The 2 Missing Ingredients for a Recession USA 2020
As I explained in “Slow Decade Ahead” and in “Central Bank Money is the Only Hope”, there is rising risk of recession or at least “slowdown” for 2020 in the USA and a challenging decade ahead in terms of growth and fiscal sustainability. Without a recession, stock index drops don’t go far and don’t last long.
The “planets” have been aligning and the stage is set: monetary tightening and increasing interest rates, the waning effects of past fiscal and monetary stimulus, significant flattening yield curves in the 1–2 year, 1–5 year, and 1–10 year curves, very low unemployment, high CAPE ratios (Cyclically Adjusted Price-to-Earnings ratio), a global slowdown of growth for the major economies, etc.
Euro quarter-on-quarter growth slowdown:
Japan quarter-on-quarter growth slowdown:
China growth slowdown, year-on-year growth, for what China stats actually can be trusted (ahem!)…
A serious recession always needs a few ingredients to “happen”:
- Inflation, which causes monetary tightening and rising interest rates.
- A large “sector” of the economy that has significant imbalances.
In 1980 and 1990, the rise of interest rates was so significant that it caused a severe recession due to the massive hit on credit markets and asset prices, along with housing. In 2001, the tech “bubble” that burst in 2000 caused a mild recession. In 2008, the real house price of US homes had gotten totally disconnected-from-reality and the entire economy was running on housing and wealth effects of rising housing and stock prices.
In all those recessions, there was prior increases of inflation and interest rates by the Fed. Now in 2019, although many indicators suggest “recession” for 2020, there is simply NO inflation in sight! This is the first “missing ingredient”…
Standard core inflation rate USA:
Core PCE inflation used by Fed as a gauge of price pressure:
Employment cost index inflation:
Same message from energy prices. There simply are no “clear” signals of price pressures or inflation. That means there can’t be much monetary tightening and all Central Banks will probably pause soon, which will be the end of the “mini global monetary tightening” that started in 2017.
There is another missing ingredient: a large sector that is “out of whack” and flashing red for “correction”. The large markets that can derail an entire economy are not many: housing, banking and credit, corporate debt, household debt, and in some countries (but not the USA or most industrialized countries) also government debt.
The ONLY market in the USA that has truly “balooned” in the past decade is corporate debt, so that WOULD be the one to watch for:
Corporate debt went from roughly 22% of GDP to 32% of GDP in the past decade:
But is this really a problem? Interest rates were extremely low, so it is normal that debt increased relative to GDP. Corporations used profits and debt funding for stock buybacks, which supported stock indices for the period the period 2010–2018 approx.
All other major sectors that can derail the economy show no signs of major imbalances that are “flashing red” for correction and there is little risk of inflation (for now), hence little risk of any further significant monetary tightening.
For the USA specifically, I see 2 things that have the “potential” to derail things, but are not likely to happen:
- An eternal stretch of the budget impasse and government shutdown drama.
- Further trade disputes with China that start to really rattle confidence about the future.
For now (end of Jan 2019), these 2 don’t seem probable, but you never know.
So as much as planets seem to be aligning for a 2020 “recession”, for now I would call it more a “slowdown signal”. Yield spreads signal no panic, credit markets are fine, housing is fine, households have manageable debt levels, etc. Of course, if inflation rises “convincingly” in 2019–2020 and forces the Fed to continue monetary tightening, then it might cause corporate debt rollover stress and other credit problems, so we’ll reassess if that happens. For now, unless domestic or global political drama causes major shocks, there is nothing to panic about for 2020 other than a probable slowdown. Do read “Slow Decade Ahead” to get a better “big picture” of the decade 2020–2030. Clap and share!
Pascal Bedard
pbeconomiste@gmail.com
Memories of climbing in Wyoming, Summer 2018:
