It’s impressive how well the U.S. economy has held up during the past year. As early as 2018, leading indicators were suggesting a heightened risk of recession in 2019 or 2020. Then early this year the yield curve inverted, a traditional signal that recession is imminent (the inversion has since reversed, but this typically happens before growth actually goes negative). The trigger for a downturn wouldn’t be hard to identify — a slowing China, combined with President Donald Trump’s trade war. Already, countries such as Singapore and South Korea, which export lots of manufactured goods to China, are slowing down.
But despite all the pieces that seem to be in place for a recession, it hasn’t happened. This expansion is now the longest in postwar history, having recently surpassed the long boom of the 1990s. Unemployment remains low and the prime-age employment-population ratio — a better indicator of labor-market strength — continues to increase:
And despite paying the full cost of the tariffs, the U.S. consumer — the traditional engine of global economic strength in earlier decades — has held up:
Steady consumption has helped economic growth plod along at an unspectacular but solid 2%. In stark contrast to 2008, the U.S. has held up better than other countries — the proverbial best house in a bad neighborhood.
But there are signs that 2020 may be a different story. Business investment, for example, has begun to fall:
Large companies have been cutting back on capital expenditures, many of them citing policy uncertainty and the trade war as their reasons for doing so (though October data looked better). Declining investment tends to mean falling wage growth, weak demand and slower hiring. Meanwhile, private residential investment ticked up in the third quarter of 2019, but has fallen since the end of 2017:
Financial markets are also starting to look a bit shakier, including the market for collateralized loan obligations, which are packages of risky loans that in some ways have begun to substitute for junk bonds in the U.S. Commentators have been worried about falling standards in the leveraged loan market for a while. Meanwhile, disruptions in the repo market, which have required repeated interventions by the Federal Reserve, might signal liquidity problems. There’s probably no big financial crisis in the offing, as there was heading into 2008, nor is there any obvious asset bubble that might burst as the dot-com boom did in 2000. But if corporations discover they’ve borrowed too much money and earnings slow because of the trade war and policy uncertainty, financial pain could exacerbate a downturn.
Government policy, meanwhile, is unlikely to provide much of a boost. Interest rates are already below 2%, so there’s little room to cut. Trump’s tax cuts didn’t do much to boost investment, so more of the same won’t help. A big infrastructure bill could provide stimulus, but Trump has been promising one forever and it hasn’t happened yet, so prospects seem dim. As for quantitative easing, it’s unlikely that the Fed would unleash this tool unless the economy was already in big trouble.
So many of the pieces are all in place for a recession to arrive in 2020, fulfilling the downbeat forecasts of 2018 and 2019. It’s also possible that the U.S. will escape, and that the longest expansion on record will stretch even longer.
First, there’s the possibility that a downturn will be shallow enough to avoid official classification as a recession. The commonly accepted definition is two consecutive quarters of negative economic growth, although the National Bureau of Economic Research uses slightly more nuanced criteria. But sometimes there are smaller slumps that fail to reach the threshold. A good example is late 2015 and 2016, when higher resource prices, a Chinese stock-market crash and a slowdown in manufacturing seemed to indicate a recession was on the way. The yield curve didn’t invert, but investment fell and growth slowed, possibly helping Trump to get elected. But toward the end of 2016, the ship righted itself and the recovery resumed. The same thing might happen this time around.
It’s also possible that economic weakness and political unrest in the rest of the world will drive capital flows to the U.S. Downturns in China and in manufacturing superstars like Germany and South Korea, combined with protests in Hong Kong, Spain, Latin America, the Middle East and elsewhere may cause a flight to safety, pushing down long-term U.S. interest rates and giving corporate debt markets a shot in the arm. The respite might be temporary, or lead to bad debts that would cause a larger recession down the road, but it could stave off recession long enough to help Trump win re-election, an event that could alter the trajectory of American politics and society in ways both small and large.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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James Greiff at [email protected]