Over the last months we have seen economic headwinds building up pressure. Despite a significant recovery in the stock market, the macroeconomic outlook does not provide much room for strong and sustained growth ahead. Since the Federal Reserve began its rate-hiking path on March 16, 2022 to fight entrenched inflation, monetary policy tightening has brought 4.75 percentage points in rate increases and the beginning of quantitative tightening, thus putting an end to many quarters of dramatic increases in its balance sheet (i.e.: quantitative easing). In fact, the pace of the rises in interest rates has been the fastest in decades and that questions whether it could lead to an economic downturn. It must be noted that the Federal Reserve is already expecting a mild recession in late 2023.

Interest rate hikes intend to slow the economy, increasing the cost of money and reducing demand, but they certainly have a delayed effect on the economy. The accumulated effects of rate increases are steadily arising because it can take up to 2 years to experience the whole impact. Financial conditions have now been tightening for several months, manufacturing is contracting, growth has significantly slowed down, the US Treasury yield curve has reached the deepest inversion since 1980s, and the IMF has warned that the global economy is heading for weakest growth since 1990.

The Institute for Supply Management (ISM) index, also known as the PMI index, typically does a very good job forecasting GDP. Its recent evolution leaves little comfort for much optimism.

The fallout from the recent banking crisis, which has spoiled confidence in the banking industry, is likely to make borrowing harder and will curb spending. At the same time, this crisis could mark a turning point in the Federal Reserve’s monetary policy. Despite this troublesome scenario, consumer spending and the labor market have so far showed strong resilience and avoided any remarkable setback.

Looking ahead, there are many challenges outstanding in terms of growth, financial stability, and pricing pressures.

Firstly, the world is undergoing a major demographic upheaval in terms of population growth and aging. Rising pension liabilities and the cost of health and long-term care will strain government budgets and may lead to increased taxation. Technological innovations and increased automation will reduce the impact of population aging, but the current trends will have profound repercussions and may jeopardize economic well-being and progress.

Secondly, several decades of lowering interest rates have led to over-indebtedness. In such a scenario, soaring interest rates create a potential problem for creditors and the stability of financial systems, as well as on future growth. As debt loads increase, a larger share of income is used to service the debt burden rather than to invest in productivity increasing activities. Over time, this ends up hindering productivity growth.

Thirdly, although we have already seen nine consecutive months with US headline inflation declining, it is too soon to say the inflation threat is officially over. It could be argued that the only way to kill inflation was to cause a recession. However, given the changes in the geopolitical stage and the emergence of a multipolar world that is severely jeopardizing globalization, once new recovery starts we are likely to see inflation regaining momentum.

Consequently, we are going to be faced with a challenging situation. Although cyclical forces can cause temporary spikes in growth, inflation, and interest rates, sustaining them will prove very difficult. Governments around the world have stubbornly tried to solve a debt problem adding more debt to finance economic stimulus and typically leading to lower growth, deflation, and lower interest rates.

Now we are transitioning into a more dangerous scenario with higher uncertainty, an ever-growing pace of change, and with stronger pressures leading to more social unrest. In this scenario, companies will need to carefully craft a solid strategy to be able to achieve growth and profitability while improving successfully and sustainably.