Tuesday , 21 March 2023

Roubini: U.S. Headed For Severe Recession; 50% Decline In Stocks

According to Nouriel Roubini, the U.S. is headed for a severe recession, a crisis that could send stocks falling another 50%.

In his article (see here) which has been reformatted, highlighted, edited [ ] and abridged (…) slightly below to provide a faster and easier read, Roubini states that the global financial and economic outlook for the year ahead has soured rapidly in recent months, with policymakers, investors, and households now asking how much they should revise their expectations, and for how long and that depends on the answers to [the following] six questions:

  1. Will the rise in inflation in most advanced economies be temporary or more persistent?…
    • This debate has raged for the past year, but now it is largely settled: “Team Persistent” won, and “Team Transitory” – which previously included most central banks and fiscal authorities – must admit to having been mistaken.
  2. Will the increase in inflation be driven more by excessive aggregate demand…or by stagflationary negative aggregate supply shocks?…
    • While both demand and supply factors were in the mix, it is now widely recognized that supply factors have played an increasingly decisive role. This matters because supply-driven inflation is stagflationary and thus raises the risk of a hard landing (increased unemployment and potentially a recession) when monetary policy is tightened.
  3. Will monetary-policy tightening by the U.S. Federal Reserve and other major central banks bring a hard or soft landing?…
    • A model used by the Federal Reserve Bank of New York shows a high probability of a hard landing.
    • the Bank of England has expressed similar views.
    • Several prominent Wall Street institutions have now decided that a recession is their baseline scenario…
    • In both the United States and Europe, forward-looking indicators of economic activity and business and consumer confidence are heading sharply south.
  4. Would a hard landing weaken central banks’ hawkish resolve on inflation?
    • If they stop their policy tightening once a hard landing becomes likely, we can expect a persistent rise in inflation and either economic overheating…or stagflation,,,, depending on whether demand shocks or supply shocks are dominant.
    • Most market analysts seem to think that central banks will remain hawkish, but I…[think] they will eventually wimp out and accept higher inflation – followed by stagflation – once a hard landing becomes imminent, because they will be worried about the damage of a recession and a debt trap, owing to an excessive build-up of private and public liabilities after years of low interest rates…
  5. Will the coming recession (a hard landing is becoming a baseline for more analysts) be mild and short-lived, or will it be more severe and characterized by deep financial distress?
    • Most of those who have come late and grudgingly to the hard-landing baseline still contend that any recession will be shallow and brief…arguing that today’s financial imbalances are not as severe as those in the run-up to the 2008 global financial crisis, and that the risk of a recession with a severe debt and financial crisis is therefore low – but this view is dangerously naive.
    • There is ample reason to believe that the next recession will be marked by a severe stagflationary debt crisis. As a share of global GDP, private and public debt levels are much higher today than in the past…[and] under these conditions, rapid normalization of monetary policy and rising interest rates will drive highly leveraged zombie households, companies, financial institutions, and governments into bankruptcy and default.
    • The next crisis will not be like its predecessors.
      • In the 1970s, we had stagflation but no massive debt crises, because debt levels were low.
      • After 2008, we had a debt crisis followed by low inflation or deflation, because the credit crunch had generated a negative demand shock.
      • Today, we face supply shocks in a context of much higher debt levels, implying that we are heading for a combination of 1970s-style stagflation and 2008-style debt crises – that is, a stagflationary debt crisis.
    • When confronting stagflationary shocks, a central bank must tighten its policy stance even as the economy heads toward a recession…[and,] because today’s higher inflation is a global phenomenon, most central banks are tightening at the same time, thereby increasing the probability of a synchronized global recession. This tightening is already having an effect: bubbles are deflating everywhere.
    • in addition, the space for fiscal expansion will also be more limited this time. Most of the fiscal ammunition has been used, and public debts are becoming unsustainable.
  6. Will equity markets rebound from the current bear market or will they plunge even lower?
    • Most likely, they will plunge lower. After all, in typical plain-vanilla recessions, U.S. and global equities tend to fall by about 35% but, because the next recession will be both stagflationary and accompanied by a financial crisis, the crash in equity markets could be closer to 50%!
      • Regardless of whether the recession is mild or severe, history suggests that the equity market has much more room to fall before it bottoms out. In the current context, any rebound – like the one in the last two weeks – should be regarded as a dead-cat bounce, rather than the usual buy-the-dip opportunity.

Though the current global situation confronts us with many questions, there is no real riddle to solve. Things will get much worse before they get better.

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