Under pressure central banks face the unenviable decision of choosing between recession or persistent inflation, according to JP Morgan’s Mike Bell.
The global market strategist said that he sees the global economic future playing out in one of two ways – either central banks will tighten monetary policy and cause a recession, or they will allow for a more relaxed environment, meaning inflation will remain above target.
This decision will likely come down to whether they are more focused on protecting employment rates or dealing with inflation.
Unemployment rates spiked in the pandemic as companies were forced to shut up shop and lay off non-essential staff but the labour market has tightened rapidly since then.
The amount of job vacancies has outpaced the number of unemployed people in many countries as businesses struggle to hire new staff following a strong rebound in spending.
A limited pool of available workers in a high-demand environment has led employers to push up wages in order to attract new staff.
Source: (Left) BLS, JOLTS, J.P. Morgan Asset Management. (Right) BLS, Federal Reserve Bank of Atlanta, Refinitiv Datastream, J.P. Morgan Asset Management.
Bell anticipates that some, but not all, of the workers who left employment during the pandemic will return to work, stating: “We think that most under 55s are going to come back to looking for work, but some 55 to 65 year olds won’t because they were able to retire early due to the value of the stock market going up a lot and the value of house prices, which have gone up an awful lot.”
Fast-rising wages have boosted inflation rates, which could stay above target if central banks choose not to act aggressively enough, according to Bell. This in turn could extend the current cost-of-living crisis that has taken hold in the UK and parts of Europe.
Although tightening monetary policy could be damaging to employment rates, it should reduce the high levels of inflation this year.However, ramping up interest rates brings with it its own difficulties – the more challenging environment would cause the gap between the number of job openings and available workers to close, which should lower wages. That dynamic would also increase the likelihood of recession.
This is not the case in the US, where large amount of stimulus pumped into the economy has allowed the country to avoid the prospect of a recession more effectively, according to Bell, but it could impact the UK.Indeed, the Bank of England (BoE) has already increased rates to 1% since December last year and the Monetary Policy Committee could raise them further as UK inflation reaches a 30-year high of 9%.
Bell said that the chance of a recession was therefore increased in the UK due to higher energy bills, which are unlikely to be offset by rising interest rates. He said: “In Europe and the UK I think the risk is higher than in the US. If you look at consumer confidence in the UK, it is frankly already at recessionary levels.”
“The risk is of course that the business surveys start to mimic the weakening consumer confidence, which is what we're starting to see the first signs of in the UK.”
Source: (Left) European Commission, Refinitiv Datastream, J.P. Morgan Asset Management. (Right) GfK, Refinitiv Datastream, J.P. Morgan Asset Management.
Regardless of which way central banks lean, Bell has identified asset themes that will provide some security in either scenario.
One trait he says to look out for is contractual assets, which are often found in infrastructure assets. Infrastructure companies that operate through contracts often have inflation protection built in to their returns, albeit with a slight lag.
For example, some private electricity generators not only provide consistency and defensive returns, but these can be adjusted to the rate of inflation. It is important to also seek out assets that are correlated with rising prices, he noted.
Commodities and energy are famously well corelated to the rate of inflation and tend to do well in that type of environment as other companies decline, but Bell said timberland assets are also a strong option.
Source: Macrobond
Assets such as infrastructure and timberland may not be as well correlated with inflation as commodities overall, but they can also provide some protection in both inflationary and recessionary environments.