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Tuesday 21.05.2019 | Name days: Ingmārs, Ernestīne, Akvelīna

Macroeconomic expert: should we expect a crisis soon?

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Baltic news, News from Latvia, BNN.LV, BNN-NEWS.COM, BNN-NEWS.RU«Questions and expectations for a new crisis come more and more often. Expectations continue growing because growth rates are becoming more and more rapid and emerging geopolitical developments are influencing businessmen’s and consumers’ mood. If USA suffers recession, its secondary effect on Europe will be direct, forcing economic decline.  In the initial phase, which could last two quarters, we might observe different trends. If this wave is felt in Europe, it will have a definite presence in Latvia. This is more attention is put on USA, because developments in this country’s economy could send waves in the global economy,» BNN was told by SEB Bank macroeconomic expert Dainis Gašpuitis.

He says concerns about a new crisis brewing in USA had first emerged last autumn. «Fixed income market, which has historically been able to predict a crisis rather accurately, is now very close to the red. This is why there is a reason for concern if historic indexes turn out correct. One of the most accurate indexes that point to a possible economic decline in USA is the slope of the yield curve, which is the difference between long and short-term bond interest rates.»

Gašpuitis notes that this usually applies to ten-year and two-year bond yield. «Because borrowing money for ten years is usually more expensive than borrowing for two, this difference is usually positive. But in certain situations 2-year yield can become larger than 10-year one, making the difference negative. Reverse yield rate has been noticed in all nine recession years in USA since 1955.»

Although unavoidable, a state of recession is not inherent for normal economy. This is why such an outcome is not expected. Growth is the normal state for any economy. In the past 100 years the US economy has suffered 18 recessions and its economy has been in decline for less than 20% of this time, says Gašpuitis.

The expert notes that there have been fewer recessions in the last decade. «In the past fifty years USA has experienced only seven economic slopes, which takes up about 14% of the period. Because the historically established model is that the US economy is the locomotive of global economy, its decline causes major ripples on financial markets around the world.»

Similarly, growth of prices on stock markets is also normal. Since 1928 the S&P 500 stock index growth (except for dividend yield) has been slightly below 6% on average. One exception is periods of economic decline. Since the Great Depression of 1930 to modern days S&P500 has dropped in less than ten out of 14 periods.

Stock markets can continue working relatively successfully in the weakest growth periods, says macroeconomic expert Dainis Gašpuitis.

«One thing that may seem odd is that economic indexes in USA are currently very strong. Even though the procurement lead index of the Institute for Supply Management has started to decline, it remains above the level when downward slope begins. US labour market is strong, with almost record-low unemployment and good emergence of new jobs. Growth rate continues. Because of that, one logical question is how are we supposed to interpret this situation? The labour market has demonstrated appropriate job growth and relatively low unemployment in a time when the rate has become reversed,» comments Gašpuitis.

He stresses this is not odd in of itself, because the labour market is a lagging factor that usually has a delayed reaction to developments in the economic sector. «A strong labour market contradicts the approach of a recession, because restrictions of the supply side are becoming more apparent and it is becoming harder for companies to find workers. A similar situation is observed with mood indexes. After the five last recessions, except for 1981, ISM index was stronger than it is now. Consumers’ mood was relatively high, too.»

It is generally hard to find a convincing argument to explain why economic indexes are so different to claim «everything is different this time». This is why it is hard to ignore signals from fixed income markets, which are coming to a possible downward slope. When will the next economic decline arrive? Data from the past five years shows that recession starts within 10-23 months after the day the yield rate becomes negative, says SEB Bank expert.

«If we look at it based on the average (16 months), the possible economic recessions in USA could start in summer 2020. This scenario provides for the yield rate to continue declining until it becomes negative. But this needs to happen. When will the stock market reach its maximum? History shows that S&P500 index reaches its maximum in 2-21 months after the rate becomes reversed. In the past five recessions this has panned on average within twelve months. It is particularly interesting that in the past five recessions the stock market has never reached its maximum value before the yield rate became negative. If this assumption is true, the stock market maximum is still somewhere ahead,» continues Gašpuitis.

He also believes the current signals should not be overdramatized, because it is not possible to accurately predict the coming of a new crisis. «Growth increase and late cycle phase makes economic processes more sensitive to geopolitical risks that increase the possibility of recession. Latvia can take signals in to account – prevent excessive budget expenditures and maintain investments for better competitiveness. If historic indexes prove true and USA drops into recession, Europe will feel it, too. Time will tell. There is no reason to fear the world and Latvia could descend into a crisis soon».

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