With clear signs that the US economy has slowed, growing trade tensions rising, and new signs that global growth is slowing, is a US recession around the corner?
“Recession” is being searched on Google as many times now as it was in the days just after the start of the Global Financial Crisis in 2008.
It’s easy to see where concerns are coming from. Trump’s trade dispute with China has been escalating for more than a year. The initial round of tit-for-tat tariff increases started in July 2018. The political landscape in Europe, particularly in the UK – the world’s fifth-largest economy – is causing unease, while Germany seems to be bracing for a technical recession. Asian markets have also seen some sharp sell-offs in recent weeks, with investors spooked both by the ongoing China-US trade dispute and civil unrest in Hong Kong. Times certainly look uncertain.
Aside from these headwinds, there is one major indicator which keeps flashing red, apparently telling us the US is set to tumble into a recession – the inversion of the US yield curve. To oversimplify, this is when yields for long-term bonds fall below short-term interest rates. The “inversion” is important because it indicates investors are pessimistic about the medium-term outlook for the economy – i.e. they fear a recession.
Thousands of column inches have already been spent on this topic. Should we be worried?
Our US Economic Team’s Monthly Momentum Indicator, shown in figure 1, suggests that over the last year GDP growth has slowed back to trend. Although slowdowns are not unusual, it can mean economies are more vulnerable to negative shocks – and, as mentioned, there are plenty of potential shocks bubbling under the surface.
In March 2019 the yield curve inverted, but why should this matter? It matters because when the yield curve inverts, recessions almost always follow.
The graph in figure 2 below shows both the normal and inverted yield curve. Although the inversion was short-lived and returned to a flatter normal curve in July.
However, the relationship between the yield curve and the economy is not simple or straightforward. First, the gap between the first inversion and the onset of a subsequent recession varies substantially. This gap has varied from around one-and-a-half years after the January 2006 initial inversion, to five months after the February 2000 inversion.
Second, variety of factors drive long-term interest rates and they do not all have the same implications for the economy. In recent years long term rates have been low more because in a world of reduced growth and modest inflation long-term bonds are attractive assets, not because there is compelling evidence that a recession is imminent. Despite speculation of an imminent US recession being on the horizon, Nomura’s Chief US Economist, Lewis Alexander, currently believes there is only a one-in-three chance of it happening within the next 12 months.
Now while we are predicting a 33% chance of a recession at the moment, it is important to keep in mind that there are many potential external shocks to the US economy that could rapidly increase the slowdown of the US economy and tip it into a recession.
The Fed has some room to act if one of the aforementioned shocks pushes the US towards a recession. Having raised rates by 175bp between late 2015 and the end of last year, the Fed is in a stronger position than central banks in many developed markets. The Fed still has some room to lower short-term interest rates to stimulate the economy.
There are, of course, fiscal policy options too, such as increasing government spending or lowering corporation or personal tax, however it is unlikely Congress and the US President would be able to act quickly enough to prevent a recession.
“In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.”
It’s often said that if America sneezes, the world catches a cold. Whether or not these are the first snivels of a feverish flu or the tickle of a gentle cough is hard to say for certain. Our current view is that there are some meaningful events which need to play out before we reach for the medicine.
For more information on the likelihood of a US recession, read our deep-dive insight reports on Probability of a US recession: Elevated, but not Acute, The world economy: Nearing an inflection point, US curve inversion – history and present.
Chief US Economist
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