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Warning Signs Point to a Global Slowdown

August 15th, 2019 | by Richard Paul
Warning Signs Point to a Global Slowdown
World
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Warning Signs Point to a Global Slowdown

Weakness in Germany and China puts pressure on record U.S. expansion, as recession risks rise


President Trump’s dispute with China over trade is hurting some U.S. factories, including those that use metal. PHOTO: LOREN ELLIOTT/ASSOCIATED PRESS

Warning signs pointing to a deepening global economic slowdown—and the risk of recession—are flashing more brightly.

Many of the biggest troubles are showing up overseas. But stock and bond markets are signaling that the threat of a downturn is spreading to the U.S., the world’s largest economy, now in its longest expansion on record.

Economic output in Germany, the world’s fourth-largest economy, contracted in the second quarter, according to a report Wednesday, while a report on factory output in China, the second-largest economy, came in lower than expected.

“It’s almost like we’re starting to see a textbook version of a pre-recessionary period,” Nicholas Akins, chief executive of Ohio-based American Electric Power Co. , said in an interview Wednesday. The company provides electricity to industrial, commercial and residential customers in 11 states.


What a Global Economic Slowdown Means for the U.S.
Stocks plummeted Wednesday after weak German and Chinese economic data raised concerns of an impeding global slowdown.

The good news is that the U.S. isn’t confronted with severe excesses to unwind, as it was in the mid-2000s with the housing boom or the late 1990s with tech-stock gains. Because of that, some economists said any downturn might be mild.

Many past recessions were traced to high interest rates instituted by the Federal Reserve, as in the early 1980s; to bubbles bursting such as the dot-com bust of 2000 and 2001; to financial instabilities as in 2007, 2008 and 2009; or some combination of the above.

Some experts predict that if a recession comes, this time it will be driven by lower business investment.

Allen Sinai, a forecaster at Decision Economics, said that if corporate earnings slip, that could lead to less investment and then less hiring, creating a self-fulfilling process of contraction. Mr. Sinai has nudged his recession risk estimate up for the first time in years.

Already, both corporate earnings and investment are sliding. U.S. corporate profits before taxes were down 2.2% in the first quarter compared with a year earlier, according to the Commerce Department. And U.S. business investment fell at a 0.6% annual rate in the second quarter, after achieving quarterly growth rates exceeding 8% in late 2017 and early 2018.

Treasury InversionYields for 10-year Treasury notes dropped below short term ones, a strong warning of a recession.Source: Tullett PrebonAs of Aug. 14, 9:50 a.m. ET
%U.S. 2-year TreasurynoteU.S. 10-year TreasurynoteAug. 143 a.m.691.561.581.601.621.641.661.681.701.72

“I think the trade thing is a big policy error,” Mr. Sinai said. He agrees with President Trump that China hasn’t been playing by the rules of global trade and needs to be confronted. But he said the tariffs the U.S. is using against China are hurting back home. “There has got to be a better way to do it,” he said.

The Fed cut short-term interest rates in July, partly in response to slower global growth, and investors widely expect it to continue with rate reductions. Lower rates could help spur investment and spending by encouraging households and business to borrow more.

“I think that the U.S. economy has enough strength to avoid [a recession],” Janet Yellen, the former Fed chairwoman, said in a taped interview to be aired Friday on Fox Business Network’s “WSJ at Large.” “But the odds have clearly risen and they are higher than I’m frankly comfortable with.”

One big factor behind the latest troubles is a downturn in global trade. The duties have driven up the price of hundreds of billions of dollars in goods made by the world’s two largest economies, hitting farmers, manufacturers, retailers and others.

For export-dependent economies like China and Germany, trade disruptions mean immediate trouble. The U.S. is less dependent on exports, somewhat insulating its economy.

Still, because American multinationals have spent the past two decades building vast global supply networks, uncertainty about trade and the changing cost of doing business are leading to trepidation about investment.

Analysts have been peppering U.S. business executives—especially manufacturers—in conference calls in recent weeks about whether they see activity softening and are prepared for a downturn.

Change from previous quarterSource: Bureau of Economic AnalysisNote: Components of U.S. GDP, seasonally adjusted
%Consumer SpendingBusiness InvestmentExports2015’16’17’18’19-10-5051015

“It’s no secret that, given the level of uncertainty right now around [a] number of issues globally that—from the standpoint of business tentativeness that we’re certainly seeing more of that right now,” E. Scott Santi, chief executive of Illinois Toolworks Inc., a Glenview, Ill., manufacturer, said when asked about recession risks in a call last week.

In a Wall Street Journal poll released last week, economists on average saw a 33.6% probability of a recession in the next 12 months, up from 30.1% in July and the highest level in the Journal survey going back to 2011. The average probability was 18.3% a year ago.

But with unemployment low, incomes rising and household saving rates higher than in the late 1990s or mid-2000s, many consumers are in better shape to weather a storm.

For now, slow growth is the concern of many analysts. Forecasting firm Macroeconomic Advisers estimates the economy is growing at a 1.7% annual rate in the current quarter, well below the 3% rate the Trump administration has said it hopes to achieve in the long run.

An economy expanding at a sub-2% rate is prone to descend into negative territory in the face of an unforeseen shock. But the domestic economy—largely driven by consumers, rather than exporters—might be able to carry the day.

Michael Uffner, chief executive of AutoTeam Delaware, which owns three car dealerships, said sales have risen modestly this year despite higher prices for new vehicles. He said his customers appear unfazed, in large part because interest rates remain low, making it easy for households to borrow for new cars.

“Even though the average transaction price has gone up, most consumers look at their budgets and can see that they can afford an automobile or a truck that’s a little more expensive today than it was a year ago,” he said.

Others are more exposed to global headwinds.

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Mr. Akins, the American Electric Power CEO, describes a contagion effect brought on by tariffs, which have hurt U.S. makers of metals, chemicals and other products. Electricity sales to industrial companies had been growing steadily most of last year, but was flat in the fourth quarter of 2018 and first quarter of 2019, then fell in the second quarter.

Companies are being hit by other factors, including the strong dollar, which drives up the price of exports when sold in foreign markets, and the higher wages that companies are having to pay to retain employees during a period of historically low unemployment.

Still, Mr. Akins said he hasn’t yet seen a notable downturn in investment. If the economy does enter recession, it is in a far stronger position than in 2009, he added.

“I think we’re certainly not starting out as far in the trough as we did before the last recession,” he said.

Corrections & Amplifications 
Nicholas Akins is chief executive of American Electric Power Co. An earlier version of this article incorrectly spelled his last name as Atkins.

Write to Josh Mitchell at joshua.mitchell@wsj.com and Jon Hilsenrath at jon.hilsenrath@wsj.com

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