Slowing US economy rings recession alarm bells

‘When the United States sneezes, the rest of the world, catches a cold’ is a well-worn phrase regularly trotted out by business writers when growing signs of trouble ahead begin to make investors nervous.
It’s a line that also captures the outsize impact the US economy has on the global economy. Where the country goes, so goes the rest of the world.
Accounting for around a quarter of global GDP, the US continues to be the world’s largest importer, while the US dollar remains the leading reserve currency, accounting for approximately 60 percent of international foreign exchange reserves.
That makes the release of the latest US jobs data on Friday – showing a labour market that contracted for a second straight month – all the more significant, as a growing number of market watchers are becoming fearful the world’s largest economy is rapidly slowing and may well be sliding towards a recession.
US employers added 142,000 jobs in August, more than 10 percent below a consensus of analysts’ forecasts of 160,000, although it was above the downwardly revised 89,000 jobs created in July that shocked markets last month.
The lower than expected reading, which had been billed ahead of time as possibly the most important economic data point of the year, sent equity markets into a tailspin, resulting in the benchmark S&P500 index recording its worst week of the year after falling 4.2 percent.
Just two years ago, the widely touted line that there were two job openings for every unemployed worker in the US meant that anyone who lost their job back then would usually have little trouble finding another one. This prevented unemployment from rising.
The same was largely true for most Western economies, including our own. There were more jobs available than there were people to fill them, and employers were constantly bemoaning the fact they were unable to find workers to fill vacancies.
But not anymore. According to Friday’s non-farm payrolls report for August, the job openings rate in the US has now dropped back down to pre-pandemic levels and those who lose their jobs are finding it increasingly difficult to secure new ones. While an influx of workers into the labour market has contributed to a rising unemployment rate over the past 12 months, close to half of that increase has been due to job loss.
It’s been a similar situation here, with a quarter of firms surveyed in the most recent NZIER quarterly survey of business opinion reducing staff numbers in the June quarter, though the release of the latest business employment data by Stats NZ tomorrow will provide a more detailed read on the health of the local labour market and is likely to show a further contraction in hiring.
As Peter Berezin, chief global strategist at BCA Research, wrote in his op-ed piece headlined ‘Reasons why investors need to prepare for a US recession’ published in the Financial Times over the weekend, a softening labour market will not only undermine consumer spending – it will have a flow-on effect to all parts of the economy.
“The personal savings rate in the US stood at 2.9 percent in July, less than half of what it was in 2019. Excess pandemic savings have now been largely depleted. In inflation-adjusted terms, bank deposits for the bottom 20 percent of income earners are below where they were in 2019. Consumer loan delinquency rates have risen to levels last seen in 2010, a year in which the unemployment rate was double what it is today.” 
All eyes will now be on the US Federal Reserve as it prepares to announce on September 18 what is likely to be its first rate cut since March 2020 in the wake of the Covid-19 crisis. The only question being, will it be a 25 or 50 basis point cut?
After the release of Friday’s labour market data, there is now growing speculation the Fed may well opt for a 50-point cut, though some economists are warning that going deeper than the 25-point cut expected by many might well spook markets further.
Just don’t expect the Federal Reserve to save the day, Berezin points out.
“The US economy succumbed to recession just months after the central bank started lowering rates in January 2001 and September 2007. The market is currently expecting the Fed to cut rates by more than two percentage points over the next 12 months. Long-term bond yields will not fall much from current levels unless it delivers more easing than what the market is already discounting. That is unlikely unless there is a recession.”
Despite what markets are expecting, interest rate cuts will not be a panacea for economies to bounce back, Berezin says.
“Even if the Fed does deliver more easing than is currently priced in, the impact will only be felt with a lag. In fact, the average mortgage rate that homeowners pay will almost certainly rise next year as low-rate mortgage debt rolls off and is replaced with higher rates.”
As a result, Berezin warns that markets will have to adjust if recession fears do ultimately become reality.
“In a recessionary scenario, we would expect the S&P 500 forward price/earnings ratio to fall from 21 to 16 times and for earnings estimates to decline by 10 percent from current levels. This would bring the S&P 500 down as low as 3800, representing a nearly one-third drop from current levels.
In contrast, bonds could do well. We expect the US 10-year Treasury yield to fall to three percent in 2025. Investors were right to favour stocks over bonds for the past two years. Now, it looks like it’s time to flip the script.”
Adding to recession concerns, the price of Brent crude oil – often regarded as a barometer for the overall health of the global economy – closed at a near three-year low on Friday at US$71.47 per barrel having experienced its biggest weekly fall this year, declining 7.2 percent and threatening to fall below the key US$70 support level which has held firm since August 2021.
Crude oil futures have now lost all their gains for the year, with analysts warning oil prices could have further to fall as fears grow that more supply would be coming on-stream at a time when demand is poised to weaken.
OPEC+ members are expected to delay a production hike of 180,000 barrels per day, originally scheduled for early October, by two months.
Bitcoin, which also sells off when investors become risk averse, was trading at a seven-month low of around US$54,000 over the weekend, having fallen almost 25 percent since late July.
The New Zealand sharemarket is expected to open weaker today following Friday’s sell-off in the US, having last week bucked the trend in the face of a slowing global economy and growing recession fears.
The local market was one of the few to finish in the green with the NZX50 gaining 1.4 percent for the week – thanks to strong gains by market leaders Infratil (up 7.8 percent) and F&P Healthcare (up five percent) – versus a dramatic 4.2 percent fall in the US S&P500 and a one percent fall for Australia’s ASX200.
Pie Funds founder and chief investment officer Mike Taylor is also concerned the sharp fall in the oil price and other commodities in recent weeks are warning signs that shouldn’t be ignored.
“These falls are certainly signalling that fears of a recession are becoming increasingly elevated. However, I also think the weakness in commodity prices is mainly coming from falling Chinese demand rather than US weakness per se. With the world’s second biggest economy slowing rapidly it’s all the more reason for the Fed to act quickly, though I still expect they will start off slowly with a 25[-point] cut later this month to avoid alarming markets unnecessarily.”
But if the Fed was to become more aggressive in this rate cutting cycle, would the RBNZ be likely to follow suit? Taylor believes they would.
“It would certainly give the Reserve Bank more cadence to follow suit. I mean why wouldn’t they? We have very restrictive rates and the economy is clearly in recession. Personally, I think the OCR should be around four percent currently and heading lower. The RBNZ I believe are well behind the eight ball here.”
Taylor believes the local market may avoid feeling the full impact of falling stock prices in the US should recession concerns continue to grow.
“Broadly the NZX should hold up reasonably well in a falling interest rate environment, particularly given the fact our cyclical names including the likes of The Warehouse Group and KMD Brands have already been suffering from the impact of a weak consumer for some time. First in, maybe first out of recession.”
In terms of the outlook from here, Taylor suggests local investors should consider adopting a wait and see attitude.
“I’d suggest sitting on the sidelines until the market has recalibrated what 2025 numbers will look like. Stick to names that will do well in a falling rate environment, though remember that Wall St is already two steps ahead. The 10-year Treasury yield is already back to 3.71 percent and in the last month utilities and defensives have rallied hard so you’d have to be pretty bearish to see significant gains from here. But if you have to be invested for the next quarter it’s a place to hide.
“Otherwise, be patient. If we have learned anything from the last 15 years, it’s that the US Fed put is alive and well. If the stock market falls 20 percent you can be assured they will come riding to the rescue. But markets don’t stay down long. 2008/9 was barely 15 months, 2018 was three months, Covid six weeks, 2022 nine months.  Meaning that, if we only have a mild slowdown and the market falls 20 percent and the Fed cuts 250 [points], then you should probably be buying aggressively!”
Warren Buffett’s recent revelation that his cash pile has never been bigger suggests he too is getting ready to pounce should markets start a sell-off.
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