Evidence is piling up as the US heads for recession

Economic indicators ranging from Saxo Bank’s proprietary credit impulse to the yield curve and credit card delinquencies all point in a single direction — the US is heading for recession. At the end of last year, the consensus eagerly embraced the “synchronised global growth” narrative and no one dared question the strength of the United States economy. Optimism prevailed among the financial community.

As we enter the second quarter of 2018, the hopes of synchronised growth are vanishing quickly as the global economy suffers a loss of momentum (global PMI has plunged to a 16-month low) and warning signs of an imminent slowdown are popping up in the US. Credit impulse is heading south Since mid-2017, our favourite leading indicator, the credit impulse (which represents the flow of new credit from the private sector as a percentage of GDP) has entered the risk zone.

Credit impulse (total and main countries) is heading south, driven by China and the United States that weigh roughly ⅓ of our global index.

Our most updated data indicate that the US credit impulse was running at only 0.4 per cent of GDP in Q4’17 (after entering into contraction in Q3) and that the Chinese credit impulse has been following a sharp downward trend since the end of 2016, running at minus 2.1 per cent of GDP in Q3’17.

Based on up-to-date domestic nonfinancial loans data, such as C&I loans in the US, there is every reason to believe that the sluggish momentum will remain in place in both China and the US on the back of deleveraging and monetary policy normalisation.

In a highly leveraged economy like the US, credit is a key determinant of growth. Lower credit generation is expected to translate into lower demand and lower private investment in the coming quarters. There is a high 0.70 correlation (out of one) between US credit impulse and private fixed investment and a significant 0.60 correlation between credit impulse and final domestic demand.

So far, there has been no sign that Trump’s tax cuts could mitigate the negative effect of a lower credit impulse by lifting companies’ investment spending plans.

In the last NFIB survey, the proportion of respondents planning to increase capital spending even decreased to 26 per cent, which seems to indicate that there is more to consider than tax alone when running a business. The spectre of recession looms The main risk for investors is the increasing mismatch between the optimistic view of the market that considers the risk of recession as being less than 10 per cent and what recession indicators are saying about the economy. These indicators suggest that the US is at the end of the business cycle — which is not much of a surprise — and hint that recession is just around the corner and Trump’s economic policy does not seem able to avert it.

The most watched indicator is the persistent flattening of the yield curve (currently at 46 basis points). A yield curve inversion combined with a negative credit impulse has predicted the last five recessions.

Over the past decades, another reliable indicator has been the contraction in C&I loans and leases which has predicted the last three recessions. Over the course of 2017, C&I loans and leases have sharply decreased to reach the low level of 1.2 per cent (year-on-year) in Q4.

Even unconventional indicators are sending warning signs. Product sales by paper and paperboard mills, which reflect the evolution of sales and therefore give a signal about the future evolution of production, have been falling since the beginning of the year. Although this indicator is certainly less reliable than in the past due to the digitalisation of the economy, there is still an obvious correlation with the economic cycle. Remember the ‘strong consumer’? Many are increasingly aware of these alarming signals but they often try to minimise their impact by pointing to the “strong US consumer” and the fact that consumer confidence is at its highest level since the end of 2000.

Even though we agree that history does not always repeat itself, it is interesting to note that historically, such levels of consumer confidence have been followed by recession and a lost decade. This is too much of a coincidence, is it not?

THE HOPES OF SYNCHRONISED GROWTH ARE VANISHING QUICKLY AS THE GLOBAL ECONOMY SUFFERS A LOSS OF MOMENTUM AND WARNING SIGNS OF AN IMMINENT SLOWDOWN ARE POPPING UP IN THE US