Manufacturing recession?

While a yield curve inversion has raised concerns of an impending recession, we believe it is still too early to call an end to the US or global expansion.

This month, the yield on US 10-year government debt fell below the yield on 2-year government debt for the first time since the financial crises. Since an inversion of the yield curve has preceded every US postwar recession, web searches for the term "recession" have recently spiked. Importantly for investors, an inverted yield curve has not historically proven to be a reliable "sell signal" for stocks. But the inverted US curve does serve as a good reflection of two fears we see currently pervading sentiment. First, fear that that the recent slowdown in economic data, mostly notable in the global manufacturing sector, will broaden and deepen. Second, fear that President Trump is willing to push the US economy into a recession to fulfill his trade objectives.


Will a manufacturing recession manufacture a recession?

Recent data points to a sharp slowdown in the manufacturing sector. Manufacturing is a relatively small, and naturally cyclical, part of the global economy. Overall, we do not think that a manufacturing slowdown will be enough to trigger a wider global recession. But a key question is whether this weakness will broaden into consumption, triggering a full US or global recession.

US

Manufacturing slowdown

We believe the US ISM Manufacturing Index will fall below 50 in the months ahead as new US-China tariffs take effect.

The good news

The US consumer economy is still in good health. US GDP expanded at an annualized 2.1% in the second quarter, with vibrant consumer spending helping to compensate for declining business investment. Monetary policy remains supportive following the Federal Reserve’s recent rate cut.

China

Manufacturing slowdown

Chinese industrial output rose by just 4.8% year on year in July, the slowest growth rate in 17 years.

Central bank support

Recently announced stimulus measures from the People’s Bank of China should help stabilize growth. The central bank announced it would replace its benchmark lending rate with a market-driven interest rate system – a move likely to lead to lower borrowing costs for businesses.

Europe

Manufacturing slowdown

The latest German manufacturing PMI reading came in at 43.6, signaling contraction.

Central bank support

Europe has less scope for interest rate cuts, but the ECB still opened the door recently for additional easing and has some leeway for potential fiscal stimulus to help boost consumer confidence.


Tariffs: Truce or dare?

Clearly, a major driver of how both consumer confidence and global manufacturing will evolve from here depends on the trade dispute between the US and China. There is little evidence that President Trump values predictability as part of his tariff policy, so he may alter his behavior at any time. But we have observed certain patterns around previous trade developments:

  • Observation 1: Previously announced tariffs have always eventually been implemented

Therefore we believe it is likely that the 10% tariffs will ultimately be imposed on the USD 300bn of Chinese imports not currently subject to tariffs.

  • Observation 2: Tariffs have only been fully implemented with the S&P 500 trading at a higher level than when pledged

While we don’t think the President bases his trade policy on the US stock market alone, these facts do display a certain sensitivity to the impact of tariffs on the US economy, business sentiment, and financial conditions. This pattern suggests that a further delay is possible.


Asset allocation

We still think it is too early to call an end to the expansion, but the risks of a recession have increased. While we wait for greater clarity, we have opted to reduce risk this month, moving back to a neutral stance on equities by closing our overweights to emerging market and Japanese stocks.

See our preferences page for more information on our asset class recommendations.


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