The global economic expansion has already entered its 10th year. With bumpy and brittle growth having given way to a robust and globally synchronized conjuncture, an aging cycle has suddenly become much more cyclical.
Alas, late-cycle booms typically mark the beginning of the end. As spare capacity erodes and central banks focus on removing accommodation, the risk of accidents in the real economy or in financial markets is rising. Thus, it is time for investors to prepare for a potentially long period of more volatile and plateauing asset prices, because it often precedes bear markets for risky assets.
To be sure, there is nothing in the economic data or financial indicators to suggest that a global recession is imminent. Unlike in the past few cycles, consumers have been relatively thrifty, house prices do not look excessive and the corporate sector has not overinvested in fixed capital – if anything, the opposite has occurred. Also, financial conditions remain favorable despite recently higher equity market volatility, and fiscal policy is expansionary, especially in the U.S.
Recession over the horizon?
Against this backdrop, barring a big geopolitical event or a full-blown trade war, the global economic expansion appears to have room to run for another year, or maybe two. However, the risk of a recession soon thereafter is high and rising.
One reason for elevated medium-term recession risks is that U.S. fiscal stimulus comes at the wrong time of the cycle because the economy is already operating at or close to potential. This raises the risk of an inflation overshoot, which could be amplified by rising commodity prices in response to globally synchronized growth. Needless to say, import tariffs, if they were to be implemented broadly, would also stoke inflation, at least initially, and hurt real income and GDP growth.
Of course, one would have to worry less about potential inflationary consequences of late-cycle fiscal stimulus if companies would step up business investment in response to lower tax rates, thus raising productivity and potential output growth. While the jury is still out, there are few signs so far that this is happening. Companies seem more inclined to use the tax cuts for stock buybacks, higher dividends and takeovers rather than productivity-enhancing fixed investment.