The trade war led to an impressive reversal in the scenarios of development of global economy, periodically released by large banks. In its latest release, JP Morgan warns clients about possible two rate cuts by the Fed in 2019 while Barclays sees the need for three rate cuts on an emergency basis. Goldman Sachs looks a little more optimistic for now abandoning the case for one rate hike in 2020.
And although none of the banks have yet made recession the baseline scenario, the yield curve component in the updated JP Morgan recession model indicates a 60% recession chance over the next three quarters. This is the most vocal warning of economic downturn by the bank since the financial crisis of 2007:
It should be noted that, based on the returns of S&P 500 and credit risk at the end of 2018, the model predicted a recession during the year with a chance of 80%. Then this chance quickly rolled back to 20%. So, it makes sense to take these figures with a grain of salt.
However, recession is often considered as an aftermath of the Fed’s policy, since each episode of tightening access to credit was accompanied by a sudden loss of equilibrium in the economy. This statement can even be clarified by a rather unobvious feature: the last three recessions (negative GDP for two quarters in a row) began three months after the first rate cut, which in turn followed the policy tightening cycle.
Considering that the Fed has a large amount of data which allow them to forecast recessions better and earlier, it is not surprising to make a connection, that such a reduction in the rate is already a response to the coming recession.
The most likely scenario now, judging by the futures on the federal funds rate, is two cuts at the end of January 2020:
JP Morgan believes that if Trump decides to introduce tariffs for the remaining $ 300 billion in Chinese exports to the US, we can expect a premature transition from the growth phase to the decline phase in the global economic cycle, and the US economy will be in recession within three quarters.
The reasons why the US stock market does not fully reflect these risks, according to JP Morgan, is a lack of understanding of the consequences of the trade war (in particular, on capital investments of companies and profitability of transnational companies), as well as a relatively smooth increase of the overall jolt. “Managed decline” on the negative news curbs the development of panic, and the absence of euphoria in the mood against the background of the constant presence of a negative factor (trade war) suggests that the irrationality of buyers did not reach the beyond limit.
Thus, without a collapse in the stock market, it makes no sense to expect the Fed to move from a neutral point. Powell’s example in December showed that it was the market panic that was the catalyst for a shift in the regulator’s policy. A worthy contender for the role of shock, which could cause a collapse in the market, are new tariffs, however Trump will probably switch to strengthening positions before the presidential election in 2020 and in this context, the introduction of new tariffs is unlikely.