· The outlook has shifted drastically over the last six months, with the general optimism at the year’s outset now replaced with growing pessimism, as increased cost pressures more than offset the quality of life benefits associated with record low unemployment and easing public health restrictions. It is not a coincidence historically low consumer sentiment comes as gas prices, perhaps the most visible variable cost to most households, touched their own highs.
· This creates a challenging environment for policymakers. The rapid stimulus-supported recovery has resulted in economies operating with excess demand that needs to be tempered in order to rein in price pressures and limit the longer-term demand destruction posed by high inflation. There is reason to believe that households and businesses have the capacity to absorb this impact.
· That said, global growth momentum is slowing, and there remains an abundance of headwinds combining with the pervasive negativity to create a fragile backdrop, materially raising the risk of an economic downturn materializing sooner rather than later; aggressively tightening policy would only serve to exacerbate the slowdown.
· The bottom line is that the outlook remains highly uncertain, and the months ahead will see policy makers weigh each datapoint carefully to determine whether the odds favour the upside risks to inflation, the downside risks to growth or the baseline scenario of as oft landing.
· For financial markets, while there are clear and present downside risks, the magnitude of the damage done to this point, combined with the abundant pessimism that is pricing in an increasingly dour outlook, arguably shifts the balance of risk in favour of potential upsides. “Bad” outcomes may not end up being “as bad as feared” as the backstop provided by underlying strength of consumer and business finances and a general lack of material imbalances could limit the overall economic fallout.
View the full analysis below.