A US recession this year is unlikely

Like most forecasters I expect a slower US economy this year with no recession (yet). But bears like David Rosenberg see a high risk of recession. Is the majority too complacent? The Conference Board’s leading index has flat-lined for the last 4-5 months and the 6-month change (my favourite indicator) is pushing back towards zero, but we have seen that 3 times already in the last 10 years and they were just slowdowns. Only a decisive move below zero signals an imminent recession.

So, a better question is, what would it take - in the US – for the US to suffer a recession now? I emphasise in the US, because we know that China and Europe are slow. But weakness abroad is never enough on its own to create a US recession. Neither the Asian crisis in 1997 nor the euro crisis in 2012 caused a US recession even though those regions suffered badly. Bad news abroad can certainly trim US growth and doubtless is doing so now – just look at Apple and Caterpillar – but it is US consumers and businesses that will determine the US cycle.

The good news is that US consumers and businesses are in good health at the moment. Consumers are enjoying rising wages as earnings finally begin to lift, while employment continues to grow robustly. Consumer confidence dipped with the stock market but is likely to pick up as long as the market does not find new lows. In any case, even the dip in Q4 left it at solid levels. And watch for confidence to pick up in coming months if the stock market avoids another fall.

Business is enjoying gradually rising capacity utilisation which will encourage new investment and raise operating leverage and thereby improve margins despite increasing wages. Business confidence also took a hit with the falling stock market but, again, has stabilised. The National Federation of Independent Businesses saw a notable fall in its index, but it remains well above pre-2017 levels.

So, what would have to change to turn the slowdown into a recession? The answer is a major shift in expectations which caused business to put hiring and investing on hold. Weakness in Europe and China is already factored in. But most people are betting on a trade deal to defuse the trade issue. If a deal proves elusive and tariffs are raised to 25% it would be a major blow. For many businesses higher input costs would be a severe headache while likely retaliation in China would threaten exports. As ever, it is the uncertainty that hurts as much as anything else. A world with permanently high tariffs would be bad for the world economy but it wouldn’t create a permanent recession. Business would adapt. The problem is the adaptation itself.

Could the stock market tip the US economy into recession? Falling stocks are a negative signal and reduce consumers’ spending power but usually the causal direction is the other way. Stocks fall because the economy is in recession or is expected to go into recession. So, for example, stocks peaked in September 2000, about 6 months before the 2001 recession started, as is pretty typical. But that recession was over and a recovery had begun before the trough in October 2002. The stock market fell another 25% in 2002 even as the economy picked up. This further fall was because the 1990s stocks bubble was still unwinding, but it just shows that a falling market in itself does not cause a recession.

Another example is the 1987 crash. At the time it triggered huge fears of a new recession but that didn’t happen for another 3 years. Of course, the Fed responded with vigorous rate cuts which helped. But the Fed has changed policy this time too, though admittedly not actually cutting rates. Still, since December mortgage rates and BBB bond yields have dropped about 0.5%, easing financing conditions.

The bottom line is that the Fed has gone on hold, President Trump has every incentive to conclude a trade deal (as does China) while the Chinese economy should be picking up again in spring (see last week’s post) so the chances are that business confidence will hold up and capital spending and hiring plans will go forward. It wont be a strong economy this year, but a recession still looks unlikely.