Is a US Recession Imminent?
The US Federal Reserve remains the most important central bank in the world.
After the Fed ended its quantitative easing (QE) program (i.e., money printing) in October 2014, the stock market began searching for direction, unsure as to whether the US economy was strong enough to sustain or elevate growth without assistance from the central bank. Although the Fed clearly telegraphed its desire to eventually raise rates, it held off for almost 14 months, until December 2015.
In the meantime, the rest of the world faced mounting challenges: a rising US dollar set against falling native currencies, plunging commodity prices, and weakening economic activity, particularly in China. And all this has occurred despite low and, in some cases, negative interest rates.
The most remarkable feature of this period is the swoon in commodity prices. In the last decade, investors saw commodity prices skyrocket as the world became acquainted with the burgeoning power of emerging markets, particularly China. Confronted with the financial crisis of 2008, however, China unleashed an epic policy response, with more than $500 billion in stimulus, and encouraged massive credit growth in the banking system.
Now, over seven years later, China is sitting on a bad debt problem that may be as large as $3 trillion. As China struggles to swallow its trillions in mis-allocated capital, its demand for commodities has fallen sharply. Europe, Japan, and other countries have been sluggish as well, with much of the world falling into recession.
This has all happened as elevated commodity capacity is coming on line. Due to exceptionally long lead times in building out commodity infrastructure, the world has had trouble hitting the mark. In terms of oil, the US shale revolution and even geopolitical events — Saudi Arabia’s proxy war with Iran, the lifting of sanctions against Iran, among them — have contributed to rising capacity and inventories at a time when oil demand is retrenching. This combination has created a sharp decline in prices for the whole commodity spectrum.
But the United States is a net consumer in general, as reflected in its persistent current account deficit, and a net importer of commodities in particular. The weakening global economic outlook is cause for concern, no doubt. And recession abroad will clearly harm significant areas of the US economy.
Nevertheless, it seems the benefits should outweigh the costs. For starters, the heart of this crisis lies outside the United States. The weakening debt and credit profile of China, for instance, will likely not have contagion effects in the United States. China has maintained highly insular financial markets. So whatever ultimately happens there, the US financial exposure to China’s bad debts should be limited.
While the US energy sector and related corporate bonds are indeed weakening in line with declining energy prices, US consumers may ultimately benefit from falling input costs, on balance. Moreover, capital is flowing into the United States, particularly into Treasuries, sending longer term interest rates materially lower. This combination may prove to be enough to offset global weakness. But time will tell. In particular, whether or not the Fed maintains the stomach to ratchet up short-term rates despite the market turmoil remains an open question.
To evaluate how CFA Institute Financial NewsBrief readers view the unfolding market tumult, we asked them whether they expected the United States to fall into recession this year. The results were illuminating.
Will the United States experience a recession in 2016?
A significant majority (60%) of the 875 respondents believe that the US economy will slow, but not into recession. This consensus seems to align with the narrative outlined above. Another 10% believe that the United States will experience sustained or improving growth in 2016. About one in five anticipate that the country will fall into recession, with 15% expecting it to be a mild one and 6% a harsh one. Only 9% of participants say they aren’t sure one way or the other.
Clearly, the current turmoil can either intensify or ameliorate, but the poll results should serve as a useful guide to present market sentiment and perhaps help you flesh out your own views.
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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.