When and whence will the new recession come? Some believe it’s time to seek shelter from the storm brewing on the other side of the Atlantic...
According to textbooks, the economy evolves through cycles of recovery and recession. In other words, after trimesters that can be likened to times of feast (which are typically more frequent, and overall more robust in terms of new income produced) come times of famine. The latter are concentrated in shorter but often intense moments of economic contraction. It just so happens than ten years have passed since the last recession. This is what the data says: the last time global GDP fell compared to the previous trimester was the second trimester of 2009. This is why investors who use technical analysis (the study of past regularities to extrapolate future market trends) are keen to understand when – not if – the new recession will arrive, because sooner or later it will, and perhaps as early as 2020.
A second highly relevant question comes as a logical consequence of the first: when the next recession arrives, where will it come from? Here we can provide a simplified answer: when it comes, it will come from the United States. For two good reasons. One is that the United States, whose GDP amounts to about USD 20 trillion, accounts for about 23% of global GDP (which reached USD 87 trillion in 2019; World Economic Outlook data, October 2019). The second is that a recession in the United States would likely drag the economies of China and the Eurozone down with it. Trump’s trade war is making us overlook this, but in spite of everything 22% of U.S. imports continue to come from China and 15% from Eurozone countries. Through international trade flows, an American recession would spread beyond the Atlantic and Pacific Ocean. These two reasons explain why all astute observers are looking to the United States to understand if and when the next global recession will take place.
In this regard, some very special circumstances that took place last summer suddenly increased the likelihood of a U.S. recession in 2020. It was 5 August. On that day, the yield on ten-year Treasury bonds fell to 1.75%, while at the same time thirty-day bonds had higher yields of 2.07%. This is what is technically known as an ‘inverted yield curve’, and is an event much feared by markets. This means that against the logic of financial markets, holding short-term bonds results in higher remuneration than holding long-term bonds. This clashes with the principles underpinning financial markets, where those who take on higher risks by immobilizing their money for a long period of time are ultimately rewarded for it. Instead, in August 2019 short-term yields paradoxically rose above long-term yields. Was this just trivia for finance operators and buffs? Not exactly. It just so happens that each and every one of the six American recessions in the last 60 years was preceded by an inverted yield curve. And since in these six previous episodes it took an average of 14 months for the inverted yield curve to turn into a contraction of GDP and economic activity, making projections is not difficult. The inverted yield curve of August 2019 suggests an American recession in fall 2020.
Should we then open up our umbrellas ahead of the storm that may be coming from across the Atlantic? Actually, no. The first thing to keep in mind is that the inverted yield curve disappeared after only a few days, as soon as the Chair of the Federal Reserve lowered reference rates for the interbank market and announced his intention to consider lowering other rates in the coming months. If the Fed lowers reference rates, the yields on short-term public bonds will also fall and normality will be restored, with short-term yields lower than long-term yields. Also to be kept in mind is that while all American recessions began after an inversion in the yield curve, the reverse is not true. In other words, sometimes an inverted yield curve has merely resulted in a false alarm. It is entirely possible that this is the case once again, and that there is no U.S. recession around the corner in the coming months.
There is no doubt that the U.S. economy is continuing to do reasonably well. GDP growth adjusted for inflation remains above 2% per year – half of what Donald Trump promised in 2016, but still higher than any other G7 country. What is more, U.S. growth appears to be sustainable, since it is taking place with inflation rates under 2% – meaning they are under control – and unemployment at 3.5%, the lowest since 1969, and without excessive salary growth compared to the increase in productivity. Taken together, data on GDP, inflation, and unemployment paint a portrait of a healthy American economy. Beyond the sophisticated correlations that investors and markets pay attention to, the only clouds on the horizon of American growth (which heavily impacted the Dow Jones in 2018) come from the possibility that the U.S.-China tariff war will continue to rage on.
Clearly, in the highly interconnected global world we live in, a recession can emerge somewhere else that in the United States as well: from a poorly managed Brexit, the implosion of the German economy in Europe or of the Chinese one, or from a liquidity crisis in the financial market, just to name a few. The fact remains that if the U.S. can guarantee another year of continued economic growth, any other problems that may emerge will be easier to absorb.