New York: In a span of less than 24 hours, developments in Washington and Wall Street have sent a vivid message: The world is ambling toward an economic morass of the sort that no mere presidential tweet can fix.
On Tuesday, President Donald Trump blinked in the trade war with China, retreating from previous plans to apply tariffs to virtually all Chinese imports September 1. The action ensures that American buyers of Chinese-made toys, smartphones and much more won’t face tariff-boosted prices this holiday season.
“Huzzah!” said the stock market. The trade war is de-escalating! Christmas is saved! The S&P 500 rose 1.5 per cent, to a level only about 3 per cent below its record high July 29.
The bond market wasn’t quite so buoyant. While longer-term Treasury yields rose, reflecting more optimism, the increase was slight — and they remained far below their levels of late July.
On Wednesday, the signal sent by the bond market worsened further. The yield on 10-year Treasury bonds plunged to 1.59 per cent by the end of trading. At some points, that rate fell even below the equivalent rate on two-year bonds.
That is called an inverted yield curve, and it is a sign that bond investors foresee weak growth and lower inflation in years ahead, and expect the Federal Reserve will respond by cutting interest rates. An inverted yield curve has often been a harbinger of recession, though not a guarantee of one.
That pessimistic signal from the bond market in turn prompted a sell-off in stocks Wednesday, reversing Tuesday’s gains.
This series of events does not bode well for the world economy. In this August of market turbulence, the shorthand explanation has been that it is a result of the trade war.
That is true as far as it goes, but the shift in the bond market since late July, and especially Wednesday, signals something bigger is going on. The trade war is just one piece of it.
Sure, forestalling the latest China tariffs will help avoid a big hit to the profits of retailers and importers over the next few months — and it helps prevent US consumers from facing sticker shock during their holiday shopping.
But this is about something more consequential than a 10 per cent tariff on iPhones. It’s really about the widening schism between the world’s two largest economies — one that cannot be reversed with a concession on tariffs by the president or with some soybean purchases by the Chinese. This clash is increasingly becoming part of the landscape that every global business must navigate.
The same could be said about the other geopolitical fires that risk flaring up. What will be the future of Hong Kong as China responds to pro-democracy protesters there? Will Britain leave the European Union on October 31 as planned, and on what terms? Can India and Pakistan avoid a devastating armed conflict over Kashmir?
Oh, and the European economy may be heading toward recession; global central banks are largely at the end of the road in terms of what they can do to offset a new slump; and there is political dysfunction in many of the world’s biggest democracies that could limit their ability to respond to a new recession with fiscal policy or other tools.
If you’re a corporate CEO making investment decisions, the environment in which you operate is shifting beneath your feet. Even with a seemingly bottomless supply of cheap capital available and a very low corporate tax rate, it feels awfully risky out there.
And indeed, through the first half of the year, falling business investment was a drag on US economic growth.
The latest developments don’t mean that a recession, or even a severe slowdown, is a certainty. The Federal Reserve, unlike its counterparts in other major economies, still has some room to cut interest rates to try to stimulate activity, and has shown it is willing to use that power. And American consumers have proved quite resilient this year even as business spending has stumbled; perhaps that will remain true.
But events this month signal that the problems facing the world economy are more complex and intractable than the immediate reaction to Trump’s trade war de-escalation might suggest. A tactical retreat here and there won’t solve the deeper problems hanging over the world economy.
Once chaos has been unleashed into the global economic system, it can be hard to reel back in.
How Global financial crisis erupted 11 years ago
The collapse of Lehman Brothers investment bank in September 2008 triggered a crisis that plunged economies around the world into the worst recession since the 1930s
Subprime mortgages (loans to borrowers with little means to repay) are repackaged with traditional mortgages and sold to investors who are left with worthless assets.
■ Feb 27: Mortgage lender Freddie Mac stops buying most risky subprime loans
■ Apr-Aug: Two major US mortgage lenders file for bankruptcy. Bear Stearns bank liquidates investments backed by subprime mortgage loans
US economy enters recession as subprime crisis infects credit markets
■ Jan 11: Bank of America agrees to buy Countrywide Financial – which finances 20% of all U.S. mortgages – for $4bn
■ Mar 16: Federal Reserve guarantees $30 billion of assets in sale of Bear Stearns to JPMorgan Chase
■ Sep 7: Government takes over mortgage giants Fannie Mae and Freddie Mac
■ Sep 15: Bank of America agrees to buy Merrill Lynch for $50bn
■ Sep 15: Lehman Brothers files for bankruptcy – with over $600b in assets it is largest filing in US history
■ Sep 16: AIG, world’s largest insurer, accepts $85bn federal bailout
■ Sep 21: Goldman Sachs and Morgan Stanley, last two independent investment banks, become bank holding companies subject to greater regulation by Federal Reserve
■ Sep 25: Regulators close Washington Mutual Bank in biggest ever U.S. bank failure
■ Sep 29: Congress rejects $700b Wall Street rescue package. Dow Jones industrial average plummets 778 points – worst ever one-day drop at time
■ Oct 3: Revised rescue package signed into law
■ Nov: IMF approves loans to stabilise countries with crumbling economies
■ Nov 23: Treasury and Federal Reserve step in to rescue Citigroup
■ Nov-Dec: As crisis deepens, Ford, Chrysler and General Motors request and receive federal bailouts
■ Dec 2008 – Jan 2009: Global economies start going into recession. Central banks cut rates to try to stem crisis
■ Jun 2009: US emerges from worst recession in post-war history
Global recession mainly affects developed economies in North America and Europe. Emerging economies like China and India suffer less impact and grow substantially in following years
Sources: USA Today, Schroders, The Balance