As the U.S.-China trade war erodes confidence and central banks prepare to unleash another wave of stimulus, investors are checking which advance warning indicators might be forecasting a global economic recession.
A decade after the 2008 financial crisis, one of the most accurate predictors of U.S recessions — inversion of the government bond yield curve — has kicked in.
But forecasting global recessions is trickier. Most countries simply can’t match U.S. data for breadth. Global recessions are also infrequent — before 2009, one would have to go back to 1990-1991 to find a period when the world economy actually shrank.
However, taking into account population growth and poor countries’ need for faster expansion rates, the broad rule of thumb is that world growth below two per cent can be classed as recession.
A recession is not expected by the International Monetary Fund, which predicts 2020 world growth at 3.6 per cent. Yet IMF chief economist Gita Gopinath highlights “many downside risks,” especially trade tensions.
“We are a world away from the four per cent (growth) we were seeing back in 2017 when U.S., Europe and China were all growing strongly at the same time,” said Andrew Milligan, head of global strategy at Aberdeen Standard Investments.
“We are seeing several of those pistons within the global engine beginning to stutter.”
Here are some frequently used recession indicators.
U.S. leads the world
If world’s biggest economy tips into recession, it’s very likely others will follow. So with its three-month borrowing costs firmly above 10-year rates, markets are spooked — this curve inversion has predicted almost every recession in the past 50 years.
China falls
Chinese Premier Li Keqiang reportedly favours three indicators to monitor growth — freight volumes, power consumption and bank loans — unified in Fathom Consulting’s China Momentum Index.
The index started sliding in 2007, its decline accelerating in 2008 ahead of the global crisis that brought on the 2009 global recession.
It hit record lows below two in 2015-16 amid Chinese “hard landing” fears and is now around five, versus almost seven in 2018. The benchmark only goes back to 2002 so doesn’t capture the 1990-1991 global downturn.
Tradeoff
If growth hinges on booming trade, alarm bells are sounding. Shipping benchmark, the Baltic Dry Index (BDI), hit three-year lows in February. Having dipped during every previous recession, it remains 40% off year-ago levels. The BDI plunged almost 60% between May and September 2008 ahead of the Lehman crisis and rebounded briefly in 2010. It is currently around 1,194 points versus the 818 touched in 2008. The record low was around 315 points in 2016, when global growth slowed sharply.
Also the World Trade Monitor compiled by the Dutch CPB agency shows trade volumes shrank last December on a year-over-year basis for the first time since January 2016.
What do purchasing managers think?
Purchasing Managers’ Indexes (PMI) have been reliable in predicting manufacturing and services trends. A global composite index from JPMorgan is currently at the weakest since the 2016 growth scare, holding barely above 50 — the mark denoting economic expansion — while a new-orders PMI has fallen under 50 for the first time since 2012.
“If the global composite PMI falls from, say, 53 to, say, 48, that on its own is a good enough signal (for recession),” Milligan said.
Inflation and bonds
Bond yields and inflation usually rise when growth is strong and vice-versa. But market-based inflation gauges — five-year forward swaps — have tumbled sharply this year. And the 7- to 10-year yields on the Bloomberg/Barclays Multiverse, a global debt benchmark, are at the lowest since 2016.
Gold vs. copper
Copper’s record as a boom-bust indicator has earned it the Dr. Copper moniker. And because gold is considered a store of value during recession, the gold/copper ratio can point where growth is heading. Very simply, if you think the economy’s tanking, you dump copper and buy gold. Consequently, gold has risen against copper during every previous growth scare episode.
“You could argue that at current levels copper is pricing, maybe not a recession, but certainly a slowdown,” said Carsten Menke, a commodities strategist at Julius Baer.
Demand for defensives
Equity markets include shares that do well when the economy is robust and others that perform in tough times. The former category comprises cyclicals — carmakers and retailers, for instance — while downturns are often preceded by demand for defensives, which include utilities and consumer staples.
Tightening belts
Financial conditions indices (FCI), comprising such elements as long-term borrowing costs, exchange rates and equity moves, show how supportive the backdrop is for growth. Tighter conditions are generally a negative.
A Goldman Sachs index shows conditions tighter than year-ago levels, but down from October when an equity selloff sent the FCI to the tightest since 2016.
Goldman noted recently its U.S. FCI had risen 30 bps since the end of April as the trade war re-ignited, enough to shave 25bp off growth in the next year if sustained.
Inventory
Demand for goods or machinery can be gauged by checking the inventory-to-sales ratio. A high ratio indicates sales are down, leaving too much stock in warehouses. The U.S. inventory-to-sales ratio and Japanese inventory ratios for electronic goods touched three-year highs earlier this year.
