Will central banks save the economy and markets from the bankers’ mistakes, the global trade conflicts and political events?
I’ve said for some time that the greatest risk to the economy and markets is that the Fed might tighten monetary policy too much, and I said in 2018 that the tightening the Fed initiated in 2015 was going too far.
We’ve seen the effects in weaker economic data in 2019, and that has increased talk of a recession. Some analysts even say now it’s only a question of whether we enter the recession in 2019 or in 2020. But while growth is slower, the data and trends say the recession talk is premature.
There are a lot of positives and negatives in the recent data, and negative data usually grab the most attention. So, the negative points are well-known.
Manufacturing in the United States is weak. By several measures, the sector is shrinking, prompting headlines that the manufacturing sector is in a recession.
Surveys of consumers and small business owners show optimism is declining. The global economy is growing very slowly and generally weakening. Europe is particularly frail, with even Germany showing signs of being close to a recession. Japan continues to struggle.
The trade conflicts, especially with China, are a major drag on both the global economy and the U.S. economy. Trade has been disrupted, and prices have increased for consumers on both sides of the conflicts.
More importantly, uncertainty about trade and the state of the global economy are freezing action by businesses. Business investment is down, and many businesses indicate that they won’t make significant investments until there’s more certainty. Politics also are having negative effects on the economy. There’s a great deal of division in many countries, making fiscal reform and stimulus unlikely.
These negatives are balanced by a number of positives.
The Fed and other central banks have stopped tightening monetary policy and are making plans to expand the monetary supply.
The U.S. service sector still is growing at a decent rate. Housing has had its ups and downs but generally is contributing to growth.
The labor market remains historically strong. A strong labor market, coupled with rising prices of stocks and homes, aids households.
Strength in the household market is leading to retail sales growth. In the first two quarters of 2019 and so far in the third quarter, strong consumer spending more than offset weakness in other sectors. Despite the recent decline in optimism, consumer sentiment still is near historic highs.
Yet, we need to remember employment is a trailing indicator. Often, the labor market is stable or even improving for months after a recession begins.
Another advantage is that banks and other lenders are healthier today than they usually are at this point in the business cycle. Financial firms didn’t dramatically in-crease their leverage during the expansion and aren’t overextended. When the Fed reduced the money supply in 2015-2018, banks and other lenders were able to step in and replace a lot of the liquidity. That’s one reason growth remained positive, despite significant tightening by global central banks and the trade conflicts.
This could turn out to be a period much like 2015. The economy slowed. Several usually reliable recession indicators even turned negative. But the economy never tipped into a recession, and growth resumed.
We’re not out of the woods yet. A ratcheting up in the trade conflicts could tip us into a recession. It also is not clear how well China’s economy is doing. A significant slowing there would affect the rest of the world. Of course, there always is the Middle East to worry about.
Events are likely to come to a head regarding Brexit, the Italian debt crisis and other issues that already have hurt the European economy.
For now, it looks like the United States can maintain growth of around 2% or so. While there are risks, it’s too soon to hunker down and bet on a recession.