Trade war boosting chances of recession

HONG KONG/WASHINGTON The escalating trade war between the U.S. and China is nudging the world economy toward its first recession in a decade with investors demanding politicians and central bankers act fast to change course.

The latest setback hit German industrial production, which in June registered its biggest annual decline in almost a decade, highlighting the severity of a manufacturing slump in Europe’s largest economy. In the Asia-Pacific region, central banks in New Zealand, India and Thailand made surprise interest-rate cuts trying to safeguard their economies from global headwinds.

In the U.S., recession risk is “much higher than it needs to be and much higher than it was two months ago,” Lawrence Summers, a former U.S. Treasury secretary and a White House economic adviser during the last downturn, told Bloomberg Television. “You can often play with fire and not have anything untoward happen, but if you do it too much you eventually get burned.”

Summers, a Harvard professor, still sees a less than 50/50 chance that the U.S. enters a recession in the next 12 months. Investors are much more bearish: A closely watched segment of the yield curve, the difference between 10-year and three-month U.S. Treasury debt, inverted the most since 2007, indicating bets on protracted weakness.

U.S. stocks fell in New York, bonds rallied globally, and havens including gold and the yen gained ground. The yield curve for both the U.S. and German economies are flashing warning signs of a downturn.

As U.S.-China trade relations sour, policy interest rates are going down. The Reserve Bank of New Zealand on Wednesday stunned investors by dropping its benchmark rate by 50 basis points, double the expected reduction and sending the kiwi tumbling. Thailand also surprised, cutting by 25 points. India’s central bank lowered its rate by 35 points.

While tight labour markets globally and the recent shift by central banks should provide a cushion, economists are starting to war game for how a recession could happen.

Morgan Stanley economists predict that if the U.S. puts 25 per cent tariffs on all Chinese imports for four to six months and the country hits back, a global economic contraction is likely within three quarters.