cool the US housing market; energy shortage hurts German factory production; and recurrent coronaviruses shutdowns hinder Chinese businesses.

The Fed and other central banks are tightening credit to combat historically high inflation, even as three of the world̵[ads1]7;s main economic engines – the US, Europe and China – sputter. With the United States and other governments also cutting back on pandemic relief spending, the global economy is getting less support from policymakers than at almost any point in 50 years, the World Bank said Thursday in a new report that warned of growing risks of global recession.

“I see a bumpy road ahead,” said Daleep Singh, global chief economist for PGIM Fixed Income. “We are in a world where the shocks are going to continue.”

FedEx shares plunged on Friday, also dragging down broader financial markets, after the package delivery company’s chief executive, Raj Subramaniam, said he expected a “worldwide recession.”

Interest rate increases are little help for Estonia’s 22 percent inflation, Europe’s worst

Central banks, meanwhile, are engaged in the most aggressive campaign of rate hikes since the late 1990s, according to Citigroup. This month, central banks in Europe, Canada, Australia and Chile have raised interest rates, and the Fed is expected to do so for the fifth time since March at its meeting next week.

Some economists fear that the world’s central banks are misunderstanding the global economy in their rush to raise interest rates, just as they did – in reverse – last year when they insisted that inflation would prove temporary and resisted action. The cumulative effects of several countries tightening credit at the same time can stifle global growth.

“I don’t really understand that many or any central banks pay much attention to how their policies affect the rest of the world,” said Maurice Obstfeld of the University of California at Berkeley, the former chief economist at International. Money fund.

The Fed’s interest rate hikes drive the dollar up against other major currencies, making imported goods cheaper for Americans, while making it harder for people and businesses in other countries can afford products made outside their borders.

Major oil importers such as Tunisia have been particularly hard hit, since crude oil is priced in dollars. The stronger dollar also hurts developing countries that have large dollar debts. As their local currencies depreciate against the dollar, it requires more Turkish lira or Argentine pesos to pay debts.

Falling food and fuel costs offer poorer nations little relief

Despite raising its benchmark interest rate by two and a half points since March, the Fed has not been able to slow the economy enough to take the pressure off prices. On Thursday, initial jobless claims fell for the fifth week in a row, in the latest sign that the labor market is still too hot for the central bank’s comfort.

Although strong hiring is good news for American workers, many economists have said that unemployment must rise before inflation slows.

The Labor Ministry’s report this week that consumer prices in August were 8.3 percent higher than a year ago – little changed from 8.5 percent in July – disappointed investors.

Some analysts expect the Fed to continue to go beyond the 3.8 percent level that politicians suggested in June would complete their anti-inflation work. On Friday, economists at Deutsche Bank said the Fed’s benchmark lending rate could reach 5 percent next year – about double the current level.

Wall Street firms such as Oxford Economics said this week that the Fed will hit the brakes hard enough to contain rates even if it sends the U.S. into a brief downturn.

“Higher for longer inflation, more aggressive monetary tightening by the Fed and negative spillovers from a weakened global backdrop will combine to push the US economy into a mild recession,” the firm said in a note to clients.

Since 1981, US and global growth have largely moved in sync, according to Citigroup research. In each of the four global recessions since 1980, the United States — which accounts for about a quarter of the world’s gross domestic product, or GDP — contracted either just before the global economy fell into a slump or at the same time.

The IMF said this summer that the world economy was at risk of slipping into recession as a result of aftershocks from the war in Ukraine, the pandemic and inflation. The IMF alarm followed a World Bank warning of the risk of global “stagflation”, a toxic combination of persistently high prices and anemic growth.

There is no official definition of a global recession, although the World Bank uses the term to describe a fall in global GDP per person. Some economists say a broad decline in a number of metrics, such as industrial production, cross-border capital flows, employment and trade, or an economic downturn involving a large number of major economies, distinguishes a true global recession.

“We have the US, Canada and Europe all in recession in the second half of this year and early next year. Whether you call it a global recession or not is in the eye of the beholder,” said Ben May, Oxford Economics’ director of global macro research. “But we are going to go through a very weak patch. It’s going to feel like a recession.”

The big concern is Europe, which is struggling to adjust to the loss of Russian natural gas supplies. Moscow reacted to European sanctions after the invasion of Ukraine by cutting shipments of natural gas to Europe by about 75 percent, according to Barclays.

As energy prices skyrocketed, consumers and businesses on the continent felt the pinch. After years of keeping borrowing costs below zero, the European Central Bank has raised interest rates twice since July to curb inflation that tops 9 percent – and plans more such moves despite a weakened economy.

“It is their most dramatic shift in policy since the global financial crisis. The energy supply shock hits them much harder than the US, says economist Carmen Reinhart from Harvard’s Kennedy School of Government.

Choose your economy: Souring labor market or exuberant growth

Some economists say a broader adjustment is underway. After decades in which global integration kept a lid on price pressures in the US and other advanced economies, external forces are now driving up inflation.

Governments in the US, Europe and China are encouraging greater domestic production via subsidies and investment restrictions. Reshaping global supply chains will cost more, as will efforts to accelerate the transition from fossil fuels to address climate change, said Dana Peterson, chief economist for the Conference Board.

“The days of ultra-low inflation are probably over,” she said.

Global economic activity fell in the second quarter for the first time since the early days of the pandemic in 2020. If this contraction turns into a full-blown recession in the months ahead, traditional solutions will not be available.

With inflation raging near 40-year highs in the US, Europe, Canada and Britain, central bankers are set to raise interest rates, not cut them – the usual remedy for low growth.

In 2008, as an imploding housing bubble ignited a global financial crisis, the Chinese government stepped up with a wave of nearly $600 billion of infrastructure spending, followed by years of generous financing from state-owned banks. The total bailout amounted to more than a quarter of China’s gross domestic product, far more than the United States spent on stimulus, according to a study by the Organization for Economic Co-operation and Development in Paris.

The Chinese spending translated into orders for factories in the US and Europe, copper mines in Peru and iron ore producers in Australia.

Today, China is preoccupied with its own problems – including a debt-ridden property sector and slowing export growth – ahead of a sensitive Communist Party congress in October, which is expected to hand Chinese President Xi Jinping an unprecedented third term.

The yuan this year has also fallen nearly 9 percent against the dollar and is hovering near the symbolically important level of 7 yuan to the dollar.

“Chinese leaders are more reluctant to use levers they have used in the past,” May said. “China is less likely to use last resort.”

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