Recession and the US Government's space to restrain recession

Will the US economy experience a recession?

In the latest PODCAST, Steve talks with Dan and Linh Hà, PhD candidate in Economics in Italy, about the global economic situation, inflation, economic recession probability, and the direction of the Federal Reserve.

Last week, US banks officially recorded losses on financial reports from commercial real estate loans and investments. This is the first action clearly indicating signs of stress in the overall economy and capital markets in particular. 

Other stresses in the capital markets have been summarized by Viet Hustler in last weekend's Macroeconomics article. In particular, Viet Hustler also emphasized that these stresses could be the source of a credit crunch and recession for the US economy if the Fed continues to keep interest rates high for longer.

Last week, the small and medium-sized business sentiment survey also showed similar content. In particular, this is the first group of businesses to feel the difficulties of the US capital crisis.

Against the backdrop of the Fed becoming more hawkish, this weekend's economic article by Viet Hustler returns to discuss recession probability from the business perspective. And next, a more macroeconomic view on the US government's policy space if a recession really occurs.

Credit crunch for small businesses and recession probability

If at the end of 2023, the market was still waiting for the Fed to cut interest rates, now the market accepts an economic scenario where interest rates will be maintained high in the long term:

Businesses have borrowed again at high interest rates without waiting for the Fed to cut rates because they have accepted the reality of a long-term high interest rate environment:

• When interest rates are unlikely to decrease significantly in the near future.

• And they cannot bet their entire business just to wait for the Fed to cut once (-25bps) in the year.

Even though businesses have accepted a more difficult business environment, the real major pressure falls on small businesses — unable to compete for debt on the bond market.

According to the NFIB survey of small businesses:

• The small business confidence index for March 2024 hit the bottom since 2011 - and equivalent to levels during previous recessions:

• In which, the pessimistic sentiment is mainly due to current interest rates having risen +75-+100% compared to the average interest rate over the past 5 years (blue column).

  

• Banks are also tightening lending conditions, making it even harder for small businesses to access capital:

  

• Therefore, small businesses have limited additional investments:

  • The proportion of businesses planning to increase Capital Expenditures (CapEx) for investing in factories and business operations has dropped to only 20%.

  • This figure is equivalent to times of economic crises or recessions.

    

• And if small businesses cut CapEx today, it means the Private Investment component in GDP in the coming months will decline:

  

CapEx cuts are not entirely due to capital raising difficulties. If they still have market demand, they would still be willing to borrow at high rates to produce:

• However, in reality, one of the concerns of small businesses according to the NFIB survey is declining sales issue (yellow column):

  

• Actual sales growth (inflation-adjusted) for the small business group is negative growth – much lower than expected sales:

  

Of course, people might say it's just the small business group?

• However, in reality, 60% of businesses in the US are small businesses (with fewer than 10 employees).

• Therefore, this small business group also drives indicators on wage growth, labor, and employment.

• And the business cycle is always tied to the hiring cycle: when consumer goods demand decreases => businesses scale back production => May lay off employees.

  

• In previous surveys: small businesses were still quite optimistic when setting fairly high hiring plans (blue chart line).

  • But reality shows their hiring activity is much lower than initial plans (black line):

  

(The above NFIB report compiled by Real Investment Advice -abridged translation and some comments from Viet Hustler)

If a recession really occurs… then what?

If a recession occurs alongside high inflation: The US government does not have as many options as before to escape the recession!

• If a recession occurs: the first thing the Fed can do is lower interest rates.

• However, if at that time inflation is still not fully controlled, then the last resort is fiscal policy — issuing relief packages to the people and stimulus.

• But with public debt rising high, and budget deficit up to 5.93% GDP, the US government no longer has much space for recession relief policies:

  

Tax revenue in April was only enough to cover about 73% of federal government spending.

• The remaining 27% still needs to be financed by debt through Treasury bonds:

  

However, demand for US Treasury bonds is gradually decreasing:

• Typically, the three consecutive auctions of medium- to long-term bonds last week all failed.

  • Read more: Bond auction results on 04/11.

• FYI: Over the past 9 out of 11 months, the amount of US Treasury bonds (US T-bond) held by Chinese investors has continuously declined:

  • Specifically, in February 2024, it decreased by - USD 22.7 billion. 

  

  • Although it's just an uncertain correlation, China's reduction in holdings of US Treasury bonds over the years coincidentally coincides with the trend of rising yields on the benchmark 10Y T-bond.

    

  • Also since 2015, Russia and China have unexpectedly increased their gold reserves, accompanied by gradually phasing out US T-bond from their foreign exchange reserve portfolios.

    

  • And not just China, global gold reserves are also increasing day by day, while the amount of US T-bond held by international organizations remains flat.

    

• T-bill yields: the world's safest financial asset (safe haven) has surged and is now 381% higher than the dividend yield of the S&P500 basket.

  

• The US government's average borrowing cost is gradually rising along with the massive outstanding debt:

  • The Federal government's interest payment costs have reached 3.67% of the entire US GDP!

    

CONCLUSION

Last week's small business sentiment report has added to the list of signs of stress in the capital markets that Viet Hustler presented in last week's article.

In particular, small businesses anywhere are always the first to feel the decline in consumer demand as well as pressure from the capital environment. 

And the NFIB report shows that these two major concerns (about sales + borrowing costs) of small businesses have warned of an upcoming downturn in the US economy in the near future. Whether the US enters a recession or achieves a complete soft-landing depends entirely on whether the Fed cuts interest rates 'enough' this year.

So the question is, if the US cannot avoid a recession and the Fed fails to cut rates in time, what other tools can revive the economy? The main answer is fiscal policy!

However, with a fiscal deficit of nearly 6% GDP and high government interest payment costs (accounting for 3.67% GDP), the US government will really have very little room for stimulus policies.