Is recession inevitable or is there something which could keep the gravy train of economic expansion rolling and continue to confound the bears?

There appears to be two likely sources which could maintain economic confidence: fiscal policy and the US dollar.

Historically, easing fiscal policy, especially spending money on infrastructure, has acted as a positive catalyst for growth. Governments could use supercheap funding to invest in infrastructure with the expectation of boosting demand and ultimately productivity.

Fiscal easing: who will blink first?

The UK appears as one of the most obvious candidates for fiscal stimulus. It has the capacity to give itself a significant shot in the economic arm, while the country’s politicians appear to have the will to do so. By contrast, most other leading political parties around the world seem less willing to be proactive.

Germany, with plenty of capacity to spend and near record low bond yields, seems another obvious candidate. But at present the government seems unwilling to loosen the purse strings. This is largely because unemployment is so low and economic conditions, in the ruling coalition’s eyes, do not seem dire enough to warrant breaching their self-imposed fiscal discipline.

The US is approaching a presidential election, where it seems unlikely Donald Trump will be able to force any new fiscal boost through the Democrat-led House of Representatives. Japan may attempt to negate the impact of rising consumption taxes, but again seems unlikely to unleash the sort of fiscal bazooka required to stimulate activity.

Weaker dollar to the rescue?

Suggesting a weaker US dollar as a means of stimulating economic activity may not be immediately obvious. In most cases of currency devaluation, the devaluing country will feel the benefit from more competitive exports, but at the expense of its trading partners. The US dollar is an exception to this rule.

Many commodities are priced in US dollars. A lower dollar will result in higher commodity prices, which is helpful to commodity producers and exporters, and can more broadly stimulate growth and inflation.

Many emerging markets issue considerable amounts of debt denominated in US dollars. Dollar strength pushes up the cost of this debt. The corresponding weakness of emerging market currencies makes it more expensive for emerging countries to buy the US dollars they need to meet bond repayments. The local currency weakness relative to the US dollar will also restrict the ability of emerging countries to ease monetary policy, typically by cutting interest rates, as this can lead to higher inflation.

However, US dollar strength is most problematic when seen through the lens of global trade. Around 80% of the financing used for international trade is denominated in US dollars[1]. When the dollar is weak lending is easier and rises more quickly, facilitating trade, but when the dollar is strong lending and trade either grow more slowly or actually contract.

The US economy has been more resilient than the rest of the world over the past year or so, largely because trade and especially, net exports, represent a relatively small part of its economy. However, evidence is building to suggest the US is not immune to external developments. It looks increasingly likely that the US economy will slow, probably leading to more aggressive easing from the Federal Reserve (Fed), and in turn weakening the dollar. Should the US cut rates further, the interest return on certain assets, bonds in particular, will fall. This will make them less attractive to foreign investors resulting in lower demand for US dollars.

A weak dollar, could indeed grease the wheels of global trade and by extension give the world a significant growth boost.

Without US dollar weakness and a corresponding pick up in growth as outlined above, it seems probable that the global consumer, arguably the last bastion of economic demand, will slow their purchases. Companies will have to consider reducing their cost base, which means reductions to the workforce and rising unemployment. The chart below, another red signal in our view, indicates that confidence among chief executives has already fallen to levels historically consistent with worsening employment conditions.

Other Wealth Management sites

Cazenove Capital UK

What we offer

Insights

Events

Contact us