Global RecessionOctober 23, 2014
Financial markets capitulated [last] week and admitted that the global economy is in recession. This does not mean the US economy is in or near recession – but rather that our continuing expansion is taking place in an environment of general weakness. This is similar to the situation Germany found itself in for the past four years, enjoying continued growth while its trade partners foundered. We believe the impact from recently lower interest rates (but probably not from lower oil prices) will sustain US growth in the 2.5-3 percent range, but it is hard to see any improvement until the rest of the world rebounds – likely starting in the second quarter next year.
The evidence of a global recession is all around us. Equity markets in Europe (the DAX, CAC and FTSE) are all down more than 20 percent in dollar terms. The dollar’s rally was an early warning of the correction to come. Oil prices have collapsed more than 20 percent to trade at $81 for WTI and $83.50 for Brent. The US 10 year note has plunged from 2.60 percent just a month ago (roughly the average for the year to date) to 1.86 percent at its lows before rebounding to 2.19 percent. Meanwhile, risk spreads have exploded in Europe, the epicenter of the recession, with Greek yields up more than 250 basis points recently. St. Louis Federal Reserve President, who was a hawk just weeks ago, has suggested the Fed should delay the end of QE (never mind think about raising rates). Volatility has surged, making any price quote dangerous, but the intensity of market action indicates a sea-change has occurred.
We argue that the proximate cause of the global recession is the credit crunch underway in China – which has been the locomotive for growth around the world since 2000. The impact of China’s tightening was exacerbated by the crisis in Ukraine and sanctions on Russia, which disrupted European trade and their recovery – much in the same way the Japanese tsunami severed global supply lines in early 2011, dampening the budding US recovery. Finally, the reduction in US QE and the discussion of rate hikes next year has generated an expectation of declining global liquidity and reduced risk taking behavior outside of the US. The feedback loop between China, Europe and Japan is stronger than with the US, leaving America relatively isolated from this global weakening.
The question now is how great the pain becomes before China and Europe alter their policies to deal with deepening economic corrections. We disagree with President Bullard, who called for a continuation of QE albeit at its current low level. Any action by the US will only provide cover for inaction in the rest of the world. The US has already suffered through years of overreaching monetary policy that allowed our fiscal authorities to remain in gridlock. In the US, the Fed has an obligation to support growth – in Europe, the ECB does not. Its sole mandate is to maintain stable prices. It is already struggling with that one. Stimulating economic growth is purely a fiscal issue.
The preceding is an abridged version of a commentary for McVean Trading and Investments, LLC and has been reposted here with permission of the author.
The ideas and opinions expressed in this blog are those of the author, and they should not be perceived as investment advice or as any other kind of advice.