David Helscher

David Helscher

Many are asking whether the U.S. is headed for a recession? Yes, but this is the wrong question.

When will there be a recession? The current expansion is 10 years old, but expansions do not end of old age. Recessions are generally defined as two consecutive quarters of negative growth, or contraction.

The U.S. experienced robust first quarter 2019 gross domestic growth (GDP) of 3.8% while the second quarter did slow down to a 2.1% GDP growth rate.

The Atlanta Federal Reserve recently projected 3rd quarter GDP tracking at 1.9%.This generally reflects slowing global economic growth. Recent figures indicate that global manufacturing purchasing managers indices are declining for the 15th consecutive month with 75% in contraction territory.

One source of slowing growth has been the tariff dispute between the U.S. and China. The imposition of tariffs on Chinese exports to the U.S. added to the costs of these exports, resulting in slowing sales.

With less demand, production of supply declines and the need for raw materials declines, slowing imports to China of these materials from various global suppliers. The reduction in the value of the Chinese currency earlier this month may have been an attempt to reduce these costs, but also raised the stakes from just a trade dispute to a currency war, and indicated hardening stances on both sides of the Pacific Ocean. In an effort to stimulate local economies, a number of central banks are reducing short term interest rates, lowering the costs of borrowing, reducing the value of their respective currencies, and increasing local production with cheaper goods available for export.

A potential source of slow growth, at least in the minds of White House officials, is an overly restrictive federal funds rate as set by the Federal Reserve. The Fed recently reduced the fed funds rate by one-fourth of a point, but made statements this was not the start of an easing cycle but a midcourse correction. This may have been to eliminate the hike last December that may, or may not, have been necessary.

Many of the recent sovereign debt securities have been issued with a negative yield, the purchaser pays to purchase the bond, receiving less than the face value at maturity. By many sources, approximately $16 trillion of sovereign debt carries negative yield. This is not the case with U.S. debt, which carries positive yields.

The U.S. dollar is the global reserve currency, has deep, liquid debt markets, and is considered a risk-free investment. Given the uncertainty in global markets, declining interest rates and currency values, global investors may have flooded the market for U.S. Treasury securities, bidding up the price and dramatically reducing yields. This also has the effect of increasing the value of the dollar relative to local currencies, as local currencies need to be sold to purchase dollars to buy Treasury securities. The safety and liquidity of the U.S. market appealed to global investors.

Reducing key interest rates may further reduce yields on key interest rates. A great deal of press attention centered on the inversion of the yield curve, when the yield on shorter term maturities exceed longer maturities. A yield curve inversion has, at times, been a precursor to a recession, but with a significant delay. At this point, the inversion earlier this month was of a short duration, a matter of days, if not hours. Generally, an inversion requires a longer duration for purposes of prediction. There are significant contrary indicators, historic low unemployment rates, rising labor participation, low inflation, and relatively high consumer confidence. Despite slowing global economic growth, 70% of the U.S. economy is dependent on domestic consumption.

When Congress returns in September, they will need to deal with the federal budget and debt ceiling agreements reached in early August. Also, on their agenda is the USMCA, or NAFTA 2.0, affecting our trade relations with Mexico and Canada. The White House has floated a trial balloon to adjust tax rates, possibly reducing payroll taxes and indexing capital gains. Capital gains indexing is seen as having a minimal impact on economic stimulus and the details of cuts in payroll taxes would need to account for any reduction in government funding.

Will there be a recession? Yes, expansions do not continue forever. When we may experience this is another matter. A single data point is not necessarily predictive. At this point, the consensus opinion is that the risk of a possible recession has increased recently, but it is not the base case the majority of economists or financial analysts see. This could rapidly change with new and different data and markets will likely react quickly, increasing volatility for some time.

David Helscher is a senior vice president and trust officer with Clinton National Bank.