Markets fret that recession fears will bring recession itself
Bank of America’s Brian Moynihan tempted fate last month, by arguing that the latest bout of angst over an economic downturn was overblown.
Echoing Franklin Roosevelt’s famous inaugural 1933 address — when the president sketched out his plans to chart a way out of the Great Depression — Mr Moynihan said: “We have nothing to fear about a recession right now, except for the fear of recession.”
But BofA’s chief executive highlighted a potential pitfall. Investors are now wondering if worries over a downturn — in president Roosevelt’s words, “nameless, unreasoning, unjustified terror which paralyses needed efforts to convert retreat into advance” — could turn into a self-fulfilling prophecy.
“If there are concerns about a recession, and corporate investment is restrained as a result, the road can in fact lead to a recession,” said Neil Williams, a senior economic adviser at Hermes Investment Management in London.
There were hints of this in the latest reading of the US Institute for Supply Management’s manufacturing index, which delivered a bleak update for August this week, including the lowest figure for new exports since April 2009. “There is an undercurrent of fear and alarm regarding the trade wars and a potential recession,” one survey respondent said.
The Fed’s Beige Book — anecdotal data gathered by the central bank’s regional arms — also indicated that businesses are becoming warier. The word “uncertain” made 33 appearances, up from the year’s previous high of 23 in July, notes Nicholas Colas of DataTrek Research.
Recession fears are apparent, too, in bond markets, which have seen a ferocious rally over the summer, driving yields lower. About $16tn of bonds, or one-third of the global debt market, now trades with negative yields and the US “yield curve” has inverted, which is something that has preceded every post-World War II recession.
However, some analysts and investors argue that plummeting yields are driven more by technical factors, deflationary forces and expectations of easier monetary policy, rather than real fears of a downturn.
They point out that while global manufacturing is in a funk, services and consumer spending — much bigger drivers of most advanced countries — are in decent shape. That is particularly true in the US, the world’s biggest economy.
Stock markets, a little short of all-time highs, are not signalling much distress either. Interest-rate futures indicate that the Fed will make repeated cuts, but not to the near-zero level that might imply a recession.
Nonetheless, there are hints that recessionary signs might spread from financial markets into the real economy, which could — if it spurs consumers and companies to rein in spending — be enough to tip the apple cart.
Google’s tool for analysing internet search trends shows that worldwide queries about “recession” have spiked to the highest level since early 2009. In the US, they have soared to the highest since October 2008.
The recent yield curve inversion — when the 10-year Treasury yield dipped below the two-year Treasury yield in mid-August, prompting president Donald Trump to tweet about the “CRAZY INVERTED YIELD CURVE!” — appears to have been a trigger. Google searches for “yield curve” last month jumped to the highest since at least 2004.
More rigorous sentiment measures are less clear. The US Conference Board and the University of Michigan’s consumer confidence surveys have now diverged by the most since 1969, with the former staying elevated even as the latter has sagged to its lowest point since 2016. But such a divergence tends to predate recessions, according to research by Deutsche Bank.
Moreover, there are fundamental reasons to worry. Michael Wilson, chief US equity strategist at Morgan Stanley, points out that more than two-thirds of purchasing managers’ indices around the world are now below the 50 mark, indicating that activity is falling. That kind of all-round slump has not been seen since the financial crisis, he notes.
He added that US companies’ profits and capital spending have been on a downward trend, too, potentially leading to lay-offs. “[That] is really all that separates the US economy from a recessionary outcome.”
For now, most analysts remain hopeful that the current gloom will not deepen.
Peter Berezin of BCA Research concedes that “a sudden drop in confidence can generate a self-fulfilling cycle where rising pessimism leads to less private-sector spending, higher unemployment, lower corporate profits, weaker stock prices, and ultimately, even deeper pessimism”. But he argues that the global economy should hold up as long as the trade war does not escalate further.
Mr Moynihan’s optimism could be well-founded. But if economic data continues to worsen and exacerbates the spreading pessimism, his comments may well turn out to be this cycle’s version of Citi’s Chuck Prince. In July 2007, as credit markets were beginning to seize up ahead of the Lehman crisis, the former chief executive made the infamous remark: “as long as the music is playing, you’ve got to get up and dance”.