Global economic momentum is decelerating, according to a broad range of financial and real-economy indicators, which is weighing on worldwide equity markets and oil prices.
The depth and duration of the slowdown is impossible to gauge at this point, whether it turns out to be simply a mild and short-lived “soft patch”, a longer but still positive “growth recession” with output falling relative to trend, or an “outright recession” with activity falling in absolute terms.
Recent declines in equity markets and softness in freight indicators may turn out to be a false alarm or a pause within an extended cycle rather than mark a cyclical turning point.
Most commentary about the economic cycle is still influenced by the last deep and wrenching recession which accompanied the global financial crisis in 2008/09.
But severe recessions have not been common since the end of the Second World War and most downturns have proved milder, which therefore seems a more likely prediction for the next cyclical slowdown.
In the United States, post-1945 recessions have tended to be short, lasting less than a year in most instances, and in some cases have seen business activity level off rather than decline.
If the economy is nearing a cyclical peak, however, the next stage in the cyclical sequence is likely to involve some combination of:
* Fiscal expansion
* Financial easing
* Lower trade tensions
* Lower oil prices
Further tax cuts or an increase in government spending, possibly on highways and other infrastructure, would be one way to ameliorate the slowdown and get the economy growing again.
The U.S. federal government is already on course to run an annual budget deficit of more than $1 trillion by the end of the decade but the prospect of even higher deficits is unlikely to forestall demands for fiscal stimulus.
If the expansion slows or tips into recession, the Federal Reserve will also come under pressure to cancel planned interest rate increases and rescind some of the rises that have already happened.
With the target federal funds rate currently at 2.00-2.25 percent, up from a post-crisis low of 0.00-0.25 percent, the central bank has scope to ease financial conditions by conventional interest rate reductions.
In the event of a mild slowdown, interest rate reductions on their own are likely to prove sufficient, but if more aggressive measures are required, the central bank could start expanding its balance sheet again.
Slower growth will lead to pressure on policymakers to reconsider trade policies that have disrupted global supply chains and damaged market access.
The Trump administration has argued the strength of the U.S. economy makes now an opportune time to tackle what it calls China’s unfair trade and investment practices.
A strong domestic economy can weather the short-term pain of a trade war to protect long-term strategic advantages, according to this argument.
But if the economic expansion falters, the administration is likely to come under pressure to reconsider the costs and benefits of its aggressive trade policies.
At a minimum, the administration is likely to come under pressure not to worsen the downturn by escalating the trade war and to find ways to reduce tensions.
If there is a downturn, the administration will want it to be over well before the next presidential election in November 2020.
Any slowdown in global growth is likely to see oil prices hit a plateau or even fall, as consumption growth moderates while production continues to accelerate.
Lower oil prices would avoid another period of oversupply by curbing the projected expansion in output and stimulating faster growth in oil consumption.
Modestly lower oil prices would also provide some economic stimulus and form part of the natural cyclical progression (a sharp fall in prices would worsen the economic outlook by curbing oil and gas investment).
OPEC members could try to support oil prices by cutting their own output, perhaps in conjunction with invited non-OPEC producers, but only at the risk of losing market share (again).
Attempting to support oil prices during an economic slowdown is unlikely to be successful, so the most OPEC may be able to achieve is to avoid a rise in inventories and averting a price collapse.
The precise mix of fiscal expansion, financial easing, reduced trade tensions and lower oil prices in the next stage of the cycle is impossible to predict in advance.
But the potential for a cyclical slowdown and flat or lower oil prices is one reason hedge funds and other money managers have been cutting bullish bets on oil and refined fuels sharply since the end of August.
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