What’s Next For The Global Economy: Three Scenarios

abrdn has just lowered its global economic forecasts and mapped out multiple scenarios that could play out from here. So let's take a look at the three most likely ones – barring the most probable: a recession – so you know what to watch for – and how to adjust your portfolio if you see them coming.

abrdn’s economists are more pessimistic than average

On average, economists around the world expect the global economy to grow by 3.2% this year, 2.9% next year, and 3.4% in 2024. Not likely, says abrdn: it believes the global economy’s multiple challenges will lead to a bigger global recession even sooner than it previously thought. The investment management firm is now predicting global growth of 2.8% this year, 1% next year, and 1.5% in 2024.

Source: abrdn

On a regional basis, abrdn says interest rate hikes from the Federal Reserve (the Fed) will tip the US into recession in the second quarter of next year. But rather than cut rates to stimulate growth, the Fed will keep rates high until later in the year when it’s confident that inflation is under control.

Emerging market (EM) countries are particularly vulnerable in this environment given their reliance on the US economy for demand and how much US dollar-denominated debt they carry. All else being equal, higher US interest rates push up the dollar’s value relative to other currencies. And that makes EM countries’ debt more expensive and harder to repay, especially in a global recession.

In Europe, the economy’s faced with a massive squeeze on incomes – with high gas prices pushing up the costs of essential things like heating, high inflation across other goods and services, and interest rates rising as the European Central Bank seeks to cool down inflation.

And in China, the persistent zero Covid policy and weakness in the country’s all-important property sector are continuing to weigh on the economy.

But there’s a chance that abrdn’s wrong: the US could avoid a recession, stagflation could take hold globally, or a recovery in supply could tame inflation worldwide…

Source: abrdn

Scenario 1: The US avoids a recession (17.5% probability)

In this scenario, the Fed would continue to hike interest rates, slowing US economic growth. But in this scenario that slowdown isn’t enough to cause a US recession – and by extension, a global one – even as other central banks hike their own interest rates.

To tell whether this is playing out, keep an eye on whether inflation expectations start to fall toward long-term averages. That’d suggest the Fed can hike rates less, therefore increasing the chances of avoiding a US recession. Also watch for an improvement in labor force participation, as people move off the sidelines and begin looking for work again, and a slowdown in wage growth.

Where are the opportunities in this scenario?

abrdn reckons that global growth in two years’ time (so pretty much 2024) will come in 2.5 percentage points higher than its current forecast and inflation 2 percentage points higher than its forecast if this scenario plays out.

Owning global stocks via, for example, the iShares MSCI World ETF (ticker: URTH; expense ratio: 0.24%) would allow you to profit from higher-than-expected economic growth, and the value-focused Vanguard Value ETF (VTV; 0.04%) could help offset inflationary pressures.

Scenario 2: Stagflation rears its ugly head (17.5% probability)

This “stagflation” scenario – where inflation is high but economic growth is stagnant – would be caused by an escalation in geopolitical tensions, causing major restrictions to the global energy supply. Europe would be particularly badly affected, with power rationing putting limits on factory production and transport. High resultant inflation, meanwhile, would put even more of a stranglehold on consumer spending, sending Europe into an earlier and deeper recession than the rest of the world. It’d quickly spill over, though, and EMs – especially those that import most of their energy – would be particularly vulnerable.

So here’s what to look out for: prices of commodities (other than European natural gas) shooting higher, and inflation expectations rising from already high levels and then being met by higher-than-expected inflation figures. You’ll probably also see business surveys showing a drop in confidence.

Where are the opportunities in this scenario?

In this scenario, abrdn expects global economic growth would come in 2 percentage points lower than its forecast in two years’ time, and inflation 5 percentage points higher.

In a world of higher inflation, value stocks like those in the Vanguard Value ETF should perform well (here’s why), as might real estate, Treasury inflation-protected securities (TIPS), gold, other commodities, and bitcoin. More on those here.

Scenario 3: Supply picks up and tames inflation (15% probability)

In this scenario, supply chain disruptions quickly fade and more people enter the workforce. And at the same time, there’s a switch in demand from physical goods to services, which is better able to cope with spikes in demand without creating bottlenecks, stimulating economic growth. That’d set the scene for inflation to fall quickly alongside a growing economy.

To see this play out, you’d need to see limited ongoing disruptions from both China’s zero Covid policy and the Russia-Ukraine war, a pickup in labor force participation (particularly in the US), and a pickup in services inflation at the expense of physical goods inflation.

Where are the opportunities in this scenario?

Here, abrdn would expect global economic growth to be 4.5 percentage points higher than its current forecast and inflation just 1 percentage point higher in two years’ time.

The iShares MSCI World ETF could, again, be a good way to benefit from broad-based growth and low inflation. Additionally, you might want to bias your investments toward services industries, meaning tech, travel and leisure, and consumer discretionary sectors might be attractive bets.