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 US 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.
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 US.
Our most updated data indicate that the US credit impulse was running at only 0.4% 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% 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%, which seems to indicate that there is more to consider than tax alone when running a business.
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% 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.
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% (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.
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?
US consumer confidence has returned to a high level but households’ financial situation remains gloomy. Household debt is at a new record of $13tn and the most fragile households are starting to face serious difficulties due to higher interest rates and tightening credit conditions. Delinquencies have increased considerably over the past few months, especially in subprime auto loans where serious delinquencies have reached ‘Lehman moment’ proportions, as well as in credit cards.
The delinquency rate on credit card loans among small banks has sharply risen in less than two years to return to its GFC peak at 5.55% in Q4 ’17. Although the share of small banks in the outstanding credit card total has considerably decreased since 2008, the evolution of this indicator is a bad sign that tells us a lot about the financial situation of the most fragile US households.
The US is a low-savings economy. In the wake of the financial crisis, however, the personal savings rate has temporarily recovered to reach a peak since 1984 at 11% before collapsing as fast as it rose to 3.4%.
This decrease can be explained by structural factors – the US consumer saves little – but also by cyclical factors, as low interest rates offer little incentive to save, especially in low-risk assets. As we know, saving is all about preparing for the unexpected and, based on the evolution of US leading indicators, everything suggests that the worst is ahead for the US economy.
However, the situation is not as dark as we might think. US households are not as ill-prepared as in 2007/08. Household debt and financial obligations as a share of disposable personal income remain well below their pre-crisis levels, at 10.2% and 15.8% respectively in Q4’17, which suggests that the effects of the next recession could be less severe than in 2008 for households. The main uncertainty concerns the evolution of interest rates: if they continue to increase, so will debt payments.
* Christopher Dembik is head of macro analysis at Saxo Bank.
Christopher Dembik
