A Glimpse of the Future

Any simpleton can recognize an unfolding calamity…

The two trains about to collide, the twister racing for the schoolhouse, the betrayed lover with a finger on the trigger.

But you require a wider vision to perceive the chains of disaster coming together… link by fateful link…

When a conductor gets his signals crossed, when the winds take a fatal shift, when someone takes the first bite of forbidden fruit.

Today we attempt a wider view of future calamity presently taking shape.

But first to a future calamity in its own right — the stock market.

Global Growth Drags on Stocks

Once again, the global economy throws a darkened shadow over Wall Street.

We learn today that Chinese industrial profits have fallen 14% year over year — their largest fall since 2011.

Meantime, European Central Bank (ECB) President Mario Draghi has drawn a dark sketch of the eurozone.

Mr. Draghi cited “weakness in world trade” and a “weakening growth picture.”

The ECB recently downgraded its 2019 eurozone GDP forecast from 1.7% to 1.1%.

The Dow Jones gave back 32 points on the day. The S&P lost 13, the Nasdaq 48.

By way of explanation Ed Yardeni, president and chief investment strategist at Yardeni Research:

There’s lots of angst about global economic growth. That’s understandable because it has been slowing significantly since early 2018. Furthermore, we can all observe that ultra-easy monetary and debt-financed fiscal policies aren’t as stimulative as policymakers have been hoping.

Yes, Mr. Yardeni. We can all observe that ultra-easy monetary and debt-financed fiscal policies aren’t as stimulative as policymakers have been hoping.

Except, perhaps, for the policymakers themselves.

Failure is only indication that they need to double, triple or quadruple existing ultra-easy monetary and debt-financed fiscal policies.

As said Wittgenstein:

“Nothing is so difficult as not deceiving one’s self.”

But we lift our gaze from the roiling present… and face the distant horizon.

A Vision of Coming Recession 

What do we spot?

Unsurprisingly, a scene of coming recession…

The present expansion is the second longest in United States history.

If the economy can peg along until July, it will be crowned the longest expansion in United States history.

But the signs of age are creeping in, like rust on a chassis…

Growth has been trending wrong two consecutive quarters — and going on three.

Even the eternally optimistic Atlanta wing of the Federal Reserve projects first-quarter GDP to expand at 1.5%.

JPMorgan Chase seers project the same 1.5% — but even that is subject to “downside risk.”

The reasons are close at hand…

Housing prices are the softest in four years, manufacturing plumbs 21-month lows, retail stores are closing at alarming rates (5,279 year to date), the American consumer languishes under record levels of debt.

And the yield curve has inverted — a recession indicator of supreme accuracy.

Looking out beyond these pristine shores, we also find the global economy wobbling on its axis.

As suggested above, China and Europe all go on unsteady legs. Japan is similarly afflicted.

Meantime, the Federal Reserve has just executed perhaps its most dramatic retreat in its history.

It has essentially guaranteed no rate hikes on the year. As recently as December it had penciled in two.

Would it throw up the sponge if it were confident in the future?

But the Federal Reserve has conceded defeat to a superior and determined foe — the stock market.

Jerome Powell ran his white flag up the pole in late December, after the market raged against his promises of additional tightening.

We are forced to conclude that the Federal Reserve cannot lift interest rates much above the present 2.50%… or restore its balance sheet to levels approaching pre-2008 levels.

That is, the economy cannot withstand interest rates that are still historically low. And the stock market will roar in protest if rates rise only slightly.

The “Real” Interest Rate

But the “real” interest rate — the nominal rate minus the inflation rate — is even lower than face value suggests.

Thus we find the real fed funds rate not 2.50%, but as low as 0.25%.

By way of comparison…

The real fed funds rate scaled 2.75% when the Federal Reserve’s last tightening cycle concluded in 2006.

And 4% when the previous cycle ended in 2000.

But sticking to the nominal rate, history argues convincingly that rates between 4% and 5% are required to beat back recession.

Only with that much “dry powder” can the Federal Reserve cut enough to lift the economy from its wallows.

But when recession does besiege us — this year, next year or the year following — the Federal Reserve will scarcely be at half-strength.

Imagine a one-armed gladiator battling in the arena… or a flyweight taking on the heavyweight champion of the world.

And so the Federal Reserve is in an awful bind…

It must raise rates to build its steam against the next recession. But it cannot raise rates above present levels without bringing the Furies crashing down upon it.

A conundrum to ponder of a blue day.

But we now return our binoculars to the purple horizon…

Recession in Fall 2020 Could Sink Trump

The next presidential election falls in November 2020 — 1.5 years from today.

Given the present drift, the economy may well be sunk in recession by that time.

Recessions are notoriously poor portents for incumbent presidents.

Since the Civil War the economy was in recession eight occasions during presidential election season.

These years were 1876, 1884, 1896, 1920, 1932, 1960, 1980… and 2008.

In all eight instances — all eight — the opposition party was voted in.

If the economy plunges into recession by next fall, could the sitting president defy the odds?

It would not be the first time.

But every man’s luck has its limits. Eventually the gods plot against him.

And recall the Federal Reserve will likely enter the next recession with barely a half barrel of steam.

Recession will roll over it like a thundering locomotive over a rat.

And the cries will go out:

“Capitalism has failed yet again!”… “This is all Donald Trump’s fault!”… “It is time to reclaim the economy for the people!”

At this point our vision of the future begins.

Part II tomorrow…


Brian Maher
Managing editor, The Daily Reckoning

The Daily Reckoning