Global economic cycle synchronization no more

The unusual era of global business cycle synchronization that surfaced with the pandemic crisis and triggered a deep downturn in 2020, followed by a fast recovery in 2021, is over. To be sure, the world economy is slowing, but in the present juncture different fundamental stories signify quite diverse outcomes.

In a Tolstoian way, all outperforming countries are alike, while every country that is underperforming is troubled in its own way. Arguably, Europe is the geography that is struggling the most. A toxic mix of severe impacts of climate change, collateral effects of the initial stage of a monetary tightening cycle and a major adverse energy shock brewed by a neighboring geopolitical crisis (the Russia - Ukraine war) is depressing economic activity in the Eurozone. Rising cost of living pressures driven by escalating energy prices (Chart I) are sapping demand in the service sector, whereas manufacturing remained in a downturn half-way through the third quarter. The situation in Eastern European nations is, of course, even worse. Under those circumstances, stagflation is not an academic speculation, but almost an unavoidable fact.

As for the United States, the main problem seems to be the recessionary effect resulting from a sharp correction of possibly overvalued assets, in response to what is now a monetary tightening cycle in its later stage. Along with financial markets, the real economy is now also feeling the pain and sluggish activity in key sectors is dragging down GDP growth. Existing home sales, for instance, fell by 21% year to date, in tandem with worse housing affordability, and the contagion effect on other businesses is already on its way (Chart II).

While it is yet uncertain whether the Federal Reserve will succeed in controlling inflation and pulling off a soft landing, it should be clear that labor market conditions will be a laggard, not a leading indicator of the actual outcome. According to the National Bureau of Economic Research, there were 13 recessions in America since the World War II. In only two of them (July 1990 to March 1991 and March to November 2001) there was no net job creation in any month during the downturn. On the other hand, after the first global oil shock in late 1973, for example, non-farm payrolls rose nine months back-to-back into the recessionary cycle that began in November of that year and lasted until March 1975. There is no irrational behavior or short-sightedness behind this phenomenon. Finding human resources that meet the firms’ needs is critical and costly, so the management is naturally reluctant to dismiss them unless the deterioration in the economic outlook is written in the wall. However, as per the latest report of the S&P Global Flash US Composite PMI, this is not the case just yet: “Despite weak client demand, private sector firms were more upbeat regarding the outlook for output over the coming 12 months in August.”1 Thus, it will take a few more months to adjust expectation for what is very likely to be the more troubling reality. But then this pivotal moment will be when the monetary authority will stop raising interest rates.

Surely there are developing economies, such as Cuba, Egypt, Ghana, Pakistan Sri Lanka, and Ukraine, whose predicaments are far more severe than those of Europe and the United States. In each case, they result from different combinations of mismanagement of political-economic affairs, climate disasters, adverse geopolitical shocks, and institutional flaws. However, on analytical grounds it is more productive to investigate emerging nations that are faring much better and real GDP outperformance provides useful coordinates to map them (Chart III). The common denominator among countries of the Gulf Cooperation Council and in Latin America is richness of natural resources, notably their capacity of being net energy exporters, along with comparatively better fiscal and monetary compacts.

Among the major Latin American countries, improvements in commodity terms of trade have been significative, except for Mexico (Chart IV). Admittedly, the prices of primary products like grains, animal proteins, minerals, and fossil fuels are off their recent highs in the first quarter of this year owing to global growth concerns, yet they are generally above the levels recorded before the COVID-19 outbreak in 2020. Perhaps more impressive is the reaction function of the central banks in the region. In response to upward inflation pressures, they embarked on aggressive monetary tightening last year, well ahead of advanced nations. Thanks to the comparatively lower indebtedness of the public and private sectors, short-term interest rates rose sharply but did not send the respective economies into a tailspin.

Interestingly, these rather uniform policy developments are taking place amid significant political realignments in the region. While Mexico and Brazil have been under populist, nationalist governments for the past few years (the former with more statist impulses, the latter with a pro-market orientation), local elections established leftist administrations in Peru, Chile and, more recently, in Colombia. Nonetheless independence of central banks and finance ministries endures, which speaks of growing institutional stability. This unexpected maturity helps explain apparent anomalies, notably the low correlation between Latin America’s economic cycles and those of the rest of the world.

Over the past couple of years, the region managed to deliver effective programs to combat the pandemic, massive vaccination being just one of them,2 thus enabling economies to reopen faster and without the recurrent lockdowns that occurred in some emerging markets (e.g., China) or in advanced nations (e.g., Australia). Accordingly, economic policy normalization - both fiscal and monetary - could begin earlier than in most geographies and the broadly favorable evolution of terms of trade only added to the already positive outlook

1 “Faster fall in US private sector output amid weak client demand” in S&P Global Flash US Composite PMI dated 23-Aug-22.

2 According to Our World in Data website, as of 31-Aug-2022, 79% of the population in South America had completed the full COVID-19 vaccination protocol. That compares to 72% in Asia, 66% in Europe, 64% in North America, and 22% in Africa.

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