The Daily Reckoning UK

Is A US Recession On The Cards?

Darren Sinden

by

Posted 15th June 2017

Yesterday we looked at the challenges facing the UK economy, in particular what they mean for UK retailers, both now and in the future.

As we noted, the omens are not good and I think it quite likely we will see more familiar names joining the likes of Woolworths, Comet and, most recently, BHS as items of retail nostalgia.

If the situation for retailers is poor in the UK then, anecdotally, at least it appears to be much worse in the USA, but for different reasons…

On the face of it, the US economy looks to be on the up, with falling unemployment, numerous job vacancies and a booming stock market.

The trouble is, the shiny exterior doesn’t reflect the reality of day to day life for many Americans, which is part of the reason Donald Trump swept to power.

Though as we’re discovering, he may actually be part of the problem, rather than the solution.

Let’s look at two numbers that speak of employment opportunities in the US, to provide you with a flavour of what I’m talking about…

As noted, headline unemployment in the US has fallen rapidly over the last 18 months and now stands at 4.3%, a figure that many market participants might consider to be approaching full employment.

But if we look at a less well publicised figure known as the Labor Participation Rate – which measures the percentage of the working-age population in employment, or actively looking for work – we find that number is 63%.

Or to put it another way, 37% of the US working-age population are not engaged with the world of work in any way.

There’s much discussion about exactly who these people are and why they are not economically active, but even conservative estimates put their number at around 20 million individuals.

That’s a massive number, equivalent to roughly one third of the population of the UK.

Now, let’s consider the number of US citizens that are financially disenfranchised (i.e. in low income households)…

If we use the numbers for those in the US receiving food stamps (literally, government vouchers that can be exchanged for food) as a proxy, we find that 45 million Americans regularly receive these state handouts.

These stats point to widening inequalities and the reality of a two, or perhaps even three, speed America.

Stock market buoyancy has made rich Americans richer, and while I’m not here to debate the morals of that situation – it is what it is – I would say that this buoyancy has been achieved by creating an ocean of cheap money and mountains of asset purchases, courtesy of the world’s major central banks.

What’s more, US businesses themselves – often awash with cash – have used buybacks to bolster their share price performance and, less palatably, to mask indifferent earnings and sales performance in their underlying businesses.

Indeed, all eyes were on the US last night, as the Federal Reserve Bank’s Open Markets Committee concluded its two day interest rate meeting.

As expected, the Bank raised US interest rates by a further 0.25%, and indicated they would aim to raise rates again in 2017 and perhaps a further three times in 2018.

Those comments came as the dust was still settling on weak inflation and retail sales numbers, which were released earlier in the day.

This data was directly at odds with the idea of an expanding US economy, and while the Fed wants to normalise interest rates and monetary policy, it needs to tread carefully if it doesn’t want to find itself out of sync with the needs of the underlying economy.

It’s interesting to note though, that US interest rate futures aren’t pricing in a second interest rate rise in 2017.

Is the party over for US markets?

We spoke earlier in the week about the correction in US technology shares.

While reading around the subject, I came across a research note from a respected independent firm of economists.

The note showed that stocks in the sector were not overvalued, at least when compared to the excesses seen in the dot-com boom.

However there was an interesting, yet somewhat unexpected, footnote to their research…

The firm were not bullish on US equities, but rather than high valuations being their downfall, the economists expected a US recession to bring the party to a close.

I might have put that comment to one side as a curiosity and thought no more about it, except that yesterday afternoon something odd happened in the US bond markets…

The difference, or spread, between the prices of 2-year and 10-year US Treasury bonds narrowed to levels not seen since last October.

Intuitively, it should cost more to borrow money longer-term in an economy that will continue to grow.

And yet, the implied longer-term US interest rates are falling, even as shorter-term rates are rising.

As the Financial Times pointed out after the US inflation and retail sales data, this kind of bond market behaviour has often been indicative of a looming US recession.

Now perhaps I am adding two and two together and getting five as my answer here…

But given some of the contradictions that exist in the USA, such as the ones I’ve listed today, I don’t think we can rule anything out.

And with Donald Trump in the White House, we have become used to expecting the unexpected.

I will keep you posted on developments here.





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