Ambrose Evans Pritchard in the Daily Telegraph every Wednesday - a great read for big picture analysis.
The global manufacturing downturn is spreading to the once-resilient service sector in a string of countries, threatening to tip the world economy into a broad recession unless there is a swift response from the authorities.
IHS Markit said the US service industry saw the sharpest drop in headcount since late 2009 last month as firms battened down the hatches and cut excess capacity. Companies are being forced to lower prices to hold onto market share.
“The US slowdown signals are multiplying,” said James Knightley from ING. “We were well aware of the problems in manufacturing given the trade war, but it is clear that there are problems brewing in other sectors. The latest developments will keep the pressure on the Federal Reserve to ease monetary policy further.”
Germany’s service sector finally buckled as well in September after seeming to shrug off the manufacturing slump and the crisis in the car industry for most of this year. The inflows of new work are falling in absolute terms. "The slowdown was even worse than first feared. A technical recession now looks to be all but confirmed,” said IHS Markit.
While the eurozone as a whole is still above water, service growth is barely enough to offset the industrial contraction. The currency bloc is now perched on the boom-bust line and vulnerable to the slightest economic shock. “There’s little doubt that winter has arrived for Europe, but the big question now is whether it is mild or harsh,” said Nomura.
The Federal Reserve still has room to cut interest rates and relaunch quantitative easing but it may have waited too long to preempt metastasis as the economic cycle sputters out, given the long lags before monetary stimulus filters through.
The Powell Fed has come under heavy criticism for claiming that the US economy faces no more than a ‘mid-cycle’ slowdown and requires no more than precautionary rate cuts. The deeply-inverted yield curve in the bond markets suggests that the underlying threat is more serious. Recessions begin on average nine months after the curve inverts. This episode started in May.
The Fed continued to sell bonds and shrink its balance sheet (QT) long after stresses began to emerge in the funding markets, and especially in the $2.2 trillion ‘repo’ segment that plays such a vital role in lubricating finance.
This has led to a global dollar shortage and transmitted a shock through the offshore funding markets. It has tightened conditions in Europe and Asia, and compounded the global damage from the US-China trade war. The New York Fed is now injecting liquidity but the level of excess reserves in the banking system is still too low.
The European Central Bank is close to exhaustion under current policies and legal limits. A study by Bank of America warned that the spectre of “quantitative failure” now looms over global markets as negative rates and ever more convoluted forms of monetary stimulus start to do more harm than good.
Barnaby Martin, the bank’s credit strategist, said the ECB’s actions are becoming counter-productive. “Households and corporates are saving more not less, debt is being repaid not utilised, and banks are tightening rather than easing lending standards,” he said.
Household saving rates in the eurozone have been rising since late 2017 as people put aside more money to make up for lost interest. They have risen 1.1 percentage points in Germany to 11pc.
Companies have also been saving more, paying down debt and hoarding cash as a safety buffer. This may now be distorting eurozone money signals. Shweta Singh from TS Lombard said the seemingly robust growth of the M1 money supply - 8.4pc year-on-year - is not as healthy as it looks.
“Firms are not raising their cash holdings in anticipation of a ramp-up in capex. Instead, they are turning increasingly cautious about access to credit. The ECB’s bank lending survey shows a tightening in loan standards for the first time since 2014,” she said.
Fiscal policy will have to take much of the strain from now on but there are barriers on both sides of the Atlantic. The US fiscal stimulus is fading and will turn to net contraction of 0.5pc of GDP (annualised) this quarter. The Democrats in Congress are in no mood to extend President Donald Trump a lifeline by agreeing to fresh round of budget largesse - except on their own political terms.
Europe has ample scope to boost spending but is hamstrung by the Stability Pact and Fiscal Compact. Any stimulus is likely to be piecemeal and too late to head off a deepening downturn.
Giovanni Zanni from Natwest Markets forecasts net fiscal expansion for eurozone as a whole of 0.4pc in 2020, led by the Netherlands (0.8pc), Germany (0.4pc), Italy (0.3pc) and France (0.1pc). Other forms of ‘quasi-fiscal’ support will ultimately kick in from green funds.
It helps but it is not enough to counter the sledge-hammer blow of a full global downturn, should that occur. Much therefore depends on Donald Trump’s state of mind as the impeachment noose tightens.
If he opts for a quick trade deal with China and dials down his threats against Europe the relief may be enough to unleash a wave of pent-up spending by companies and to restore animal spirits worldwide. If not, the mounting contagion from manufacturing to services may prove unstoppable.
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