Trade war escalation with China nudges US closer to recession

Bengaluru - Nearly 70% of economists polled say latest developments brought next US recession closer

The recent escalation in the US-China trade war has brought forward the next US recession, according to a majority of economists polled by Reuters who now expect the Federal Reserve to cut rates again in September and once more next year.
Despite expectations for further easing, the August 6-8 poll gave a median 45 per cent probability of the US economy slipping into a recession in the next two years, up from 35 per cent in the previous poll and the highest since that question was first asked in May 2018.
A closely-watched bond market gauge of US recession risk flashed its biggest warning since March 2007 on Monday, underscoring concerns the spillover from the battle between the world's two biggest economies over trade will accelerate a global downturn.
Nearly 70 per cent of economists responding to an additional question said the latest developments had brought the next US recession closer.
"Certainly, escalating trade tensions through higher tariffs and restricted access to markets is hurting sentiment, increasing costs, damaging supply chains and weakening corporate profitability," wrote James Knightley, chief international economist at ING.
"This then feeds through into consumer sentiment and spending more broadly in the economy with recession risks mounting," he added.
Last month, economists predicted a follow-up rate cut after July's in the fourth quarter, but no more through next year.
Financial market traders have ramped up bets for more rate cuts, pricing in September, followed by another 25 basis point cut in October, and a more than a 40% chance of another in December.
But it is not clear policymakers are keen to cut rates again, let alone several, especially after Fed chair Jerome Powell downplayed the latest reduction as "a mid-cycle adjustment to policy."
"By cutting rates, the Fed is unintentionally underwriting the trade war," said Aditya Bhave, senior global economist at Bank of America Merrill Lynch.
"We worry about an adverse feedback loop in which the Fed eases and things get better: financial markets, the economy and so on. That encourages more escalation in the trade war - things get worse and then the Fed eases again."
Indeed, Federal Reserve Bank of St Louis president James Bullard said this week that the central bank would not deliver an interest rate cut each time there were policy threats or announcements on the trade war that roiled markets.
Asked if the US economy needs more rate cuts this year nearly three-quarters of respondents said yes. But the rest did not.
"The Fed is under the illusion that this is a mid-cycle adjustment, and that by delivering a few insurance cuts they can defer the recession," said Philip Marey, senior US strategist at Rabobank.
"They don't need to cut at the moment. But in their calculation they think if they do it now then they won't have to later, and I think that will all be in vain."
According to the latest Reuters poll, US economic growth was forecast to slow to an annualised rate of 1.8 per cent by end-2020 from the 2.1 per cent reported for last quarter and well below the 3.1 per cent rate in the first.
That consensus was little changed from last month, even though a higher number of economists now predict a substantial slowdown despite the shift in expectations for Fed easing.
The more difficult prediction is trying to gauge what President Trump will do or say next.
"Trump is playing a game of chicken. He thinks by adding more punitive measures...he will bring down the Chinese economy and force them to act quickly," Rabobank's Marey said.
"He hopes in the end the Chinese will blink and come to the table and give him what he wants."
PPI up; inflation muted
Meanwhile, US producer prices increased moderately in July, lifted by a rebound in the cost of energy products, while underlying producer inflation retreated, which could allow the Federal Reserve to cut interest rates again next month.
The Labor Department said on Friday its producer price index for final demand rose 0.2 per cent last month after nudging up 0.1 per cent in June. In the 12 months through July the PPI increased 1.7 per cent after advancing by the same margin in June. Excluding the volatile food, energy and trade services components, producer prices edged down 0.1 per cent last month.