The Financial Express

Wall Street flashes recession warning as trade war backfires on US economy

| Updated: August 29, 2019 14:58:04

Evaly and Fianancial Express Evaly and Fianancial Express
Wall Street flashes recession warning as trade war backfires on US economy

The Wall Street has sent warning signs of a possible economic recession ahead as the trade war continues to take a toll on American businesses, farmers and the overall economy.

The slowing economy could tip into recession by the end of 2020 if trade tensions escalates further in the coming months, economists said.


The bond market signaled the strongest recession warning yet last Wednesday, when the yield on 10-year US Treasury securities tumbled below the 2-year Treasury yield for the first time since June 2007, as rattled investors rushed to long-term safe haven assets.

Typically, investors demand higher yields to buy longer-term bonds to compensate them for the opportunity cost of tying up their money for a longer period of time.

When yields on short-term bonds are higher than on long-term bonds, the pricing anomaly known as a "yield curve inversion" is widely viewed as a reliable indicator for a looming recession.

The 1-year, 2-year, and 10-year Treasury yields have been below the three-month yield for months. But the inversion between the two-year and 10-year yields indicated greater fear among bond market investors about gloomy economic prospects.

"In fact, the last five recessions have been preceded by a 2-10 inversion," Nick Raich, CEO of The Earnings Scout, wrote in a research note, referring to the inversion on the 2-year and 10-year Treasury securities.

"The inverted Treasury yield curve, taken by itself, gives a probability of recession of about 40 per cent by the end of 2020," Gary Hufbauer, a former US Treasury official and senior fellow at the Peterson Institute for International Economics, told Xinhua.

The alarming signal in the bond market helped drive the Dow Jones Industrial Average down some 800 points, or 3.0 per cent on last Wednesday, as investors suffered their worst day of the year. The S&P 500 and Nasdaq Composite also saw similar declines.

Analysts have warned for months that the US economy is poised for a sharp slowdown with tougher headwinds on the horizon, such as the waning effect of the tax cuts, the rise of policy uncertainties, disruption of global supply chains, slower productivity growth, and a ballooning public debt.

But the recession warnings across the Wall Street began to intensify recently until the administration announced that it would impose additional 10 per cent tariffs on 300 billion US dollars of Chinese imports.

"This recent Wall Street roller coaster isn't an aberration, but a predictable response to what many investors fear could be a protracted and costly trade war with a valued economic partner," Hufbauer said.

Economists at major Wall Street financial institutions have warned that trade dispute is going to have a larger impact on US economic growth than originally estimated and the risk of recession is rising.

"Fears that the trade war will trigger a recession are growing," Goldman Sachs chief economist Jan Hatzius said in a note. "The business sentiment effect of increased pessimism about the outlook from trade war news may lead firms to invest, hire, or produce less."

Morgan Stanley estimated that a global recession will come in about nine months if the trade war further escalates through the US raising tariffs to 25 per cent on all imports from China for 4-6 months.


While the administration of US President Donald Trump has repeatedly blamed the Federal Reserve for the slowdown of US economic growth, economists have argued that the administration's trade war and tariffs against major trading partners are holding back growth.

"Tariffs on China have caused clear harm to the US economy in the short run," said Jason Furman, a professor of practice at the Harvard Kennedy School and former chairman of the White House Council of Economic Advisers.

"In the second quarter of this year they contributed to the decline in business fixed investment, and they're likely subtracting about half a percentage point from growth in gross domestic product this year," Furman said.

US economic growth slowed to 2.1 per cent in the second quarter of this year, marking a sharp slowdown from the 3.1-per cent expansion in the previous quarter, according to the US Commerce Department. Economists are expecting the economy to slow further in the second half of the year.

Partly due to escalating trade tensions, US manufacturing output has declined for two consecutive quarters, meeting the technical definition of a "recession" for the sector.

The purchasing managers' index (PMI), which gauges the performance of the manufacturing sector, fell to 51.2 per cent in July, the fourth straight monthly decline and lowest reading since August 2016, according to the Institute for Supply Management (ISM).

Meanwhile, growth of manufacturing jobs in the United States has slowed significantly so far this year, adding an average of 8,000 jobs per month compared with 22,000 jobs per month in 2018, data from the US Department of labour showed.

The recent increases in US tariffs against imports are also seen to be pushing up prices and reducing profits for American manufacturing and service firms, according to a report recently published by the Federal Reserve Bank of New York.

In assessing the overall effect of trade policies on their bottom lines, 51 per cent of manufacturers perceive a negative effect in 2019 and 47 per cent anticipate a negative effect in 2020, the report showed.

Manufactures aren't the only casualty of the administration's flawed trade policy. US farmers have also become increasingly worried about losing the Chinese market as the trade disputes have stretched over a year.

Farm and ranch families have dealt with plunging commodity prices, awful weather and higher tariffs in the last 18 months, said Zippy Duvall, president of American Farm Bureau Federation, in an earlier statement.

According to Duvall, exports to China were down by 1.3 billion dollars during the first half of the year.

"Now, we stand to lose all of what was a 9.1-billion-dollar market in 2018, which was down sharply from the 19.5 billion dollars US farmers exported to China in 2017," Duvall added.

According to estimates made in February by research firm Trade Partnership Worldwide LLC, tariffs are expected to cost the US agricultural sector 59,000 to 71,000 jobs over the next two years.

"The administration is imposing an additional 10 per cent tax on US businesses and US consumers. This is a tax that will hurt every American," said Rick Helfenbein, president and CEO of the American Apparel & Footwear Association. "The tax increase will hit Americans this holiday. It is time we realised this."

Helfenbein's words are echoed by Donald Boudreaux, a professor of economics and senior fellow with George Mason University's Mercatus centre.

"We now don't get to enjoy the lower priced, higher quality goods and that we once bought from China. I have to pay a penalty imposed by our own government for purchasing those goods," Boudreaux told Xinhua.

Boudreaux said that when business investment shrinks, the productivity growth will be undermined, which ultimately leads to lower wages and decreasing living standards.

"These are all the inevitable consequences of these tariffs and the trade war that they unleash," he said.


A majority of business economists are growing sceptical that the US economy could withstand a protracted trade war without serious harm, as the economy could tip into recession in the next two years.

About 38 per cent of economists predict that the next recession will begin in 2020, while other 34 per cent believe it will occur in 2021, according to a survey released by the National Association for Business Economics on Monday.

The survey, however, was conducted from July 14 to Aug. 1, before the administration announced the latest round of tariffs against China and before the financial markets signaled the possibility of a US recession.

"We have not had a trade war of the current magnitude in living memory, so we don't have a statistical estimate of what the trade war does to the probability of recession," Hufbauer said, while predicting that the probability of a recession could increase to over 50 per cent by the end of 2020 if the trade war escalates further.

Economists are also concerned that the US government has limited room to stimulate the economy, such as cutting interest rates and increasing government spending, if the recession does occur.

The Fed recently lowered interest rates for the first time since the 2008 global financial crisis, amid rising concerns over trade tensions, a slowing global economy and muted inflation pressures. But the Fed's benchmark federal funds rate is just over 2.0 per cent now, compared with 5.25 per cent heading into the last recession in 2007.As the federal budget deficit is expected to reach 1.0 trillion dollars in the current fiscal year and the national debt exceeded a record 22 trillion dollars, a divided Congress is unlikely to approve more stimulus measures to prop up the economy, analysts said.

"Instead of picking temporary winners and losers and holding the US economy hostage, it is time to reach an agreement that finally puts an end to the trade war," Tariffs Hurt the Heartland, the national campaign supported by over 150 of America's largest trade organisations, said recently in a statement.


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