Is a US Recession Imminent? Part Two

In January, we asked CFA Institute Financial NewsBrief readers if the United States would experience a recession in 2016.

At that time, 70% of the 875 respondents indicated that no, the United States would continue to experience positive growth: 60% said that expansion would be slow, while 10% expected sustained or improved growth. Only 21% anticipated a recession, with 15% betting on a mild one and 6% believing a harsh downturn was imminent. The remaining 9% were unsure what would happen.

Alas, the game never ends, so we asked CFA Institute Financial NewsBrief readers whether they anticipated a recession in 2017.

Today, only 62% of 1,000 respondents believe that the United States will continue to grow next year — an 8% decline over 2016 expectations. Another 24% feel a US recession is coming, up from 20% in 2016. The percentage who expressed uncertainty rose from 9% to 15%. It appears readers are becoming more cautious about the future of US economic growth.

Will the United States experience a recession in 2017?

In my poll analysis from earlier in the year, I suggested that the major economic problems in the world were centered in Japan, Europe, China, and other emerging markets. The weaknesses in these markets from late 2014 to early 2015 led to globally declining commodity prices and an influx of capital into the United States. Despite the sputtering growth, it seemed that the United States would escape a recession as the US Federal Reserve struggled to raise rates. Ten months later, this appears to have been validated.

What has changed? To begin, China decided to ramp up its fiscal stimulus, running a ¥3 trillion RMB deficit in the past 12 months. This meant a large increase in construction spending, more housing investment and auto sales, and more government debt. In turn, it also meant a greater demand for commodities coming from China, which helped the commodity markets stabilize. While these actions have stabilized China’s economy in 2016, they come at a cost.

In Japan, the Bank of Japan (BOJ) began buying equities, in the form of exchange-traded funds (ETFs), in January 2015, and has since become the single largest owner of ETFs in the country. The BOJ has continued to amass roughly ¥80 trillion in Japanese government bonds annually, pushing rates further into negative territory, while the nation’s economy remains as sluggish as ever. Counterintuitively, the yen has surged during the course of the year. Because Japan has such large holdings of foreign assets, uncertainty in the market generates a strong bid on the Japanese yen as Japanese investors take their money home.

The story is similar in Europe. The European Central Bank (ECB) has driven rates on many European sovereign bonds into negative territory although it has been unable to beat the deflationary forces of excess debt. In Germany, for example, yields on 10-year bunds have declined from about 0.37% at the start of the year to a low of negative -0.156% (though they have recently spiked to 0.137%). Negative rates are taking a toll on the banking system by increasing loan volumes and decreasing net interest margins and profitability.

US commodity prices are no longer declining like they were in 2015 — oil prices have risen this year — thereby eliminating a tailwind for the US economy.

S&P 500 earnings have declined for five consecutive quarters as of the second quarter of 2016, enjoying a modest bump in Q3 2016. Yields on 10-year US Treasury bonds declined from 2.3% in December 2015, to a low of 1.3% in July 2016, reflecting the amount of capital inflow into the United States. Since then, rates have climbed to more than 1.8%.

Total credit outstanding is still growing, but what is different in 2016 is that mortgage volumes are picking up. In June 2016, total mortgage debt outstanding was roughly $14 trillion, up roughly 3% vs. one year earlier. After peaking at $14.8 trillion in June 2008, mortgages outstanding declined to $13.3 trillion over the course of the following five years ending 30 June 2013. Growth in mortgages, all else being equal, bodes well for economic growth. But since when is all else equal?

The real trade-weighted US dollar has stabilized at roughly 99 after a strong upward movement in 2015, causing US exports to grow more expensive. However, the market-implied probability of a December rate hike has spiked to 80%.

Of course, with such low rates for so long, the economy is sensitive to Fed actions. Moreover, it is also likely the US stock and bond markets will react to a Fed rate hike, making the continued resilience the United States has shown so far this year tenuous at best.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.