Looking at the current scenario, the US economy has been in good shape after keeping the unemployment rate static at 3.6 percent since 1949. Taking a glance at the reported earnings, the companies have performed above estimations because of which the consumer confidence has risen.
There are concerns about an impending recession. A section of economists believes that the US economy is overheating as it reported a growth of 3.2 percent in the first quarter. According to the NBER, the longest business cycle expansion in the US lasted for 120 months starting from March 1991 to March 2001. The current cycle, the second-longest expansion in history, began in June 2009 and questions about the longevity of the current business cycle are natural.
The fear of a market crash has been marked from the economic fallout of the escalating US-China trade war. The fear has led to a slowing Chinese economy and has resulted in persistent fear of a slowdown of the global economy. The constant fear of the economic fall can be seen by the inverse yield curve which relates to the assumption of a possible slowdown of the US economy.
China has been very aggressive with threats and tariff hikes after the US introduced the last round of hikes. China's threat of restrictions on rare earth metal exports to the US played a game in breaking the US supremacy over the trade economy. The US imports roughly 80 percent of its rare earth metals from China for the manufacture of phones, missile systems, and other hi-tech devices.
It has always been evident from the 1929 global depression that protectionism has always affected the global economy adversely. With campaigning for the US presidential elections nearing, the aforesaid might lead to global financial market risk. Legitimate concerns of the US regarding China's trade practices and escalating the US-China trade war might be harmful to the short term global economy.
The Chinese data released by the National Bureau of Statistics has seen a dip of 0.5 points, which is not encouraging. A Bloomberg survey indicates that economists foresee a 15 percent probability of a recession in China in the next 12 months. China contributes a third to the global growth and with a debt to GDP ratio of 265 percent, the problems in China are structural in nature. The growth rate of the Chinese economy is slowing down, what matters is the pace with which the economy slows down rather than the sustainability of past growth momentum. There has been a devaluation of the Chinese Yuan and the reserve requirement ratio has been reduced to 13.5 percent for smaller banks and 15.5 percent for large commercial lenders. China has also announced a fiscal stimulus program.
Wang Yang, one of the seven members of China's Politburo Standing Committee said that the US-China trade war could shave off one percentage point off China's economic growth this year. China is staring at a housing bubble caused by its massive stimulus during the global financial crisis of the last decade. This has the potential to cause a hard landing for the economy. According to the Chinese data provider, home pricing has increased manifolds.
Real estate contributes approximately a fifth of China's GDP and the Chinese banks have significant exposure to it. This coupled with the risk of an escalating US-China trade war, poses a great risk to China and the global economy as a whole.
Adding on to the fire of the trade war, the 'Tariff Man', Trump, imposed a 5 percent tariff on all goods imported from Mexico starting from June 10th. The tariff would increase in increments of 5 percent each month till it reaches 25 percent. The US imported $346 billion worth of goods from Mexico right from auto components, avocados to beer and TVs. This should affect the US auto industry badly and has soured market sentiment. Similarly, German retail sales fell unexpectedly and yields on 10-year German government bonds are in negative territory and fell to a record low. Italy is facing pressure over its rising debt-to-GDP ratio.
There have been a few highly demoralising data that points out the slowdown of the economy. Orders for Capital Goods fell 0.9 percent in April indicating the economy is not an expansionary mode. US Manufacturing ISM fell sharply to 52.8 vs. 55.3 in March. It marked the weakest growth in factory output since October 2016; this coupled with a slower increase in new orders and production has made investors jittery.
Due to worries about the fallout of the US-China trade war, concerns about a global recession and volatility in financial markets may cause the US Fed to move away from its neutral stance and possibly cut rates in the near future. The central bank is already struggling with low inflation and Inflationary expectations as indicated by yields in inflation-indexed bonds are low. The 5-Yr yield on inflation-indexed bonds is hovering at 1.6 percent vs 5-year yield of 1.8 percent on normal bonds.
The US has experienced low inflation due to weak wage growth but this may change. Average hourly earnings for April were 3.2 percent higher over last year, 9th straight month of above 3 percent growth. While this may be attributed to a host of factors including a narrow definition of unemployed by the labor department, minimum wage increases in cities and states across the US, a tightening labor market, substitution effect due to offshoring and automation. However, we believe that this impact would be negated by a deflationary impact caused by depreciating Yuan.
The signs of a slowdown in the global economy are clear and the cyclical upswing it experienced for the last two years appears to be ending. However, the data is still not consistent with an impending recession. Stimulus in China should have an impact and the US has room to ease policy. IMF expects the growth rate for the world economy to decline from 3.6 percent in 2018 to 3.3 percent in 2019. We also believe that due to policy stimulus, the global economy should pick up in H2 of 2019 and we wouldn't shy away from investing in risky assets.
The world's two largest economies engaged in a tussle with China dubbing the US actions as "Economic Terrorism" does not augur well for countries like India and the rest of the emerging economies which will certainly feel the heat. On the other hand, if this escalates, some of them in the East in South Asia may benefit from China's shift in the manufacturing base.
[Rajiv Singh is the CEO of Karvy Stock Broking. The views and opinions expressed in this article are those of the author and do not reflect those of International Business Times, India]
