A recession that threatens to sharply contract the economy and the equity markets may come a lot sooner than many investors think. A long list of financial leaders and analysts are warning that the sudden and sharp escalation of the U.S.–China trade war could either shorten the timeline for an economic downturn or make it steeper, according to a detailed story in Bloomberg as outlined below.
What it Means for Investors
In a worst-case situation, Morgan Stanley economists say that if the U.S. placed 25% tariffs on every Chinese import for four to six months and China hits back, a global recession would be likely within three quarters. Bank of America also is concerned. “With no end in sight, there are significant downside risks to our forecasts for U.S. and global growth,” Bank of America economists warned clients this week. “If the trade war escalates—this could include a more explicit currency war—uncertainty would be considerably higher and financial conditions much tighter.”
Playing With Fire
The last economic downturn a decade ago, the Great Recession, saw a steep contraction, soaring unemployment and a more than 50% drop in the stock market. This year, the big concern is that recent easing from the Federal Reserve and other central banks may not be enough to offset the damage inflicted by the trade conflict between the world’s two largest economies.
The risk of recession in the U.S. is “much higher than it needs to be and much higher than it was two months ago,” said Lawrence Summers, former U.S. Treasury secretary and a White House economic adviser during the last recession. “You can often play with fire and not have anything untoward happen, but if you do it too much you eventually get burned.”
Weakening Global Data
The global economy already appears highly vulnerable to new stresses. Recent data already suggest that a global manufacturing contraction is underway. The June reading of JPMorgan Chase & Co.’s purchasing manufacturing index (PMI) was at the lowest level in six-and-a-half years and the first back-to-back sub-50.0 reading since the second half of 2012, according to a recent news release. A reading below 50.0 indicates contraction. Germany, Europe’s largest economy and the world’s fourth largest economy, saw its PMI reading fall in June to its lowest level in a decade. U.S. Manufacturing growth has fallen for four consecutive months.
These slowdowns come as China has retaliated to the Trump administration's move to impose10% tariffs on an additional $300 billion worth of Chinese goods next month after raising tariffs from 10% to 25% on $200 billion of China imports this spring.
The U.S. yield curve, which has acted as a fairly reliable predictor of recession, is also flashing warning signs as the negative spread between the U.S. 10-year note and the 3-month bill increased to its widest level since the financial crisis. Similarly, in Japan, the world’s third largest economy, the yield on 10-year government bonds is poised to fall below that of 2-year for the first time since Japan’s economic bubble collapsed in 1991, according to Bloomberg.
Unlike the Great Recession, central banks may not have enough ammunition left to stave off a debacle. “Asset purchases—if the ECB and others take that path—will be less effective this time than they were in the past. Conventional policy space is limited. Unconventional policy is of limited effectiveness. Best hope it’s not needed,” said chief Bloomberg economistTom Orlik.