US Economy Veers Toward Recession as Trade War Escalates

Amid rising tension between the US and China, the American economy is edging dangerously close to recession. This is the prevailing belief of economists polled by Reuters August 6 to 8.

Results assign a median 45% probability that the US will go into recession within the next two years, while more than half of the surveyed economists expect the Federal Reserve to cut interest rates once again in September. This represents a 10% increase since the last poll in May 2018, when 35% of respondents predicted an economic downturn.

Fears of a recession are fueled by the escalating trade conflict between the world’s largest economies. US President Donald Trump announced a new wave of tariffs last week, and the Chinese retaliation with currency devaluation, Washington has officially branded China a currency manipulator for the first time since 1994.

Officials in Beijing warned that this would “severely damage international financial order and cause chaos in financial markets,” and that such moves by the American government could prevent a global economic recovery. In response, market watchers have flashed their biggest warning signal since 2007.

“Certainly, escalating trade tensions through higher tariffs and restricted access to markets is hurting sentiment, increasing costs, damaging supply chains, and weakening corporate profitability,” said James Knightley, chief international economist at ING. “This then feeds through into consumer sentiment and spending more broadly in the economy with recession risks mounting.”

The second big factor in the trade war has been the Federal Reserve’s interest rate cuts, which the US president has deemed insufficient. It is not clear that policymakers at the Fed will be willing to oblige him again. Federal Reserve Bank of St. Louis President James Bullard said that the central bank will not cut interest rates each time there are policy threats or new announcements in the trade war.

Aditya Bhave, senior global economist at Bank of America-Merrill Lynch, joined other experts in worrying that the Fed is “unintentionally underwriting the trade war” by cutting interest rates. “We worry about an adverse feedback loop in which the Fed eases and things get better: financial markets, the economy and so on.” Bhave said. “That encourages more escalation in the trade war - things get worse and then the Fed eases again.”

The Reuters poll forecasts a slowdown in US economic growth to an annualized rate of 1.8% by late 2020, down from 2.1% in the most current quarter. A growing chorus of experts predict an economic slowdown despite the easing of interest rates by the Fed, in part because of uncertainty about what President Trump will do next.

“Trump is playing a game of chicken,” said Phillip Mrey, senior US strategist at Rabobank. “He thinks by adding more punitive measures...he will bring down the Chinese economy and force them to act quickly. He hopes in the end the Chinese will blink and come to the table and give him what he wants.”