The global economy appears finely balanced.
While economic data has softened and the bond market is hinting recession, a shift in interest rate policy may yet act to prolong the expansion.
Is a recession imminent? Or can the business cycle continue?
The indicator that has investors particularly worried is the yield curve.
The US yield curve did temporarily invert in the summer meaning short-term rates are higher than long-term rates.
Historically, this has been a sign of recession, though with a lag of up to 18 months.
To our mind, an inverted yield curve is not necessarily a sign of imminent recession – it depends on why it is happening.
If long-term rates are lower than short-term rates then this is normally because investors are expecting that short term rates will need to drop over the longer term.
Often short-term rates will have spiked because central banks have been forced to push up rates in response to an inflationary threat – and central banks have a poor track record on raising rates without causing a recession.
This time, long-term rates are depressed because lower interest rates have prompted unprecedented demand for longer-dated bonds.
Pension funds, central banks, insurance groups are all buying longer-dated paper.
Progressively, this higher demand has pushed up prices and pushed down yields.
In the meantime, short-term rates were rising as part of a policy normalisation, rather than responding to an inflationary threat.
As this reverses, quantitative easing resumes in much of the developed world and the US is taking an accommodative stance to interest rate policy; so we are already seeing the yield curve revert to a more normal pattern.
In this way, we believe that perhaps this time, it may not be deterministic.
Nevertheless, there are some worrying signs among the economic data.
Trade war
The trade war has had its casualties far beyond China and the US.
Germany is perhaps the most notable.
The September reading for German manufacturing data showed its worst print in more than a decade (rising 30 basis points in October) and there has been real weakness across the Eurozone and in export-focused Japan.
That said, there are other reasons for the weakness in German manufacturing.
It is particularly reliant on the car industry, which is in the grip of a major structural transformation as diesel engines’ halos have slipped, the combustion engine is losing its pre-eminence and electric cars gain modest popularity.
German unit labour costs have also increased significantly, which has weakened the country’s manufacturing competitiveness.
Elsewhere, data is coming under pressure, but perhaps not as savagely.
In the US, consumer data is still relatively buoyant. October retail sales data in the US reversed the 0.3 per cent drop in September, gaining 0.3 per cent.
