“Signals that predict U.S. recessions are far from perfect. But what is striking is just how many of them are now flashing red. The next U.S. recession is a question of when, not if. Across the indicators, a recession around 2020 is more likely than not. This will have big implications for Asia’s economies. They’d best get ready now.”
- Adam Triggs, director of research, Asian Bureau of Economic Research, Crawford School of Public Policy, The Australian National University
Triggs raises this dire warning in his December essay, What the looming U.S. recession means for Asia, for East Asia Forum. In the piece, he says a number of indicators are now “flashing red”:
U.S. business cycle: The U.S. economy has never gone more than a decade without a recession and is fast-approaching that milestone.
Monetary policy: Recessions have followed four of the past five periods of interest-rate hikes by the U.S. Federal Reserve. The current episode of rate hikes is already under way, with more increases expected in 2019. Indeed, in a Dec. 19 statement from the Federal Open Market Committee’s meeting, the Fed hiked interest rates a quarter point — its fourth increase of this year — to a target range for its benchmark funds rate of 2.25 percent to 2.50 percent. While the move was expected, the Fed signaled just two interest rate hikes for 2019, down from a previously projected three increases.
Term spreads: A flattening yield curve — when short- and long-term interest rates start converging — has predicted every U.S. recession in the past 60 years.
Spare capacity: The level of spare capacity in the economy is another recession predictor. According to Triggs, the past 10 U.S. recessions were preceded by a closing of the output gap. With the U.S. output gap now near zero, “employment is heading beyond full employment and, while inflation and wages are moving slowly, they are beginning to shift.”
Triggs is not alone in his assessment of a looming U.S. recession; Bank of America Merrill Lynch, the Economist Intelligence Unit and two-thirds of the economists surveyed by the National Association for Business Economists anticipate a U.S. recession around 2020.
And according to a recent survey of economist by The Wall Street Journal, most “view a trade war between the U.S. and China as the biggest threat to the U.S. economy in 2019, a sign that forecasters view political uncertainty and the potential for new punitive tariff barriers as greater risks than macroeconomic or financial disruptions.”
The U.S.-China trade war is another factor Triggs says is slowing the U.S. economy by “dragging on growth in unpredictable ways because of cross-border supply chains,” and indicates the International Monetary Fund forecasts a one-third drop in U.S. GDP growth by 2020 given current trends. This, Triggs suggests, leaves less room for shocks to the system to be absorbed.
Triggs argues that, should the U.S. economy slow, the Fed will have to resort almost immediately to quantitative easing — or other unconventional, politically controversial, monetary policy.
Implications for Asia
The looming slowdown to the U.S. economy will have major implications for Asia, according to Triggs, who cites IMF estimates that a 1 percentage point decrease in U.S. growth usually reduces emerging-market growth by 0.6 percentage points. The story this time around, he says, may be more complicated.
“The big increase in trade among Asia’s economies has led some to believe that Asia is less reliant on the big industrial economies. The opposite is true. Asia’s intra-regional trade is driven in large part by cross-border production chains that are linked to demand from the major industrial economies,” states Triggs, who cites additional IMF research that Asia’s trade dependence on the United States has increased rather than decreased.
“The biggest concern isn’t the fire. It is the lack of water with which to put it out,” says Triggs, who indicates the Fed has historically supported the U.S. economy during downturns by cutting interest rates by 5 percentage points. Doing the math with the Fed’s December rate hike, the Fed only has half that amount right now for stimulating the U.S. economy.
“The only certainty is volatility, particularly for Asia,” suggests Triggs. “The last round of quantitative easing saw money flood into Asia in search of high yields. The dollar-denominated debt of emerging-market firms other than banks quadrupled. Conversely, if risks increase, capital flowing back into the United States will drive the dollar up, causing more stress for emerging markets already struggling with their dollar-denominated debt stocks.”
Now, before a recession hits, is the time for Asia to build domestic buffers — in monetary and fiscal policy, and in the accumulation of foreign exchange reserves — to shield it from as much external economic shock as possible.
