Just how likely is a recession?

It is looking more likely than not, explains Ed Tomlinson.

As we draw closer to the end of the financial year, talk of economic recession – a dominant theme of 2023 – is continuing.

The anxiety we’ve seen in investment markets this year has not abated. Investors remain uncertain about the strength and resilience of the global economy against a number of negative forces.

The most dominant of these forces is inflation. And despite all that central banks and governments have done in the past year, it’s proving very difficult to control. This means they may have to do even more, which will increase pressure on the economy, making recession more likely (but not inevitable).

While risk of recession will be different depending on geographical region (more so in the US and less so here), and the duration of recession may be short, uncertainty among investors is likely to continue.

Against this backdrop, investment markets are holding up quite well. We recorded strong returns for the first quarter of 2023 across almost all smartMonday investment options, despite what was a turbulent three months globally. The graph of the Australian sharemarket performance below shows you what that turbulence looks like.

As long as inflation remains a problem we expect this volatility to continue. This outlook has led us to reduce sharemarket exposure across our growth-oriented portfolios, investing more in fixed interest and cash which now offer decent yields. (To explain a little further, the problem for risky assets, such as shares, is that they’ll be negatively impacted if we enter a deep recession, which is looking more likely than not.)

We will continue to closely monitor the economy and markets, and carefully manage risks across our investment options.

Right now we are in an economic no man’s land. For the past 12 months interest rates have shot up, but we do not yet know if they’ve risen far enough to significantly bring down inflation, or whether more action is required (interest rate hikes take time to have effect, which means the full impact is yet to be fully felt by economies). Inflation is now at 7%, down from 7.8% in December. But it’s proving difficult to reduce below 3% in a reasonable timeframe, which is the Reserve Bank of Australia’s goal. That means no one should rule out further rate increases, as the bank certainly hasn’t.

We’re also concerned about the continuing impact of high inflation itself. Inflation seems to be weighing on consumers’ ability to spend and save, which means it is weakening economic growth – a sign that all the rate increases of the past year are finally beginning to bite.

This negative effect is obvious in our economy and globally. In his federal budget speech earlier this month, Treasurer Jim Chalmers described the global economy as “slowing due to persistent inflation, higher interest rates and financial sector strains”. He said the next two years are expected to be the weakest for global growth in over two decades, which would reduce Australia’s economic growth to 1.5% next year. The world economy is expected to grow only slightly faster, at 1.9%, according to Oxford Economics.

This slowing economic growth, high interest rates and sticky inflation means it's unlikely central banks can easily avoid a recession and provide an economic soft landing (a gradual slowdown that avoids recession). We’ll keep you informed as we progress throughout the year.

Ed Tomlinson is chief investment officer at smartMonday