21 June 2018
South Korea's exports fell for the 17th straight month in May as companies are reluctant to spend on machineries. Photo: Bloomberg
South Korea's exports fell for the 17th straight month in May as companies are reluctant to spend on machineries. Photo: Bloomberg

Indicators show rising risk of global recession

The situation in the United States today is almost the same as what happened before the Great Depression, according to a report from Morgan Stanley last week.

Late last year, I wrote that the risk of a global recession is one of the 10 things that could happen in 2016.

I’ve always believed that the US Federal Reserve has very limited room to hike interest rates, and any sharp increase could be a policy mistake.

If so, the US economy could reach an inflection point.

Capital expenditure of non-financial firms in the US fell again in the first quarter of this year, suggesting that corporates have little interest in making investments.

Corporate capex usually falls back when the US is heading for a recession.

Currently, the US is the best-performing economy in the developed world. Global economic growth is unlikely to stay intact if the US falls into a recession.

Let’s review the magnitude of the risk that global economy might slow down or head towards another recession.

Over the last two years, the yield spreads between short and long-dated sovereign wealth bonds of major economies have either fallen off the peak or stayed near the bottom.

The yield curve is flattening or even showing an inverted pattern. An economic slowdown or recession usually occurs when we see such a situation.

During the last five recessions in the US – 1979, 1981, 1990, 2000 and 2008 – we’ve seen falling credit spreads or even negative spreads.

The slope of the yield curve is a reliable predictor of recession, according to an earlier report from the Federal Reserve Bank of New York.

It outlined a model using the difference between 10-year and three-month Treasury rates to calculate the probability of a recession in the US 12 months ahead.

The good news is that the credit spread in the US remains very far from zero, which means it’s unlikely to see a recession this year.

However, many other economies may fall into a recession based on this model.

South Korea is a major exporter of heavy industries, and therefore its exports would partially reflect the strength of the global economy.

In fact, the year-on-year change of South Korea’s exports does move in tandem with global economic growth. The two has a correlation coefficient of 0.7.

As of May this year, South Korea’s exports fell 6 percent year on year, marking a negative growth for 17 straight months, the second longest in history.

Companies from various countries are reluctant to spend on machinery amid gloomy world economic growth outlook.

Caterpillar, the world’s largest construction and mining equipment producer, tells a lot about global economic growth in its sales figures.

By the end of May, its sales in the US and Asia dropped 12 percent and 13 percent respectively from the month before, accelerating from a decline of 11 percent and 10 percent in April.

The company’s overall sales also retreated by 12 percent in May from the month before, marking a decline for 42 straight months.

That’s the longest in the company’s history, even worse than the 19-month decline during the 2007-08 financial crisis.

Copper price is another good indicator for gauging the world economy. It has recorded year-on-year declines in 16 quarters out of the last 19 quarters, and posted double-digit drops in 13 quarters.

Some big investors or hedge funds continue to build up short positions in copper futures, in a sign that investors are bearish on the world economy.

All these indicators show a rising risk of global recession.

Will central banks just sit and wait for that to happen?

I believe they might join hands to relax fiscal policy or even launch a new round of monetary easing measures if economic growth further deteriorates.

If they do that, asset prices are set to take off.

This article appeared in the Hong Kong Economic Journal on June 23.

Translation by Julie Zhu

[Chinese version 中文版]

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Hong Kong Economic Journal chief economist and strategist

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