Prepare for a Slowdown, Not a Recession

Wharton's Jeremy Siegel discusses whether the economy is headed for another recession.




Last week, the U.S. Treasury market spit out a historically reliable signal that the next recession is on the horizon: The yield on the 10-year Treasury note fell below the one for the 2-year Treasury, causing an inverted yield curve. Also troubling is that the yield on the 30-year bond fell to an all-time low. That means investors believe economic growth will falter and interest rates are headed lower.

“Are we heading for a recession? Will we eventually have one? Yes, of course. The question is, will it be within the next year, or year and a half?” said Jeremy Siegel, Wharton finance professor and markets expert, on the Knowledge@Wharton show on SiriusXM. “Right now, outside of the [signal from the] yield curve, there are no real signs that we’re heading for a recession.”

Siegel is in good company. Former Fed Chair Janet Yellen recently said the inversion may be a “less good signal” now of a recession. She also doesn’t think the next recession is coming, although “the odds have clearly risen and they’re higher than I’m frankly comfortable with.” Siegel said most market experts he follows put the odds of a 2020 recession at one in three or a little bit higher.

Meanwhile, the stock market remains spooked by fears of an economic slowdown as the U.S.-China trade wars continue. “If there’s no agreement on the trade [talks] and there’s still threats of 10% and … 25% [tariffs], I see no progress in the stock market for the year end,” Siegel said. “In fact, I would say it could be lower.” But if the U.S. and China get a trade deal, “we’d be up 10% to 15% from where we are today.”

Demographics and Lower Rates

A headwind to those market hopes is the inverted yield curve. “Is that inversion worrisome?” Siegel postulated. “There is no question that when the long-term interest rate goes below the short-term interest rate, that has been, in the past, an extraordinarily reliable indicator of a coming recession.” Historically, he added, there’s only been one time in the late 1960s when an inverted yield curve did not lead to a recession.

What’s different today is that other factors are helping to lower rates, “which may make it less threatening this time than in the past,” Siegel said. These are “fundamental factors that go far beyond what central banks in the world are doing today.” He cited changes in demographics, such as an aging workforce and longer life expectancies that push people into saving more.

As they age, many buy bonds because these are considered safer and less volatile than stocks. “When things are bad, when you see the stock market down 1,000 points or whatever, you will see Treasury bonds jump up in price,” Siegel said. “Whenever you have an asset that moves [in the] opposite [direction as] stocks … they become very desirable in investor portfolios because they lessen the risk.” Long-term U.S. Treasuries in particular have become the “hedge asset of choice,” he added.

Since there’s only “so much supply [of bonds, demand] is driving up their price and lowering rates,” Siegel said. “What we have now is a tremendous number of people piling into these bonds, not because they think the yield is good. The yield is not good.” It’s because they believe U.S. government bonds offer more security relative to other assets. “Never before, at least in post-World War II history, has the Treasury bond ever served better as such a risk diversifier as it does today,” he added.

With this demand for bonds helping to push long-term interest rates down, the current yield curve inversion is “less threatening than in the past,” Siegel said. So if this recession signal is less reliable now, should the Fed even be considering lowering the Fed Funds Rate, a key short-term interest rate, at its next meeting in September as the market expects? “I actually think they should be moving the Fed Funds Rate down 50 basis points,” he said.
For one, “it is normal for the short-term rate to be below the long-term rate,” Siegel said. Also, the U.S. is at odds with other mature economies. Currently, the Fed set the target for the rate, which influences what banks pay on deposits and rates on loans, among others, at 2% to 2.25%. “Right now at 2.15%, that’s the highest rate in the developed world for any maturity” of government debt, Siegel said.

Globally, low interest rates have led to negative yields for nearly all the 10-year bonds in Europe. For example, the 10-year German bond is yielding negative 0.7% compared to 1.6% for the 10-year U.S. note — a big gap. That means investors looking for a place to park their money will find U.S. yields more attractive. “People have been moving from Europe to the U.S.,” Siegel said.

Slowdown, Not a Recession

Siegel doesn’t see a recession coming in the near term, but “I definitely think we are in a slowdown.” (A recession is marked by declines in real GDP. A slowdown means the economy is still growing, but at a reduced rate.) He said most experts he follows believe third quarter GDP will come in at around 2%. “Last year, we had 3%, and revised down to 2.5%,” Siegel added. “We are in a slowdown and many people believe that if the Trump trade wars continue, [GDP growth] is going to fall into the 1 [percent range.] So it seems reasonable to me for the Federal Reserve to provide an insurance policy and a boost here” by cutting rates.

Some might believe that since the last recession began more than 10 years ago, the U.S. might be due for another one soon. But Siegel said there is no set cycle for when recessions occur. He pointed out that Australia didn’t have a recession for 20 years and Great Britain had an economic expansion that lasted nearly as long. “It’s not necessarily that we’re due for one any time,” Siegel said. “We have the potential I think if we don’t mess up policy to keep this expansion going for three or four years.”

Moreover, this current economic expansion that began a decade ago was “very disappointing in terms of the GDP rebound,” Siegel said. The average GDP the U.S. achieved was 2% when historically the norm has been around 3% or 3.5%. While the Trump tax cuts and regulatory loosening helped a bit, “now we’re sinking right back down and maybe even a little lower than the average we got during the Obama administration.”

“GDP growth has been disappointing because productivity growth has been disappointing,” Siegel continued. “When productivity growth is disappointing, real wage growth is disappointing — and it has been … the slowest real wage growth in any recovery.” However, consumers have continued spending and are “actually carrying the economy in 2019.” He noted that consumer spending drives two-thirds of the U.S. economy. And while consumer sentiment has dipped, it has not decline “seriously,” Siegel said.

Rather “where we really see a slowdown and what people fear might get worse — if there’s more tariff escalation — is business spending” weakening, Siegel said. “A lot of businesses are saying, ‘I don’t know which way these tariffs are going to go, I’m putting off my decision [to expand]. Economists are more worried that capital spending is going to be the initiator of the next recession, if we have one.” But if consumer sentiment dives too, there’s very little the U.S. can do to “save ourselves from a recession.”

Europe must be braced for a trio of trade shocks

It is high time for the EU to unlock the fiscal side of its macroeconomic armoury

Martin Sandbu


© James Ferguson


US President Donald Trump has been lampooned, with good reason, for his claim that “trade wars are good, and easy to win”. But in one sense he is right. The American economy is huge and relatively closed. That combination means trade turmoil involving the US can inflict much greater damage on others than its own economy has to absorb.

Despite a contraction of US industry and higher prices for American consumers, overall growth remains adequate. It remains to be seen how the latest market gyrations affect the economy, but so far, the brunt of the macroeconomic damage has fallen not just on Mr Trump’s main target — China — but on Europe, which has been caught in the crossfire.

Unlike the US, the EU economy is as trade intensive as China’s, and accounts for the largest share of world trade of the three. While China is experiencing a slowdown partly due to US actions against it, Europe is suffering just as much in collateral damage.

Europe’s growth rate has slowed to a trickle and has been markedly lower than the US’s for the past two years. Trade is not the only cause, but it is the most important one. The OECD has highlighted that European countries’ trade growth stalled last winter, both among themselves and with the outside world. Germany, the continent’s trade-oriented economic core, has been one of its worst performers over the past year. It saw gross domestic product shrink in the last quarter, its car production continues to plummet and industrial weakness has spread to other EU economies.

Worse may yet be to come. As Shahin Vallée of the German Council on Foreign Relations warns, the US-China stand-off may intensify from trade war to currency war, with competitive devaluations adding to Europe’s export woes. The big question now is whether the crisis in trade-dependent manufacturing will weigh on domestic confidence and reduce demand for the much larger services sector. There are signs this is already happening.

All this is bad enough, but it is only one of three possible trade-related shocks about to hit the EU. In addition to being a collateral casualty, Europe is at risk of becoming the next direct target of American trade aggression. The OECD’s chief economist, Laurence Boone, said in July that the trade war will move to the EU “probably at the end of the summer”. Mr Trump has been rattling his sabre in that direction for both French wine and German cars — the bloc’s single biggest agricultural and industrial export items. Trade flows between the two economies amount to more than $1tn a year.

The third risk is a no-deal Brexit on Halloween, which would throw up big trade barriers overnight. Britain and Ireland would be the most hurt by this, but that does not mean the shock to other members of the bloc would be negligible.

If this trifecta of trade shocks materialises, the German car industry, which has big markets in both the US and the UK, will again be at the centre of the trouble. Given its importance in the German economy and its interconnections with the rest of Europe, the sector can act as a superconductor of shocks to other industries and countries. That is the lesson of the first of the three shocks; there is all the more reason to fear similar effects from the other two.

What should the EU do? It cannot insulate itself from the trade disruptions themselves. That would mean shifting the German economic model, and the European supply chains linked to it, away from relying on manufacturing exports. Such a step would take time, require extraordinary political leadership, and may be unwarranted if the trade troubles prove shortlived. For economic as well as strategic reasons, the EU may simply have to live with trade disruptions.

What Europe can do is to use demand-side policy to limit the wider effects. A macroeconomic stimulus would boost demand, incomes and confidence in the domestic economy and thereby contain the damage of the trade wars to the exporting sector. So far, this job is falling to the European Central Bank. At its September meeting, the ECB should exceed expectations and give a jolt to confidence by announcing a big package of more negative rates, more discounted refinancing for banks that lend to business and renewed bond purchases.

It is also high time for Europe to unlock the fiscal side of its macroeconomic armoury. Fiscal policy has barely contributed at all to the eurozone’s seven-year economic recovery. The best that can be said for this timidity is that low deficits now put most member countries in a safe place to loosen the purse strings.

The obstacle is political. There is too much resistance to countercyclical fiscal policy, most importantly in the German establishment — which is, absurdly, also the most critical of the monetary efforts the ECB has been forced to undertake because of fiscal restraint.

But it is through Germany that the trade shocks will spread throughout Europe. If the country wants to offer not just a problem but a solution, it must reconcile itself to the idea that the EU economy needs stimulus — and soon.

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Turkish Democracy Is Down, But Not Out

Relations between Turkey and the West are damaged, but not irreparably, and the same is true of Turkish democracy. Although President Recep Tayyip Erdoğan seems to believe that his country’s geostrategic importance gives him carte blanche, the fact is that Turkey needs the West, and the West needs Turkey.

Javier Solana




MADRID – Relations between Turkey and the West are clearly going through an extremely delicate phase. Under President Recep Tayyip Erdoğan, the Turkish government is pursuing an increasingly volatile foreign policy and presiding over the continued erosion of democratic norms at home. The widening schism between Turkey and its nominal Western allies is further proof of the decay of global cooperation. And yet that process is not irreversible.

The latest setback stems largely from Turkey (a NATO member) purchasing and taking delivery of a Russian S-400 anti-aircraft missile system. NATO considers the S-400 to be incompatible with its own systems, and the United States believes its presence will compromise the security of its new F-35 fighter, which Turkey has expressed an interest in acquiring. In retaliation, the US government has expelled Turkey from the F-35 consortium and is contemplating imposing sanctions.

Erdoğan, meanwhile, has done little to calm matters. His threats of military intervention in northeast Syria worry the US, which has tried to buy time with a vague preliminary agreement with Turkey to establish a safe zone. Kurdish forces, which dominate the region in question and played a key role in the fight against the Islamic State, now must hope that US President Donald Trump won’t leave them in the lurch.

Tensions between Turkey and the European Union have also spiked, owing to the Turkish government’s recent decision to send drilling and exploration ships in search of new hydrocarbon reserves around Cyprus. The EU, alleging that Turkey’s actions violate international law, has imposed sanctions. In response, Turkey has announced the suspension of the 2016 agreement under which it had been stemming the flow of refugees into the EU. Although the deal’s practical effects are now slight, it is symbolically important for having breathed new life into the EU-Turkey relationship, albeit briefly.

That relationship has deteriorated sharply since 2005, when Turkey (with Erdoğan as prime minister) began its EU accession negotiations. Back then, Turkey had just abolished the death penalty – a prerequisite for EU membership – and approximately 60% of Turkey’s citizens looked favorably on European integration. Today, however, Erdoğan advocates reinstating capital punishment, and less than 40% of the Turkish population favors accession to the EU.

The stalling of Turkey’s EU accession process reflects several factors. After welcoming ten new members, mostly from Central and Eastern Europe, in 2004, the EU succumbed to a sort of “enlargement fatigue” that was aggravated by the 2008 global financial crisis (only Croatia has since joined the EU). During this time, the European project entered a more introspective phase and, bewilderingly, an ethno-religious interpretation of European identity began to take hold. The Turkish writer and Nobel laureate Orhan Pamuk lamented that Europe was “turning away from Turkey.” For ardent Europeans like him, the Great Recession was the prelude to the Great Frustration.

Meanwhile, Erdoğan was busy consolidating his power, a seemingly limitless task that continues to preoccupy him to this day. His tightening grip on the state has led to the erosion of many of the basic pillars of Turkish democracy, such as freedom of the press. Although the EU has condemned this trend, there is no denying that illiberal governments have emerged within the bloc itself. After a controversial 2017 referendum in which Turkish voters narrowly endorsed a shift to a presidential system, one EU leader broke ranks to congratulate Erdoğan: Hungarian Prime Minister Viktor Orbán.

Like Orbán, Erdoğan specializes in bold moves aimed at mobilizing public opinion in his favor, even when this means performing a volte-face. The West has not been the only party injured as a result of his wayward behavior. Erdoğan’s pretensions in Syria, for example, have done away with his government’s earlier policy of “zero problems with the neighbors.” And at home, his increasingly personalized rule has taken a toll on Turkey’s economy, impoverished public debate, and left the public deeply polarized.

Yet, despite all this, Turkey remains a dynamic and pluralist society, with an extraordinarily resilient democratic spirit. This was illustrated by the outcome of the recent rerun of the municipal election in Istanbul, ordered after Erdoğan’s Justice and Development Party (AKP) was narrowly defeated in the original vote in March. Relentless and tireless, Istanbul’s citizens returned to the polls en masse in June and gave Ekrem İmamoğlu, the main opposition candidate, an irrefutable victory. Thanks to a positive campaign loaded with cross-cutting messages, İmamoğlu won the AKP’s most emblematic stronghold, which the party had governed since Erdoğan himself became mayor in 1994. The president’s dictum that “whoever wins Istanbul wins Turkey” has a very different implication today.

Much like the state of Turkish democracy, relations between Turkey and the West are damaged, but not beyond repair. Erdoğan seems to believe that his country’s geostrategic importance will allow him to continue pulling the cord without snapping it. But he does not have carte blanche: after all, Turkey also needs the West. The fact is that the two are condemned to get along; there are plenty of shared challenges, and thus also opportunities for cooperation. The discoveries of gas reserves in the Eastern Mediterranean may yet provide an incentive to restart peace negotiations in Cyprus, while giving a new impetus to EU-Turkish rapprochement.

Turkey’s attitude toward the West will not become more constructive overnight. But the potential for such a shift is there, as recent – and not so recent – political developments have shown. Let us remember that Turkey’s earlier pursuit of the European dream brought the likes of the Islamist Erdoğan and the secularist Pamuk closer together, despite their deep differences.

Unfortunately, that dream, along with everything it represented, has been deferred for now.

But it will never be too late for Turkey to bet on unity – and on European unity.


Javier Solana, a former EU High Representative for Foreign and Security Policy, Secretary-General of NATO, and Foreign Minister of Spain, is currently President of the ESADE Center for Global Economy and Geopolitics, Distinguished Fellow at the Brookings Institution, and a member of the World Economic Forum’s Global Agenda Council on Europe.