The IMF View: Broad Slowdown-or Does Everyone Hate the Fed?

The global economic horizon has darkened considerably in the past few weeks. Published at the outset of the annual IMF/World Bank October 2022 meetings, the IMF reports that it expects global economic growth to slow down from 6% in 2021 to 3.1% this year, and 2.7% next year. Of the three largest economies, the United States and the European Union may be heading to recession, while China’s economy is close to being flat.  This bleak economic picture is occurring as policymaking in major countries is in disarray.

The headwinds that have plagued the global economy have not abated, while at the same time we have seen a worsening of some of the existing risk factors and the emergence of new ones.

Monetary tightening:  Led by the US Federal Reserve, central banks of the major advanced and emerging market economies have engaged in simultaneous, albeit uncoordinated, front-ended monetary tightening to try to bring down historically high inflation.  These actions have led to sharp increases in interest rates across the board. The Federal Reserve Bank has increased  the Fed Funds Target rate from 0-0.25% at the end of March to 3.00-3.25% in October, and is expected to increase rates further to 4.25-4.50% by the end of the year. Moreover, the tightening is by no means over, the Fed seems determined to bring inflation under control, and increases in the interest rates could extend to 2023.   Paradoxically, the good October labor market numbers in the United States have strengthened the case for continuous monetary tightening by the Fed. Furthermore, the Fed has finally began to shrink its massive balance sheet (aka Quantitative Tightening, QT), which had more doubled in size in the two years since the beginning of the pandemic to close to $9 trillion.  The balance sheet has shrink by about $200 billion since April 2022, and the Fed is vowing to accelerate the pace of contraction—no more Fed put for financial markets addicted to easy money.

Collateral Damage from the Strong Dollar: Global turmoil and high U.S. interest rates have led the US dollar to strengthen beyond the levels justified by fundamentals.  The dollar index, (a weighted average against six major currencies) has appreciated by-over 15% in the past year, and the dollar has appreciated against all major currencies.  This trend has forced the major central banks to react by tightening monetary policy. For emerging markets, the global spillovers of the US monetary policy are a double shock .In combination, higher U.S. interest rates and the stronger dollar make the servicing of external obligations more onerous. Furthermore, imported inflation and the weakening currency force the central banks to hike domestic interest rates, adding to deflationary pressures. Joseph Borrell, the Foreign Affairs Commissioner of the EU, has been at the forefront of the Fed critics, accusing it of exporting recession.

Energy Geopolitics:  The recent decision by OPEC+ to reduce oil production ceilings by 2 million barrels per day has added to the economic headwinds.  The OPEC+ action undoes the welcome declining trend for oil prices (West Texas Intermediate, WTI), which fell by 36% since their peak of $120 per barrel in mid-June 2022 to the end of September. Since then, the price of crude has risen by 20%.  Two factors mitigate the impact of the OPEC+ action. First, in reality the reduction will be more in the order of 1 million of barrels per day relative to today’s oil production. Second, Saudis are competing with deeply discounted Russian oil in Asia, and might not want to lose market shares. Nevertheless, the oil producers’ action illustrates the deepening chasm between OPEC and the West, and could add to global recessionary pressures.  A new unknown is related to the domestic turmoil in Iran.  We have witnessed strikes in the oil sector in that country, which could affect Iranian oil output.

Emerging Markets Distress:  The perfect storm of high interest rates, strong dollar and higher oil and food prices has added to the challenges of the low income countries. While these so-called distressed debt countries (54 in total) account for a small fraction of global GDP, they are most vulnerable to advanced countries policy spillovers.  Without adequate help, many of them face a debt crisis and insolvency.  The multilateral financial institutions and the major countries need to step in address these issues. The G20 Common Framework for Debt Treatment provides a mechanism to deal with the distressed debt. 

Putting Out Fires: Globally, the economic situation calls for concern.  Excessive monetary tightening might not be able to quickly squelch inflation in the face of significant cost-push pressures. Unpredictable geopolitical shocks complicate the task of economic stabilization and policy coordination.  In such an uncertain environment, there is little room for policy mistakes, and policy flexibility and adaptability on the part of the major players will be critical.  The IMF is calling for policy coordination.  In particular, given the long lags in monetary policy implementation and impact, the Fed and other major central banks may fine tune their approach and adjust the monetary tightening time paths as circumstances dictate.  On the dollar front, there is talk of another Plaza-style joint intervention (referring to the 1985 agreement among the major central banks to intervene in the currency markets) by central banks to weaken the dollar.  Finally, in regard to distressed debt countries, debt restructuring will not be sufficient, and a package of broad debt forgiveness and financial assistance should be under consideration.