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from stratfor.com
Summary
The markets are in the midst of a major correction, but that does not (yet) mean a recession is imminent.
Analysis
All of the major global stock indices have plummeted for the past week, with the United States’ consumer price index (CPI) report of May 17 serving as the trigger.
The CPI is the leading measure of U.S. inflation, and the May 17 report pegged its April value at 0.6 percent. High inflation means that the U.S. Federal Reserve Board will need to ratchet up interest rates to slow consumption in order to get that inflation back under control. The side effect, of course, is slower growth. So, from the markets’ point of view, high inflation in the superpower’s economy means higher rates, slower American growth – and since the United States is the No. 1 global importer, slower growth worldwide, too.
The current American expansion is now in its 19th quarter. Eleven of the past 12 quarters have seen growth above 3 percent, and strong and irrational growth in China has taken energy and commodity prices to heights of insanity. A bit of a breather is thus probably in order.
And a breather is certainly being taken. All of the major global and regional stock markets have fallen by at least 4 percent, and commodities are taking similar hits: Oil and gold are down 6 percent and 8 percent from recent highs, respectively.
This does not necessarily mean a recession is imminent, but it is indeed likely that global growth is cresting.
For the CPI report to be confirmed as the first omen of a U.S. recession, however, two other things must happen. First, a single market sell-off – even one as extreme and broad-based as the current one – rarely is alone in preceding a cyclical downturn. Before a recession, there generally is a rebound and then a second sell-off. Such a double dip is what we are now looking for.
Second, there would need to be an inversion in the yield curve. In its simplest sense, an inversion in the yield curve means getting money for short-term needs is harder than getting it for long-term needs – the inverse of “normal conditions” when long-term risks are considered greater than short-term risks. Put another way, money begins being treated irrationally, and as such, a market correction ensues.
The yield curve inverted very briefly in January, but has been broadly flat since. If the United States is indeed over the horizon of a recession, U.S. markets need that second dip and the yield curve needs to take on a decidedly different bend.
If that is the case, this expansion still has a few months of kick left to it. Double dips rarely happen within a month of each other, and from the point the yield curve inverts to the point a recession begins is rarely less than six months. The year 2006, as we noted in our annual forecast, will be a banner year.
But 2007 is looking sketchier by the day.
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