Recession yes or no? A cold winter not only for gas

He, too, therefore, has begun to talk about a retreat into negative territory in world GDP, or at least in some of the major industrialized countries, which are now caught in a pincer, between the commodities crisis, rising inflation and the consequent rise in interest rates by central banks.

And so, like clockwork, international analysts have begun to look to the future with much less optimism than before, not sparing Italy, of course. On our country's economy, there recently came a downward upgrade from the U.S. rating agency Fitch.

During the coming year, according to Fitch analysts, Italy's gross domestic product (GDP) could contract by 0.7 percent, that is, end up in recession after two years of growth (+6.6 percent in 2021 and +3 percent in 2022). Other international bodies and institutions still see a plus sign, although their estimates are from recent months and could be revised downward in the months ahead.

The International Monetary Fund, for example, has estimated Italian GDP growth of a laughable 0.7 percent in 2023 while the OECD has forecast +1.7 percent. Slightly lower, however, is the Bank of Italy's growth forecast of +1.3 percent. Whatever the exact figure, one thing seems certain: the picture of the economy is deteriorating due to a mix of concomitant factors.

As anyone who follows the economic and financial news knows well, today in the major industrialized countries (including Italy) there is a flare-up of inflation, that is, a sharp rise in prices caused in turn by other factors: first by a strong demand for goods and services (triggered by the recovery of economic activities after the pandemic), then by a shortage of raw materials on the market (also linked to international tensions after the outbreak of war in Ukraine).

In this scenario, never seen before in the past 30 years, central banks (in Europe the ECB and in the United States the Federal Reserve) began raising interest rates, that is, the cost of money. Usually these maneuvers are the central banks' main weapon to curb inflation, as they reduce the amount of money in circulation, which fuels the price hikes. There is, however, the other side of the coin.

Raising rates precisely means making money more expensive, curbing investment and consumption. It means, in other words, curbing economic growth or even driving GDP into the negative, if central banks think inflation is a worse threat than recession itself.

"Inflation has reached very high levels in most developed and emerging economies" says Generoso Perrotta, Head of Financial Advisory at Banca Generali, who adds, "Although in some countries it may have already passed the peak, and in others it is close to doing so, the current rates of price increases are still far from the targets of central banks, which are showing increasing determination to continue the fight against inflation through further interest rate increases. Based on the forecasts of the major central banks, price increases are expected to remain above target levels even in 2023 and then tend to converge in 2024."

Perrotta points out that the restrictive monetary policy actions (i.e., raising rates) taken so far are leading to a slowdown in economic growth worldwide. In addition, expectations that monetary authorities will continue further down this path are driving down consumer and business confidence in all major economic areas worldwide.

Perrotta therefore believes it is likely that the economic slowdown will continue in the coming quarters and that the greatest effects on growth will be seen during 2023, with the impact varying across geographic areas and individual countries. In the U.S., where peak inflation appears to have already been reached, the Federal Reserve may have room to undertake the exit from the restrictive monetary policy phase as early as the first quarter of 2023, providing the economy with a better chance of avoiding a recession.

Conversely, the possibility of recession may not be entirely ruled out in some areas, especially in Europe. "Economic activity, particularly in the Eurozone, could be more impacted by geopolitical uncertainties and energy supply disruptions from Russia," continues Banca Generali's head of Financial Advisory, "the effects of which are expected to manifest themselves more severely over the next two quarters. Slowdown risks could prove to be higher in those states that find obstacles in implementing economic policies aimed at reducing energy dependence on Russia itself in the short term or fail to adequately support businesses and households due to high energy prices."

In such a scenario, the European Central Bank may have to delay its exit from the current restrictive phase of monetary policy to counter further price increases, resulting in increases in the cost of debt and reductions in disposable income that could lead the Old Continent to experience a recessionary phase during 2023.

"The market would seem to be discounting this hypothesis with increasing likelihood," Perrotta adds, "Short-term yields on the core Eurozone government curves, which are more sensitive to expectations about the evolution of reference rates, have in fact risen markedly in recent sessions." 

Also supporting the upward movement of yields on the short end of the Eurozone curves are recent comments by some ECB officials. President Christine Lagarde emphasized that price stability is prioritized over growth, although advisors De Cos and Centeno, while expressing support for further hikes, signaled that they prefer a more gradual approach to limit the impact on activity and employment.

In such a scenario, it is possible that bond markets will continue to be characterized by volatility, i.e., fluctuating rates. Seen in perspective, however, this scenario should be evaluated carefully: given the current and prospective economic slowdown environment, bond yields, especially on the long end of the curves, may in fact have reached attractive levels to build investment solutions that can ensure a positive coupon flow and performance in the coming quarters. "In light of the above," Perrotta concludes, "an increase in exposure to the bond market, identifying, in the different countries, the most interesting stretches of the curve, appears to be appropriate."