Markets bracing for end to US growth run

Markets are becoming increasingly worried about the prospects for the US economy.

The economy continued to perform strongly in the opening quarter of this year. GDP grew by a healthy 3% annualised, employment continued to expand at a strong pace, while the country's unemployment rate fell to 3.6% in April, its lowest level in almost 50 years.

Markets, though, don’t think this will last. The US yield curve is widely watched as a signal of future economic trends. A yield curve shows interest rates on the same type of debt over different maturities. Normally, the longer the maturity of the debt the higher the interest rate. However, if the curve inverts and long-term interest rates drop below short-term rates, it is often seen as a sign of slower growth ahead that could trigger rate cuts.

In this regard, the markets pay very close attention to the gap between the three-month US treasury bill rates and 10-year treasury bond yields as it has turned negative ahead of every US recession in the past 50 years.

The past couple of weeks have seen the gap between three-month and 10-year treasuries turn negative, dropping to -20 basis points, its lowest level since 2007, just ahead of the last US recession.

Futures contracts are now pricing in a 25 basis points Federal Reserve rate cut by the end of the year, with an increasing probability of two further rate cuts in 2020.

Fears that the yield curve inversion is signaling a recession ahead have undermined sentiment in equity markets. US stock markets fell by some 7% in May. Sentiment has not been helped, either, by some recent weak US data, which came in well below expectations - including falls in retails sales and industrial production.

US data for May also made for worrying reading. The manufacturing index fell to 50.6 from 52.6 in April, its lowest level since September 2009. Meanwhile, the services index fell to 50.9 from 53.0.

The data point to a marked slowdown in US business activity, with the indices now just above the 50 level that signals continuing expansion.

Caution, though, is warranted about reading too much into recent yield curve trends. Sentiment in both markets and the economy has been hit by the escalating trade war between the US and China, which is now also becoming a technology war.

This is another factor driving investors into the safe haven of US treasuries, pushing yields lower. Furthermore, on most occasions when yield curves invert, it is caused by central banks raising short-term interest rates, which can lead to a recession.

This time, though, it is falling long-term interest rates that is at work. Thus, the previous strong relationship between yield curves and recessions may not hold this time around.

One other factor that may be weighing on sentiment is that this month will see the current US expansion become the longest on record. Thus, naturally, there are concerns that the expansion could soon end.

The fiscal stimulus that boosted the economy last year is fading, while the lagged effects of the monetary tightening in 2017 and 2018 may be impacting activity.

Global growth has also weakened in the past year, against the backdrop of rising trade tensions.

Markets will be keeping a very close eye on data in the months ahead to gauge whether we are witnessing a moderation in US growth to more sustainable levels, or a much deeper downturn in the economy.

Oliver Mangan is chief economist at AIB

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