Concerns about U.S economic recession

The US economy shrunk an annualised 0.9% in Q2

>> Why is US economy slowing down?

The US dollar has opened this week with the same sort of vulnerability that we’ve seen recently, particularly against the yen. Headlines of “recession” in the US, after that second consecutive fall in GDP in Q2, when paired with a not-so-hawkish FOMC meeting last week has caused investors to put two and two together to produce expectations of a more lenient Fed policy and a weaker dollar.

However, Mr. Steve Barrow, Head of Standard Bank G10 Strategy think they’ve put two and two together and got five. At the same time, a stellar Q2 GDP figure from the euro zone last week may have raised hopes that the U.S economy can avoid a recession but the market’s sums are incorrect.

It is ironic that the- far more vulnerable- euro zone economy produced a robust and better-than-expected 0.7% rise in Q2 GDP last week while the US economy shrunk an annualised 0.9%, which was far worse than anticipated. The data are a misleading indication of the risks that are both evident now and those that exist in the future. This is because Europe has suffered a much more adverse energy price shock than the US from the conflict in Ukraine and, in the end, the discrepancies between growth performances usually come from the asymmetries in such shocks.

When shocks are more symmetric, like COVID-19, the scope for economic divergence is usually far more limit  ed. But in the case of the Russia/Ukraine shock, the implications not only differ significantly, but threaten to push much of Europe into recession, while the US could emerge unscathed. Importantly, Mr. Steve Barrow does not believe that the news of an “economic recession” in the US will alter the course that Fed policy is likely to take in coming months, and nor will the more robust euro zone data impact ECB policy materially.

This being said, there may be some caveats here. For a start, while a two-quarter economic downturn in the US does not qualify automatically as a recession, history suggests that such downturns do usually get labelled as a recession in the long run by the official adjudicator on this issue – the National Bureau of Economic Research’s business cycle dating committee.

>> Will a recession hit the U.S economy?

In Mr. Steve Barrow’s view, there are arguments why this might not happen this time. For instance, and as we’ve mentioned before, another measure of growth, which is Gross Disposable Income (GDI) was positive in Q1 and could well have stayed above zero in Q2 (the data are not released for another month). Another factor is that the unemployment rate is very low and not climbing; which is something else that suggests the US might not be in a recession right now. But while such arguments may hint that the US could escape being officially labelled as having fallen into a recession at this time, the country is most likely to slip into recession in the future even if the current two-quarter downturn does not get labelled as an official recession at some point.

Should the US slide into a ‘proper’ recession this year, there’s bound to be more speculation that it will constrain the Fed’s room to hike rates. “We’ve already said that we don’t think it will impinge on Fed policy but it is the opinion of traders and investors that count and there are already signs that such speculation could draw out the dollar bears. But the problem we have with this scenario is that, while hopes of less aggressive Fed rate hikes could bear down on the dollar, the euro zone is likely to be going through a really uncomfortable recessionary phase later in the year and this could serve to prompt euro weakness to “counterbalance” any vulnerability we see in the dollar. All told, we continue to think that the euro’s downtrend against the dollar is not over yet. We even still see a risk that policymakers will have to step in at some point in the future to try to turn the dollar down because the market will not do it on its own”, said Mr. Steve Barrow.