Leading economists question yield curve link and explain why it remains a "fertile environment" for equities
The overwhelming consensus that the US will slip into recession in 2020 has been opposed by BMO Global Asset Management’s leading economists.
At their recent Global Investment Forum, top figures concluded that the rising role of intangibles – branding, intellectually property, for example – and mild inflationary pressures suggested the US will experience only a modest dip in the next downturn.
While the forum recognized US growth is expected to slow because unemployment can’t keep falling by 1%, the boost from President Donald Trump’s “hefty” tax cuts will fade and the Fed is only half way through its interest-rate increase, the flattening of the yield curve is not such a straightforward indicator of a recession this time around.
The report said: “In the past, a flatter yield curve has compressed bank lending margins. This has led to a downturn in the credit cycle, which has made a recession more likely. This casual link appears to be absent this time around. Lending margins have widened as the yield curve has flattened. Failure to appreciate this may have led many market participants to overstate the chances of a US recession.”
Discounting the cause of the last financial crisis, the US housing market, BMO GAM also believes the ability of the intangibles – think Google and Facebook – to avoid capacity restraints would suggest that rather than an outright contraction, the States will experience only a modest slowdown.
“As it stands, there is no obvious trigger for the next recession,” the forum report said. “But if one should arise, perhaps brought about by an energy shock or an overzealous policy reaction by the Fed, we believe it would be mild and short-lived.”
Looking at its base scenario, the forum suggested that the world economy is in good shape, inflation is in “goldilocks” territory and that there is a “fertile environment” for risk assets.
However, in contrast, while equities are expected to perform reasonably well with corporate earnings continuing to grow, BMO GAM fears that government bonds and corporate credit may be vulnerable as the central banks wind down their stimulus programme.
Despite this upbeat outlook, there are significant clouds on the horizon that need to be watched closely.
The forum report said: “The US Federal Reserve is currently raising interest rates, as are other central banks. We are also witnessing an escalating trade war between the US and China, which is straining relations between the world’s two most powerful nations.
“Elsewhere on the geopolitical stage, we look on with unease as Brexit and a surge of nationalism threaten the established order in Europe.”
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