Is a recession looming?

WHILE Malaysians are revelling with the economy reopening, many are seemingly unaware of recession clouds gathering over the rest of the world.

There is a clear sign of risk aversion in the market – demand for the dollar has been rapidly rising with the dollar index surpassing the 100-point mark, leading to the depreciation of other currencies including the ringgit.

The sudden slump in the value of the ringgit was also spurred by a sudden collapse of the yen, which triggered competitive devaluation in east Asia against the dollar.

The Japanese economy, trying to take off after the pandemic, seems to have “run out of runway.”

After many years of pumping money into the economy under quantitative easing, the Japanese economy does not seem to have achieved the economic rejuvenation that the stimulus was intended for.

Meanwhile, Malaysians appear to be blissfully unaware of the looming “train wreck” of recession approaching; the almost complete reopening of the economy and sense of return to normality had papered over any sign of the impending gloom settling over the rest of the world, according to former Inter-pacific Securities head of research Pong Teng Siew.

Against the fears of recession, many view that it is premature to expect one soon, and that Malaysia, which is seeing demand for semiconductors and commodities, may have some growth momentum in the short term.

In the United States, the recession risks may be low, but fears are growing as the Federal Reserve (Fed) is determined to do what it takes to control inflation, currently at a 40-year high.

This includes raising interest rates until it hurts the economy, weakens demand and potentially puts workers out of jobs.

Following an initial 25 basis points (bps) hike, which had no effect on curbing inflation, the Fed pushed up the federal funds rate (FFR) by 50 bps.

The last time the Fed, under the late 12th chairman Paul Volcker, raised rates drastically and triggered a recession, was in the 80s when inflation hit 14.5%. US inflation in March stood at 8.5%.

A recession in the US will likely lead to negative and risk-off sentiment, causing foreign portfolio capital outflows, which will in turn, cause stockmarket weakness, net foreign selling in the bond market and currency pressures against the dollar.

Financial as well as foreign exchange markets will be closely monitored, said Maybank Investment Bank Bhd chief economist Suhaimi Illias.

That the Fed looks set on considerably ratcheting up interest rates may weigh on business sentiment and the housing market, while signs of US yield curve inversion have also set the market thinking of recession.

With the inverted yield curve, where short-term US Treasuries are paying higher interest rates than those in the long term, bond

markets are flashing a warning sign about the long-term growth prospects of the US economy.

Yield curve inversion has often been an accurate predictor of

recession. The impact will be significant – the US is the world’s largest economy and an important market for exports from Malaysia and emerging economies.

Over the past two decades, Malaysia’s gross domestic product growth has had a high correlation of 79% against that of the United States, said OCBC Bank (M) Bhd economist Wellian Wiranto.

The US economy has been accelerating significantly and its interest rate of 0.25%, prior to the first hike recently of 25 bps in March, was too low and has to be higher to reflect prevailing economic growth and inflation.

The risk of over-heating is real and dangerous; between 2003 and 2004, the FFR was kept at 1%, the lowest in 40 years, and by 2007 to 2008, sub-prime mortgage lending had collapsed.

Investors were pouring money into such lending and its derivatives like collaterised debt obligations to search for higher yields.

So this time, the Fed will have to strike a delicate balance between supporting the economy and avoiding the risks of overheating, said Bank Islam Malaysia Bhd chief economist Mohamed Afzanizam Mohamed Rashid.

Some view that the hawkish stance taken by the Fed is intended to soften demand, and it is premature to say that its tightening monetary stance will lead to a US recession.

“But if a US recession were to develop, Asia will not be spared despite China’s easing stance, a policy undertaken to cushion its slowdown,” said Fortress Asia Asset Management Sdn Bhd CEO Thomas Yong.

US inflation may ease in the coming months with the release of its strategic oil reserves and potential sourcing of oil from Venezuela.

There is medium risk of a recession in the United States where employment is still strong, and the Fed has plenty of room to back off from its aggressive rate hikes, said Etiqa Insurance & Takaful Bhd chief strategy officer Chris Eng.

To be cautious, it will be good to get prepared in case something does go wrong and we land in a recession; it may be time to, among other things, land that new job and set aside some cash.

“If a US recession were to develop, Asia will not be spared despite China’s easing stance.” Thomas Yong