US dollar bill, US economy, US interest rates, recession

Investors should start preparing next year for a recession to hit in 2020, according to Keith Wade, chief economist at Schroders.

Wade sees compelling reasons for the emergence of stagflation in the US, with a rising oil price, prolonged trade wars and the end of fiscal stimulus leading to higher inflation, slower growth and, ultimately, a recession.

The market will begin to anticipate this a year ahead of time, he adds, so investors must start to position for it early next year.

We've already seen the removal of accommodative monetary policy from the Federal Reserve's policy statement on Wednesday, and the fiscal boost of President Donald Trump's tax cuts will likely fade through 2019 and into 2020.

Wade expects trade tariffs to continue, with claims of the spat with China being a ploy to boost Trump's popularity ahead of the mid-term elections now firmly debunked. This will lead to higher prices for both firms and consumers, leading to less demand.

Tight job market

The US labour market also looks extremely tight, with recent data showing there are currently more job openings than there are people unemployed. So, "in theory there could be no unemployment in the US".

This would lead to rising wage growth, which will need to be mitigated by companies by charging consumers higher prices in order to maintain margins.

With fiscal stimulus that has thus far emboldened both households and corporates set to fade significantly going into 2020, growth is likely to slow as consumers spend less.

"The problem is, when you get to 2020 all the fiscal policy stops. What they've created will be like a fiscal hole," says Wade. "That's probably when the cycle's going to end.

"You will start to see quite a slowdown in 2020, which means as investors we've got to start thinking about it in early 2019 because the market will start to anticipate it a year ahead."

This will likely put Trump in a tricky position, as it will come while he is on the re-election campaign trail. It certainly won't help a president that seems obsessed with measuring his success through the strength of the economy, Wade says.

Where next For interest rates?

Current expectations are for rates to be hiked five times through 2020, which would take the Fed Funds rate up to 3.25-3.5 per cent. However, Wade reckons the Fed will get to 3 per cent by the middle of 2019 and then stop.

There's a risk it could go further due to pressure as the impact of its rate rises takes effect slowly and inflation continues to creep up. But Wade thinks this will only accelerate the process of a slowdown and recession.

"This is one of the challenges for the FOMC. They will see inflation rising and the temptation will be to keep raising rates. What they need to do is stop at 3 per cent and stand back. If they keep tightening, which is a risk, then we’ll probably get a recession."

 

More from Morningstar

• Investing Basics: How to build and invest your emergency fund

• Mixed emotions as US Federal Reserve hikes rates again

• Make better investment decisions with Morningstar Premium | Free 4-week trial

 

David Brenchley is a reporter for Morningstar UK

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.