The GCC will feel the effects of the coming US recession

Reuters

The US economic cycle has a disproportionate impact on the GCC states for multiple reasons. 

The Gulf’s US dollar peg means that regional central banks shadow the US interest rate cycle.

A US recession invariably leads to a business slump in the GCC since it also triggers a collapse in crude oil prices, risk aversion on Wall Street and asset contagion in the equities and credit markets worldwide. 

The GCC states learnt this lesson the hard way during the 2001, 2008 and 2020 recessions. My analysis suggests the $27 trillion US economy is on the precipice of another recession in the next six months. Why?

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US retail sales in May were a shocker, up a mere 0.1 percent. 

This figure is ominous since US GDP growth, 3 percent last year as a result of the Biden White House’s epic 25 percent expansion in the Federal budget deficit and double-digit growth in credit card debt, has now plummeted to only 1 percent in the second quarter of 2024. 

The trend is unmistakable. We are headed for zero, even negative growth by year-end 2024. The overnight borrowing rate (Fed Funds) has been higher than the 10-year US Treasury note yield for the longest period since the Volcker Fed in the early 1980s. 

The Powell Fed’s swiftest, most draconian interest rate hikes in 40 years have now hit consumer confidence and retail sales in an economy where consumer spending is 70 percent of GDP.

The $1.3 trillion credit card market is the same size as the subprime mortgage market was in 2007 and now exhibits the same systemic risk metrics.

• We need to talk about the American debt spiral
• Is it back to the 1970s as global macro storm clouds loom?
• A looming US fiscal crisis could hit the Gulf hard

The level of 90-day credit card delinquencies has spiked to the levels of 2009, when the unemployment rate was 9 percent and the global economy was in its post-Lehman ice age. 

Vehicle repossessions have spiked 22 percent in the past three months, not exactly a bullish omen for auto loans. New York Fed data now shows that these default rates have forced lenders to cut back on credit card and auto loan limits. This is how a credit crunch begins.

The Federal Reserve’s tight money obsession in the past two years has led to dollar strength on a scale that is now hurting global trade, a classic proxy for recession risk.

King Dollar has wreaked havoc in Asia, where weaker currencies have led to higher import costs at a time when the prices of crude oil, food and logistics have moved higher. 

I do not believe in Tinkerbell and thus do not believe in business cycles that never end

Ironically, in the GCC, a strong dollar reduces import inflation. Even Japanese exporters, beneficiaries of a currency windfall, are now experiencing higher supply chain costs for manufactured products.

Average input costs in Chinese factories have risen at a time when the property/shadow banking distress mires its $18 trillion economy in a 1990s Japan-style deflation nightmare. 

Three trade metrics now flash a recession SOS: the plunge in Hong Kong container throughput, US new export order contraction and dismal German business sentiment.

Why has the Fed ignored the telltale signs of recession? Jay Powell’s credibility was hit badly on Wall Street after he kept insisting that “inflation will be transitory” even as the consumer price index spiked to 9 percent in June 2022.

Powell is thus understandably reluctant to risk an inflation resurgence due to a mistimed Fed rate cut. Unfortunately, time, tide and the credit cycle wait for no man – even if the man is the most powerful central banker on the planet.

• Oil’s inverse correlation to the dollar could return
• Tax on foreigners may be axed to boost Saudi bond market
• Rise in startup exits a sign of UAE’s ‘market maturity’

Milton Friedman won his 1976 Nobel Prize in Economics for his insight that monetary policy works with long and variable time lags. This is exactly why it took two years for the US economy to swoon after Powell unsheathed his monetary sledgehammer in the summer of 2022.

I do not believe in Tinkerbell and thus do not believe in business cycles that never end either.

The Biden White House cannot deliver a fiscal lollipop to the consumer since the Federal Budget deficit is already $2 trillion or 7 percent of GDP. In any case, the US budget deficit has risen 4-6 percent in every US post-war recession.

One thing is certain: this US economic cycle will end not with a whimper but a bang that will be heard across the world.

The Fed will scramble to slash the overnight dollar rate from 5.5 percent to near zero since it can no longer expand its quantitative easing-bloated $7.5 trillion balance sheet. This plunge in short dollar rates will then lead to an epic fall of the US dollar against the Japanese yen. 

Bank deposit rates in the Gulf will plunge as the Fed pivots to easy money and the big chill of global recession hits the Gulf. Borrow long, lend short!

Matein Khalid is the chief investment officer in the private office of Abdulla Saeed Al Naboodah and the CEO designate of a venture capital firm. He is also an adjunct professor of real estate investing and banking at the American University of Sharjah