Introduction
Share markets have seen big falls on the back of rising recession fears. For the last two years there has been constant fears of a recession – or a contraction in economic activity – on the back of central bank rate hikes.
With it failing to materialise and inflation falling enabling central banks to pivot to rate cuts many thought it would be avoided, and shares surged to record highs into July. However, recession fears are now back with a vengeance, particularly in the US, so share markets have fallen sharply from their highs – with the key direction setting US share market down 8.5% and global shares off 8.9% and Australian shares having a 5.7% fall from its high last week. What's more, bond yields, commodity prices and the $A are all down consistent with renewed growth concerns. This may have been accentuated by an unwinding of so-called Yen carry trades (where investors borrow cheaply in Yen and invest globally) after the Bank of Japan raised interest rates. Even Bitcoin has had a near 30% fall from its July high indicating again it’s become a leveraged version of shares.
So why the sudden recession worries? How serious is the risk? Does it mean central banks including the RBA have got it wrong? And what does it mean for investors?
More US recession indicators flashing red The basic argument for recession over the last two years is that the most rapid monetary tightening in major countries in decades and cost-of-living pressures would depress spending driving a recession. Indeed, the Eurozone, UK and Japan have seen growth stall or arguably have had mild recessions over the last 18 months and Australia is already in a “per capita recession” (with falling GDP per person) even though GDP has still been rising. But the US economy has been robust, and this has kept the key direction setting US share market strong until recently. However, while the US economy has been stronger than expected, the risk of recession never fully went away, with key indicators highlighting ongoing recession risk. In particular:
• The US yield curve which is a guide to whether monetary policy is tight or loose has been flashing red, with short term interest rates above long-term rates, since 2022. And while this has given false signals it has preceded all US recessions over the last 60 years. It’s still inverted and so its recession signal remains.