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Caution is warranted but US 'should avoid recession,' economists say



The U.S. and the global economy should avoid a recession in 2020, with a combination of strong retail sales, potential monetary policy easing and service sector robustness expected to mitigate slowing growth, according to several leading economists.

A choppy week for global markets last week saw a significant sell-off in equities, while bond market spooked investors as the U.S. 10-year / 2-year Treasury yield curve inverted, an event widely seen as a warning sign of recession.

Meanwhile, the German economy contracted while eurozone GDP (gross domestic product) growth halved to 0.2% for the second quarter.

However, underlying factors across major economies indicate that recession fears may be overblown, economists have suggested.

Over the weekend, German Finance Minister Olaf Scholz indicated that Europe's largest economy would be willing to take fiscal measures if a recession loomed, shifting the government's tone.

Meanwhile, the People's Bank of China has announced a program of interest rate reform aimed at stimulating an economy reeling from the impact of the trade war.

U.S. consumers to the rescue

Strong retail sales figures for July suggested that the U.S. Consumers are continuing to prop up the economy, partly offsetting the drag on business confidence from the US-China trade conflict.

Sales climbed 0.7% month-on-month in July, a fifth successive increase, reiterating the American consumer's role in providing lifeblood to the economy.

A note from UBS Global CIO Mark Haefele on Monday said this reinforces the belief that the U.S. economy should avoid a recession. Assuming no trade war escalation, UBS has assigned only a 25% chance that the U.S. economy will contract for two consecutive quarters in 2020.

"But despite the strength of the consumer side of the US economy, we would expect falling business activity to push US growth below trend, forcing the Fed to cut rates more than we had previously expected," Haefele added.

However, recent data showed that factory output fell by 0.4% in July, while manufacturing output has now contracted for five of the past seven months, mirroring a broader slowdown worldwide led by China and Germany.

What's more, a swift resolution to the trade war remains unlikely, Haefele suggested, meaning business investment will remain subdued globally, delaying an expected pick-up in growth that was anticipated for the second half of 2018. UBS now expects U.S. economic growth of about 1.8%, below trend, in 2020.

"So while we do not believe a recession is booming, and we remain cautiously positive on global equities, we now expect a longer period of lower rates," the note said, adding that UBS now expects the U.S. Federal Reserve to cut rates by 25 basis points three more times – in September, December and March.

Robust underlying factors

HSBC Global Asset Management has also played down the risk of recession, both statewide and globally, retaining a pro-risk stance in its multi-asset portfolios. Global co-CIO Joseph Little highlighted on Monday that equity markets have performed well year-to-date, despite this month's sell-off.

He added that the "valuation gap between equities and relatively expensive bonds continues to increase," but advocated a more cautious short-term approach given the downside risks to growth.

"The global economy is in a difficult place, but investor pessimism could be overdone. Looking at the growth outlook, US activity is being tempered by a solid labor market," Little said.

"Meanwhile, the recent weakness in the euro area data has been driven mainly by a large downturn in the industrial sector."

While there is no clear indication of a turnaround here, the services sector remains robust, offsetting the impact of dwindling industrial performance.

In addition, muted global inflation trends have kept the door open for further monetary policy easing, and Little suggested that alongside an expected further Fed rate cut and stimulus package from the European Central Bank (ECB) this year, fiscal policy could also play an increasing role. important role.

For instance, the U.K. The government has signaled a large program of spending and tax cuts, while Germany has now indicated that it is prepared to deploy fiscal stimulus should its economy continue to lag.

With regards to bond yields, which touched all-time lows across Europe last week, Little said there is no precedent for an inversion at such low government bond yields, but "yield curves have to revert further before they reach levels that have preceded previous. recessions. "

An inverted yield curve is generally considered a recession predictor. When short-term yields climb over longer-dated yields, it shows that borrowing costs in the short-term are more than the longer term. In these cases, businesses could find it more expensive to expand their operations. Meanwhile, consumer borrowing could also decline, thus leading to less consumer spending in the economy. All of this could lead to further contraction in the economy and rise in unemployment.

New all-time highs for equities in 2020

While respecting the historical significance of the U.S. yield curve inversion in preceding recessions, J.P. Morgan equity strategists led by Mislav Matejka highlighted a number of variables that are inconsistent with such events.

"Typically, the inversion curve is a sign that real policy rates have become too high; lending conditions are tightening and banks are beginning to restrict access to credit; high yield credit spreads are worsening; and the labor market has begun to deteriorate," Matejka said in a note on Monday.

"This time around, high yield spreads are well behaved, real rates are not well above zero, and claims remain resilient."

Matejka also highlighted that the differential yield between the U.S. and the rest of the world remains near highs, which may be a factor affecting the U.S. yield slope curve.

"Put together, the inversion curve might be more of an indicator of the extreme market nervousness present, of increasing central bank activity, skewed bond ownership, and of a global search for yield, rather than a sure sign that the US is about to enter a recession, "he added.

As such, J.P. Morgan expects equities to hit new all-time highs in the first half of 2020, though this development is increasing the potential market potential for this cycle next summer.


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