Global finance chiefs to plot escape routes for world economy

A summer laced with economic strains looms for the world's richest economies.

In the US, President Joe Biden and congressional Republicans are locked in a staredown over raising the $31.4 trillion borrowing limit. Meantime, the deepest US banking stress since the 2008 financial crisis is starting to squeeze lending. 

In Europe, inflation remains sticky, Germany's industrial production has plunged and Russia's war in Ukraine rolls on, with new offensives expected. 

Globally, labor shortages and the rising cost of living is triggering strikes — from train drivers in the UK to screenwriters in Hollywood. The El Nino weather pattern threatens to disrupt food and energy output. Manufacturing activity around the world is contracting. And tensions between China and the US continue to simmer. 

That's the daunting mix of risks confronting finance ministers and central bank chiefs from Group of Seven nations who began three days of talks in the northern Japanese city of Niigata on Thursday.

While it's not on the agenda for group talks, top of mind for Treasury Secretary Janet Yellen is the debt cap impasse. Failure to avoid default would undermine Washington's ability to provide international leadership and defend US national security, Yellen told reporters.

A default "would spark a global downturn" and "would also risk undermining US global economic leadership and raise questions about our ability to defend our national security interests," Yellen said. 

Strengthening the global financial system, debt relief for poorer nations and building more resilient supply chains are all on the agenda for the talks. Policy makers will also discuss measures to impede Russia's efforts to evade sanctions, Yellen and Japan's Finance Minister Shunichi Suzuki both said separately. 

Policymakers will also discuss the ongoing battle to curtail inflation — excluding Japan — with the steepest interest-rate tightening in decades starting to hit the real economy as the long and variable lag in policy catches up with borrowers and lenders. 

While the Federal Reserve has hinted at a pause, European Central Bank President Christine Lagarde stoked expectations for ongoing rate hikes when she warned last week that the bank remains "riveted to our objective."

G7 central banks

Change in interest rates since December 2021

Source: Bloomberg

Even if only some of those summer worries eventuate, traders who are betting the hiking cycle is largely over will likely be proved right. Perversely, if policymakers can skirt the pitfalls and keep their economies humming through to autumn, that success will only create new headaches.  

"Near-term recession risk is elevated and if the US and other economies contract in the coming months, pricing power will likely be contained without generating a dilemma for central banks," Bruce Kasman, chief economist for JPMorgan Chase & Co., wrote in a recent note. 

"However, if central banks are successful in navigating the expansion through this turbulence, they are likely to reinforce the underlying shift in the inflation process now underway and will be under pressure to restart the tightening process," Kasman said. 

Optimists point to overall activity around the globe that's better than what was expected at the beginning of the year, mostly due to Europe's easing energy crisis, China's sudden reopening and US jobs data that continues to defy expectations for a dip. 

Investors are bracing for tougher times. Stan Druckenmiller, the billionaire founder of Duquesne Family Office, said Tuesday during the 2023 Sohn Investment Conference that he thinks the US economy is teetering on the edge of a recession and predicts a "hard landing." 

April statement

When G7 ministers last got together in Washington in April, they noted that global economic growth was proving more resilient than had been expected, inflation remained elevated, central bankers were determined to tame prices, and that bank jitters highlighted economic uncertainty.

Since then, both the Fed and ECB raised interest rates again and the Bank of England is primed to do so later Thursday. Treasury Secretary Janet Yellen has warned of "economic and financial catastrophe" if the debt limit stalemate isn't resolved. And First Republic Bank joined the growing list of regional lender casualties.  

"It is still hard to get a clear read on how the global economy is faring," HSBC Holdings Plc economists Harriet Smith and James Pomeroy wrote in a recent note. "Inflation remains far too high. And risks are plentiful, not least those relating to potential spillovers from strains in parts of the banking sector, particular the US regional banks."

— With assistance by Zoe Schneeweiss