Special Issue Focus - Slowdown or Recession in 2019?





Since 1980, there have been eight major global slowdowns, in which world growth has dropped clearly below its long-term average of 2.9 per cent per year. The current slowdown began in Q3 2018 and is the third since 2010 (see Chart 1).

Of the eight slowdowns, four have turned into recessions. However, the two most recent global soft patches (2011-12 and 2015-16) did not. So, what are the risks of the latest deceleration worsening into a slump? And what are the key factors that will decide the issue one way or the other?

Currently, the world cyclical position looks similar to that in 2016, and survey-based leading indicators on trade and investment (which lead actual data by several months) are at weak levels, suggesting that growth will remain slow in the near term (see Chart 2).

Some of the key factors for determining the severity of the current slowdown are as follows:

1. Risks from past monetary tightening: a key difference in this slowdown versus 2011-12 and 2015-16 is a much bigger degree of monetary policy tightening. U.S. rates barely changed in the two previous slowdowns but have now risen by a cumulative 225 basis points from their trough. Most Fed hiking cycles have been followed by recessions – four out of six since 1980 (see Chart 3).

Importantly, recent Fed hikes have not been accompanied by rising rates in other major advanced economies, reducing the risk to global growth. However, many emerging economies have raised rates so that total ‘global’ monetary tightening has still been considerable.

2. Limited inflation risk: Although the risk from past monetary policy tightening looks greater than during the last two world slowdowns, some key recession drivers look less worrisome.

Inflation in the advanced economies looks subdued, limiting the danger of more monetary tightening, and even allowing policy to be relaxed – as occurred recently in the eurozone. Core inflation in the U.S. and China is steady at around 2.0 per cent and is below 1.0 per cent in the eurozone and Japan. U.S. non-petroleum import prices, a decent proxy for global traded goods prices, are declining (see Chart 4).

3. Emerging market stress: over the last year, emerging markets (EM) have suffered a similar pattern of external shocks to those in 2014-15, harming world growth (see Chart 5).

However, the recent incidence of crises is much lower than that associated with world recessions (i.e. in 1980-81, 1990-94, and 2008) and lower also than in 1997-98 when EM distress was very severe, but a world recession was avoided.

4. Oil price shock: One factor behind the recent global slowdown was the rise in oil prices in 2017 and 2018 – prices rose by around 50.0 per cent in the year leading up to Q2 2018.

However, this price rise has now tailed off and was not nearly as large as before past recessions; peak annual rises in 1979 (over 150.0 per cent), 1990 (70.0 per cent), 2000 (138.0 per cent) and 2008 (77.0 per cent) were much bigger. Oil demand per unit of GDP was also somewhat higher in those earlier episodes.

5. No decisive market sell-off: Financial markets have seen several periods of significant weakness in the last 18 months, with steep stock market corrections in early and in late 2018. However, a market rally in recent weeks has reversed much of the prior decline.

With global house prices still rising, albeit more slowly than 12-18 months ago, there is an absence of negative wealth effects that could deepen the current downturn.

6. Yield curve inversion: A much-discussed potential recession signal is the recent inversion of the U.S. yield curve (featuring 10-year yields below 3-month rates).

It is certainly true that all seven recessions since 1970 have been preceded by yield curve inversions (see Chart 6). But we would note first that the gap between inversions and recessions can be long – up to 12-18 months. In addition, the yield curve has sent a false recession signal on a few occasions; the inversions in 1966 and 1998 were not followed by recession; neither was the near-inversion in late 1995. It is possible that inversion can point, for example, to a likely future easing of monetary policy without that also signaling recession.

Finally, factors such as quantitative easing and lower volatility of growth and inflation are likely to have reduced the slope of yield curves compared to the past. This makes inversions more common in the U.S. and other advanced economies, and therefore, less likely to signal recessions. So, while we do not entirely discount the yield curve as an indicator, we are cautious about what it may signal.

Overall, we doubt there is enough negative momentum for the current slowdown to turn into a recession. The current slowdown shares some features with past recessions but these ‘triggers’ do not appear to be as severe. Moreover, a dovish turn in policy in the U.S., eurozone and China in recent months will also reduce risks.

Nevertheless, downside risks that could spark a recession do exist. These include the danger of policy errors (e.g. too-rapid rises in interest rates) or a major financial market sell-off. The risk of the latter is heightened by the fact that equity market valuations, LBO leverage levels, and M&A multiples are all elevated.

This update was researched and written by Oxford Economics, 121 St. Aldates, Oxford, OX1 1HB, England, as of 22 April 2019.