Are we closer to a US recession?

In August 2019, the US Treasury bond yield curve did something it does only rarely: it inverted. So with longer-term yields in the US falling below their shorter-term counterparts, is this inversion phenomenon the harbinger of recession that history suggests it is?

In last year’s Forum, we expressed a strong view that a large splash of tax cuts would be sufficient to stave off recession in the US. But while it’s true that President Trump’s fiscal largesse has kept the world’s leading economy ticking over nicely, risks have undoubtedly risen. The most dangerous joker in the pack has been trade wars. The tariff spat between the US and its major trading partners (notably China) may have had a relatively modest direct impact on US growth, but business confidence has weakened, taking global investment growth down to zero.

There are concerns that business could follow the investment cutbacks by pulling down employment. If the closely monitored US non-farm payroll number starts to dip, a hit to consumer confidence would surely follow, and the consumer is the main pillar of US growth. Indeed, we are already seeing a threat to employment in the corporate sector, with profit margins falling but labour costs rising.

Against these threats, however, are some important offsetting factors. First, we believe that, with a US election just over a year away, President Trump will move to secure a vote-winning trade deal with the Chinese, thereby unlocking pent-up investment spending. Second, with rate-cutting flexibility and possibly further quantitative easing in its arsenal, the US Federal Reserve still has scope for a meaningful monetary response to any shock. For example, if job creation were to slump to just 100,000 a month, we believe the Federal Reserve would be able to deliver 75 basis points of interest rate cuts by the spring of 2020. Finally, financial imbalances are low and inflation is remarkably stable.

CEO confidence on the wane

Source: Bloomberg, Chief Executive Magazine as at 25 Sept 2019

The Global Investment Forum, London, 2019

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Yield curve inversion may have had a strong track record in predicting a US recession but on this occasion there are not enough data points to draw a conclusion. Although we feel a deep recession is unlikely, with trend growth being so low, the normal ebb and flow of economic data could easily push GDP expectations below the zero line, prompting recurring recessionary scares. Overall, however, we expect US growth to remain positive, if slow, over the medium term. Therefore, if a recession does materialize, it is likely to be moderate.

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