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Warning Signs Point to a Global Slowdown

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08/14/2019 | 04:44pm EDT

By Josh Mitchell and Jon Hilsenrath

Warning signs pointing to a deepening global economic slowdown -- and the risk of recession -- are flashing more brightly.

Many of the biggest troubles are showing up overseas. But markets are signaling that the threat of a downturn is spreading to the U.S., the world's largest economy, now in its longest expansion on record.

Economic output in Germany, the world's fourth-largest economy, contracted in the second quarter, according to a report Wednesday, while a report on factory output in China, the world's second-largest economy, was lower than expected. Earlier this week, Argentina's currency and stock market tumbled, stoking fears over one of South America's largest economies.

The Dow Jones Industrial Average fell about 800 points, or some 3.1%, in its biggest loss of the year.

Investors sought ultrasafe holdings, as they often do during moments of uncertainty, buying U.S. Treasury securities Wednesday.

The yield on the U.S. 30-year Treasury note, which moves inversely to the price, fell to a record low, a sign of expectations of low inflation and slow growth in addition to investor appetite for safe assets.

At the same time, the yield on Treasury notes with a 10-year maturity briefly fell below the yield on Treasurys with a 2-year maturity, a phenomenon known as an inverted yield curve, which has indicated a looming recession in the past.

"It's almost like we're starting to see a textbook version of a pre-recessionary period," Nicholas Atkins, chief executive of Ohio-based American Electric Power Co., said in an interview Wednesday. The company provides electricity to industrial, commercial and residential customers in 11 states.

"I think that the U.S. economy has enough strength to avoid (a recession)," Janet Yellen, the former Federal Reserve chairwoman, said in a taped interview with The Wall Street Journal to be aired Friday on Fox Business Network. "But the odds have clearly risen and they are higher than I'm frankly comfortable with."

The Fed cut short-term interest rates in July, partly in response to slower global growth, and investors widely expect it to continue with rate reductions. Lower rates could help to spur investment and spending by encouraging households and business to borrow more.

One big factor behind the latest troubles is a downturn in global trade, stoked by a spat between the U.S. and China that has led to a series of dueling tariffs. The duties have driven up the price of hundreds of billions of dollars in goods made by the world's two largest economies, hitting farmers, manufacturers, retailers and others.

For export-dependent economies like China and Germany, trade disruptions mean immediate trouble. The U.S. is less dependent on exports than others, somewhat insulating its economy.

Still, because American multinational corporations have spent the past two decades building vast global supply networks, uncertainty about trade and the changing cost of doing business are leading to trepidation about investment around the globe.

U.S. business investment fell at a 0.6% annual rate in the second quarter, after achieving quarterly growth rates exceeding 8% in late 2017 and early 2018. U.S. exports also contracted in the second quarter.

Economists say that trend could continue if corporate profits continue to fall. U.S. corporate profits before taxes, across the whole economy, were down 2.2% in the first quarter compared with a year earlier, according to the Commerce Department.

Investment analysts have been peppering U.S. business executives -- especially manufacturers -- in investor conference calls in recent weeks about whether they see activity softening and are prepared for a downturn.

"It's no secret that, given the level of uncertainty right now around [a] number of issues globally that -- from the standpoint of business tentativeness that we're certainly seeing more of that right now," E. Scott Santi, chief executive of Illinois Toolworks Inc., a Glenview, Illl., manufacturer, said when asked about recession risks in a call last week.

A Wall Street Journal poll released last week showed economists believe the probability of a recession has risen. On average, they saw a 33.6% probability of a recession in the next 12 months, up from 30.1% in July and the highest level in the Journal survey going back to 2011. The average probability was 18.3% a year ago.

Many past recessions have been caused by excessively high interest rates instituted by the Federal Reserve, as in the early 1980s; bubbles bursting such as the tech bust of 2000 and 2001; financial instabilities as in 2007, 2008 and 2009; or some combination of them all.

Allen Sinai, a forecaster at Decision Economics, worries that businesses -- not households, banks or the Fed -- could lead to the next downturn. If business earnings take a hit, that could lead to less investment and then less hiring, creating a self-fulfilling process of contraction. Mr. Sinai has nudged his recession risk estimate up for the first time in years.

"I think the trade thing is a big policy error," he said. He agrees with President Trump that China hasn't been playing by the rules of global trade for many years and needs to be confronted. But he said the tariffs the U.S. is using to punish China are hurting back home. "There has got to be a better way to do it."

The good news is that the U.S. isn't confronted with severe excesses to unwind, as it was in the mid-2000s with the housing boom or the late 1990s with tech-stock gains. Because of that, he and several other economists said, a downturn now might end up being mild if it happens at all.

With unemployment low, incomes rising and household saving rates higher than the late 1990s or mid-2000s, many consumers are in better shape to weather a storm than in earlier years.

For now, slow economic growth is the estimate of many analysts. Macroeconomic Advisers, a forecasting firm, estimates the economy is growing at a 1.7% annual rate in the current quarter, well below the 3% rate that the Trump administration has said it hopes to achieve in the long run.

An economy expanding at a sub-2% rate is prone to descend into negative territory in the face of some new, unforeseen shock. But the domestic economy -- largely driven by consumers, rather than exporters -- might be able to carry the day.

Michael Uffner, chief executive of AutoTeam Delaware, which owns three car dealerships in the state, said sales have risen modestly this year despite higher prices for new vehicles. He said his customers appear unfazed, in large part because interest rates remain low, making it easy for households to borrow for new cars.

"Even though the average transaction price has gone up, most consumers look at their budgets and can see that they can afford an automobile or a truck that's a little more expensive today than it was a year ago," he said.

Others are more exposed to global headwinds.

Mr. Atkins, the American Electric Power CEO, describes a contagion effect brought on by tariffs, which have hurt U.S. makers of metals, chemicals and other products. Electricity sales to industrial providers had been growing steadily most of last year, but were flat in the fourth quarter of 2018 and first quarter of 2019. They fell in the second quarter of this year.

Companies are being hit by other factors, including the strong dollar, which drives up the price of exports when sold in foreign markets, and the higher wages that companies are having to pay to retain employees during a period of historically low unemployment.

Mr. Atkins said he hasn't yet seen a notable downturn in investment. If the economy does enter recession, it is in a far stronger position than in 2009, he added.

"I think we're certainly not starting out as far in the trough as we did before the last recession," he said.

Write to Josh Mitchell at joshua.mitchell@wsj.com and Jon Hilsenrath at jon.hilsenrath@wsj.com

Stocks mentioned in the article
ChangeLast1st jan.
DJ INDUSTRIAL 1.20% 25886.01 Delayed Quote.10.97%
NASDAQ 100 1.59% 7604.108768 Delayed Quote.18.33%
NASDAQ COMP. 1.67% 7895.993811 Delayed Quote.17.16%
S&P 500 1.44% 2888.68 Delayed Quote.13.59%
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