J.P. Morgan

2 Other characteristics are adding to recession fears. The Federal Reserve reversed course from its rate hiking campaign that began in December 2015 by lowering interest rates at the end of July. In the past, rate cutting cycles have started in response to rapidly deteriorating economic conditions. Globally, manufacturing and trade data are suggesting very weak levels of activity, and the tit-for-tat escalation of the trade dispute between the United States and China is damaging sentiment and adding to uncertainty because it threatens to undo the benefits of globalization that took decades to develop and accrue (Exhibit 2). EXHIBIT 2: TRADE WAR HAS BROUGHT U.S. TARIFF RATES BACK TO 1970 LEVELS U.S. effective tariff rate, (duties collected/total imports) Source: Esteban Ortiz-Ospina and Max Roser, "International Trade," U.S. International Trade Commission, USITC, U.S. Census, JPMAM. September 3, 2019. WHILE WE AREN'T DISMISSING THESE FACTS, WE BELIEVE THAT THE FEAR OF IMPENDING RECESSION IS OVERBLOWN Based on our interpretation of the last few decades of economic history, an economy ends up in recession 1 because punitive interest rates render imbalances untenable. Said differently, over- extended sectors of the economy (think commercial real estate in the early 1990s, tech valuations in the early 2000s or the housing market in 2007) unwind because borrowing costs restrict further investment and investors' previous return assumptions turned out to be too optimistic. For every boom there is a bust. Today, we don't see credible evidence that interest rates are overly restrictive or that there is an imbalance large enough to impact the domestic U.S. economy as a whole. On the contrary, the Fed's pivot toward accommodative policy has driven borrowing costs lower. The only imbalance with a magnitude that could threaten the economy as a whole is non-financial corporate debt. Importantly, the accommodative interest rate environment reduces the risk that corporate borrowers will be unable to pay their debt service. 2 To be clear, there are serious growth problems in manufacturing and other sectors exposed to the production of goods. However, manufacturing contributes less than 15% of value added to overall U.S. gross domestic product. Services, which look much more stable, are around 70% of GDP. Finally, consumer confidence, income and spending all look to us like they can sustain a healthy, albeit historically modest, pace of growth. 1 What is a recession anyway? This is one that is trickier than you might think. The definition that most know is a "technical recession": two back-to-back quarters of negative growth. This one is easy because it is standard and objective. The problem is that most people in the United States (whether they realize it or not) actually rely on the National Bureau of Economic Research's definition of recession. Theirs is much more subjective: "The NBER does not define a recession in terms of two consecutive quarters of decline in real GDP. Rather, a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales." For the purposes of this piece, we define a recession as a meaningful rise in the unemployment rate, a decline in spending in the cyclical sectors of the economy, and significant losses in risk assets such as equities and high yield bonds. No matter the definition, we don't think the economy is on the brink of "recession." 2 This point is further demonstrated in Japan's unusual multi-decade low interest rate environment. Japan has seen a drastic collapse in growth since the late 1980s, but because rates secularly collapsed, the corporate sector has not experienced one visible default cycle. Indeed, since then, the average default rate for Moody's-rated Japanese HY issuers was just 1.0% vs. 4.6% globally.

• Cover