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Higher US interest rates could be dangerous in a ‘wobbly bike’ world economy, says Schroders

Corporate recession risks are usually on the rise at this point in the economic cycle

PUBLISHED : Friday, 20 November, 2015, 1:22pm
UPDATED : Friday, 20 November, 2015, 3:59pm

Uncertainty surrounding the global market and an anticipated US interest rate rise leaves analysts conflicted about the state of the world’s largest economy, with some remaining wary of a potential recession.

The US may be poised to raise interest rates in December for the first time since 2006, reflecting a favourable view of the economy from the Federal Reserve. Yet the recent vulnerability of the global market to shocks - for instance the depreciation of the Chinese currency, collapsing energy prices and the terrorist attack in Paris - has caused some to speculate about whether continued growth is sustainable.

Rising inflation, falling corporate profits and imbalances caused by growing debt in the US market are key triggers that could potentially drive the economy towards a recession, according to a report released by Schroder Investment Management this month.

“Investors are still focused on the downside risks and while the likelihood of a China hard landing may have receded, there has been increasing concern about a turn in the US cycle,” the report said. “This sets a ‘wobbly bike’ view of the world economy: slow moving, not very stable and vulnerable to pot holes.”

This sets a ‘wobbly bike’ view of the world economy: slow moving, not very stable and vulnerable to pot holes
Schroder Investment Management

Unemployment is currently at about 5 per cent, according to latest statistics from the US Department of Labor, reaching levels close to those seen in 2001 and 2007. The current rate also rests below the level seen just prior to the 1990 recession.

Should unemployment decline further or remain at current rates, wages may start to increase -triggering a round of price hikes for products and services that could fuel an inflationary spiral. It’s not clear that will happen, as an appreciating US dollar and falling imports may counter this trend, the report said.

Meanwhile, the outlook for corporate profits looks challenging at best. For years companies were recording rising profits as a share of GDP, but that trend now appears to be on the wane.  Adding to the headwinds, US companies are beginning to rein in their capital expenditure, perhaps in anticipation of more difficult times ahead, indicating fewer outlays on expensive machinery and other big ticket items.

“Should we see an acceleration in wages, profits will be squeezed unless firms can maintain pricing power and pass on cost increases...or productivity accelerates,” the report said.

Retail sales in the US were disappointing last month and the S&P 500 index shed 3.6 per cent.

Analysts at Reorient said the weakness in the share prices of leading American companies might be an early indicator of softness in the global economy that raises “question marks behind the wisdom of the Fed’s expected [rate lift-off] decision.”

Other experts see an increasingly strong labour market as a positive signal for the US economy, citing increased consumer spending as a way to stimulate growth.

In October, there were a net 277,000 new jobs created- a higher increase than expected. And in spite of weakness in wage growth, the personal consumption expenditure increased by 3.2 per cent in the third quarter.

The consumer comfort index, which measures views on the condition of the economy and personal finances, also started to rise in the first week of November after having fallen for three consecutive weeks.

“Continued strength in the labour market should be a boost to consumer sentiment and spending,” analysts at Principal Global Investors said in a report for the week of November 9 to 13. “If payroll growth remains strong...there is some hope that fourth-quarter GDP will be an improvement.”

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