New Kind of Recession Threat Presents Problem for Powell and Fed

(Bloomberg) --

This won’t be your father’s recession -- if indeed the U.S. ends up tumbling into one.

Traditionally, U.S. downturns are home-grown and household-led, triggered by spikes in interest rates and fueled by the unwinding of financial and economic excesses. None of that is arguably at work this time, at least for now.

Instead, what’s making investors nervous about a recession is a global, geopolitical shock to business sentiment that’s prompting U.S. companies to curb spending amid uncertainties from the U.S.-China trade war to Britain’s potential pullout from the European Union.

“The global economy continues to soften and we are taking steps to cut capacity,’’ FedEx Corp. Chief Executive Officer Fred Smith said in a Sept. 17 conference call. The slowdown is being “driven by increasing trade tensions and policy uncertainty.’’

That poses problems for Federal Reserve Chairman Jerome Powell and his fellow policy makers as they decide whether to cut interest rates later this month for the third time this year.

The unusual nature of the forces at play -- and the fact that many of them are geopolitical and emanate from abroad -- makes it more difficult for policy makers to decide how far to go in easing credit.

There’s even a question of how effective rate cuts will be in an economy where business executives fear such dire developments as the breakup of global supply chains.

Powell is expected to deliver his latest thinking on the outlook when he speaks to the National Association for Business Economics in Denver at 2:30 p.m. U.S. East Coast time on Tuesday. He said last week that despite some risks, the U.S. economy is in a “good place,’’ and that the Fed’s job is “to keep it there.’’

Break or Bounce?

If business pessimism turns out to be overdone, there’s even a chance the economy could snap back as companies rev up outlays and monetary stimulus kicks in with greater force.

“The scenarios are quite extreme,’’ JPMorgan Chase & Co. chief economist Bruce Kasman said. “Either we bend and then break or we bend and then bounce.’’

A study by IHS Markit’s Macroeconomic Advisers calculated that gross domestic product could be boosted by roughly 0.5% if uncertainty over trade policy ultimately dissipates.

Negotiators from the U.S. and China are scheduled to meet on Thursday for the first high-level talks since July, though hopes of a breakthrough are not high.

What Bloomberg’s Economists Say

Bloomberg’s model puts the chance of a downturn in the next 12 months at about 25%. “That is a warning sign, but not yet a panic signal. The chances of a recession are higher than they were at the start of the year. They are lower than they were over the summer, and before previous downturns.”
-- Eliza Winger, Yelena Shulyatyeva and Andrew Husby
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Moody’s Analytics Inc. chief economist Mark Zandi said a recession is all but inevitable if President Donald Trump follows through on his threat to impose tariffs on virtually all U.S. imports from China by the end of this year.

Such a move would probably rock financial markets and hurt the economy, said Matthew Luzzetti, chief U.S. economist for Deutsche Bank Securities. In the event that happened, he said the odds of a downturn would rise to 50-50.

Some other analysts are not as pessimistic. Former International Monetary Fund chief economist Maury Obstfeld said a ratcheting up of tariffs on China would likely lead to slower growth, but not a recession.

“I just don’t see what would set off a broad contraction in activity,’’ said Obstfeld, who is now a senior fellow at the Peterson Institute for International Economics.

That’s because many of the traditional drivers of downturns seem to missing in action:

• Inflation isn’t high and rising. If anything, it’s too low, at least as far as the Fed is concerned.
• The central bank isn’t raising interest rates. It’s lowering them.
• Stock prices are elevated, but arguably not in bubble territory given the low level of rates.
• And households are not over-leveraged and generally are in good financial shape.

“The consumer right now in the U.S., at least in terms of our business, is doing really well,” Hugh Johnston, chief financial officer for PepsiCo Inc. said in a recent interview.

“You have a lot of trouble identifying what the trigger would be for a recession in the U.S., especially a deep one,’’ said Andrew Hollenhorst, chief U.S. economist for Citigroup Inc. “That makes us feel a little less concerned.’’

He put the chances of a recession over the next 12 months at about 30%.

Veteran forecaster Allen Sinai said the current situation reminds him of the lead-up to the 1990-91 recession. Companies back then responded to a profit squeeze from rising wages by cutting back spending and hiring.

This time it is slowing sales abroad that could prompt U.S. companies to pull back, said Sinai, president of Decision Economics Inc.

He said the lesson from the earlier period is that the Fed needs to respond aggressively and preemptively to the danger of a recession.

The trouble is that the outlook is far from clear.

Some risks, like Brexit, have yet to materialize. Others, like the U.S.-China tit-for-tat tariffs, have soured business sentiment but only recently begun to crimp output.

“We are having a hard time judging how large this geopolitical shock is,’’ said JPMorgan’s Kasman, who reckons that the odds of a recession over the next 12 months are 35% to 40%.

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