US recession concerns rise

Among the greatest concerns currently is that the march towards recession seems to be gathering pace, with persistent inversions of the US Treasury yield curve.

Yield curve inversion has mostly presaged a recession; some think that this time, it could be just a sharp slowdown which may be averted by the Federal Reserve cutting interest rates.

Nevertheless, these inversions should not be ignored; increasing signs of rate cuts are a leading indicator of falling inflation and a poor economic outlook.

A gauge for US manufacturing, the Institute for Supply Management Index, fell in April to 52.8 from 55.3 in March, still signalling expansion, but was at its weakest level since 2016.

Some think this time it is different; US consumer sentiment and labour market remain strong, investors are not dumping bonds at the short end.

Inversion may be caused by distortion of the rate profile from the unwinding of quantitative easing (the Fed’s bond buying stimulus programme).

Bond yields move inversely with prices; investors fleeing to safe havens or expecting rate cuts snap up 10-year Treasuries, drivingyields lower than the three-months, thus inverting the yield curve.

“The fear is when yield curve inversions become widespread, something exceedingly unpleasant may follow,” said Anthony Dass, head of AmBank Research.

Yield curves in the euro area, Britain and Switzerland have inverted at shorter maturities. Canada’s yield curve inverted the most in 12 years on proposed US tariffs on Mexico.

Japan and South Korea have flat yield curves (showing little difference between short and long term yields) with possibleinversion.

Morgan Stanley’s adjusted US yield curve that accounts for quantitative easing and tightening, has been persistently inverted for the past six months, according to Bloomberg.

The current phenomena of 10-year yields falling bears watching; the recession triggered by Russia’s sovereign bond default, and the collapse of Long Term Capital Management, both in 1998, was preceded by a rapidly falling 10-year yield.

This time, there are several contributing factors such as slow growth, poor yields elsewhere, weakening data, trade tech and geopolitical worries, the rise of protectionism and limitations in fiscal and monetary measures to stimulate growth.

In view of the fragility of global financial markets, any pronounced correction in the US and China, would have negative repercussions on regional economies, said Nor Zahidi Alias, the associate director of economic research at Malaysian Rating Corp.

The trade war is widening in its scope and implications, with possibly catastrophic impact on global supply chains.

“Nowhere else in the world is the manufacturing ecosystem as complete as it is in China.

“By shutting China off from US components (as in the case of the equipment and export ban on Huawei), US President Donald Trump forces a fragmentation of global supply chains and uniformity of manufacturing standards that have nurtured seamlessness in communications and economic integration,’’ said Inter-Pacific Securities head of research Pong Teng Siew.

With the benefits of globalization about to come apart, growth everywhere may be brought to a shuddering halt.

Paltry global growth currently, and the belligerent posturing of opposing camps relating to imposition of tariffs, provide a hint of disaster that may follow.

Locally, there is additional uncertainty with Malaysia being included in the US watch list for currency manipulation.

Under the US Department of Commerce proposal to impose countervailing or anti-subsidy duties on countries deemed to have deliberately undervalued their currencies to benefit or subsidise their exports, there is no criteria yet on how this benefit or subsidy is defined.

Are there differing policies between the US Treasury report of the watch list that includes nine more countries, following the Department of Commerce proposal for countervailing duties on currency manipulators?

A potential risk arises, given the increasing tendency to weaponise trade policies via tariff and non-tariff measures, said Maybank Investment Bank group chief economist Suhaimi Ilias.

Examples of such weaponisation involve the tech angle in the race for 5G, the US ban on Huawei and the possibility of China restricting exports of rare earth minerals used in US high tech industries.

Also, the proposed initial 5%, possibly hitting 25%, of US tariffs on Mexico over illegal immigration.

Malaysia was included in the watch list partly due to the Treasury’s lowering of the threshold for current account (CA) surplus to Gross Domestic Product (GDP) from 3% to 2%.

Malaysia’s CA surplus was 2.1% in 2018, and 4.5% in the first quarter of 2019; however, quarterly CA surplus has been volatile between 0.8% to 4.5%.

Over the year, the ringgit has exhibited a pattern of appreciation and depreciation, a reflection of a flexible exchange rate regime, according to Socio Economic Research Center executive director Lee Heng Guie.

  • Columnist Yap Leng Kuen reckons it is better to err on the side of caution.
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