Europe is not so lucky – The majority of analysts think Europe is headed for recession in Q1 2023

Outlook: Last Thursday after our final report of the week, the Atlanta Fed published a revised GDPNow at a stunning 2.6% for Q3, from 1.6% the week before. The basis is a rise in consumer spending growth and in the growth of real gross private domestic investment to a less negative number. We get a fresh Atlanta Fed update tomorrow. So much for recession, at least so far.

Europe is not so lucky. The majority of analysts think Europe is headed for recession in Q1 2023 if not before. This puts the expected 75 bp rate hike on Thursday into a cloud of doubt. Bloomberg finds that nearly half the analysts in its survey expect 50 bp or even 25 bp.

Oxford Economics is not too gloomy, saying the eurozone economy will contract only about 1% this winter. Lowering energy consumption is do-able and the eurozone can avoid "hard" rationing, now that voluntary "soft" rationing has already started to work. Gas consumption is down 12% year-to-date, led by Finland. See the chart. Oxford thinks the loss of Nordstream can be offset by imports from the US and Norway. “Italy is the most at risk of shortages, as its gas demand has not fallen. Factors related to adverse electricity market fundamentals, the weather, and government interventions could also tilt the balance.” Remember the Italian election is Sept 25.

Barely noticed amid all these high-octane risks is the Reserve Bank of Australia rate hike by 50 bp to 2.35%, perhaps because it came exactly as expected. The RBA statement says “The Board is committed to returning inflation to the 2–3% range over time. It is seeking to do this while keeping the economy on an even keel. The path to achieving this balance is a narrow one and clouded in uncertainty, not least because of global developments.” The path ahead for additional rate hikes is not pre-set.

It’s not clear whether the Australian experience has an effect on the other Other Dollar. The Bank of Canada meets this week and is mostly expected to do 75 bp, although another 100 bp as in July is not off the table.

We have far too much risk abroad in the world to consider that many will shun the safe haven of the dollar. It’s not just Russia weaponizing natural gas–now there is talk of doing the same thing with uranium. The second Big Factor is the Chinese lockdown. The last one lasted two months and had dire consequences globally. And while sterling was happy with a conventionally conservative new prime minister, the rally is disproportionate to Truss’ skill base. Bottom line–don’t bet against the dollar (or for the emerging markets).

Tidbit: A slew of articles are appearing lately on whether sanctions on Russia are working, including The Economist, meaning do they lead anyone to think economic pain will change the outcome of the war in Ukraine? The answer seems to be yes, Russia is suffering mightily, but Russians expect to suffer and nobody does more of it than Russians. And no, it won’t change Putin’s management of the war, although he apparently decided not to initiate conscription into the army to avoid annoying the public.

Now Bloomberg has an internal document from Russia outlining the likely outcomes, summed up as “deep and prolonged economic damage” in the headline. The document was prepared for a closed-door meeting of top officials on Aug. 30.

See the chart. “Two of the three scenarios in the report show the contraction accelerating next year, with the economy returning to the prewar level only at the end of the decade or later. The ‘inertial’ one sees the economy bottoming out next year 8.3% below the 2021 level, while the ‘stress’ scenario puts the low in 2024 at 11.9% under last year’s level.

“All the scenarios see the pressure of sanctions intensifying, with more countries likely to join them. Europe’s sharp turn away from Russian oil and gas may also hit the Kremlin’s ability to supply its own market, the report said.”

In addition, the restrictions hit about a quarter of foreign trade, although the contraction will be less than 3% this year. Technological and financial curbs add to the pressure. The report estimates as many as 200,000 IT specialists may leave the country by 2025, the first official forecast of the widening brain drain.

Bloomberg Economics comments that Russia’s economy will contract 0.5%-1.0% in the next decade on the loss of technology from the West. “Thereafter, it will shrink further still, down to just above zero by 2050. Russia will also be increasingly vulnerable to a decline in global commodity prices, as international reserves no longer provide a buffer.”

As for that gas issue, “A full cutoff of gas to Europe, Russia’s main export market, could cost as much as 400 billion rubles ($6.6 billion) a year in lost tax revenues, according to the report. It won’t be possible to fully compensate the lost sales with new export markets even in the medium term…. Metals producers are losing $5.7 billion a year from the restrictions, the report said.”

A global recession means demand for Russian supplies goes away first. And The inability to repair imported equipment and supplies like animal feed and fertilizer is a big deal, and could lead to food shortages. Then there is the inconvenient fact that in aviation, “95% of passenger volume is carried on foreign-made planes and the lack of access to imported spare parts could lead the fleet to shrink as they go out of service.” In addition: only 30% of machine tools are Russian-made. About 80% of domestic pharmaceutical production relies on imported raw materials. Russia’s telecommunications sector may fall five years behind world leaders in 2022 and will be short of SIM cards by 2025.

A forecast of economic contraction by only 1% seems like small potatoes considering these shortcomings.

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