Recession Threat Is Back—and Maybe Something Worse
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Hello, listeners. Meryn Thumbs at Web here. Just wanted to remind you that if you are enjoying our weekly podcast, and I do hope you are, you'll also probably really enjoy my weekly newsletter for Bloomberg subscribers. It hits inboxes every Saturday. This past week, I wrote about Latin American markets and why they're undervalued, under-owned, and very, very poorly labeled. So check out the link in the show notes for how to subscribe to the newsletter. It does mean signing up for a .com subscription, but I promise you it is

worth it. You will also get access to John's Money Distilled newsletter and informative and actionable stories from more than 2,700 journalists worldwide. Right, on to this week's show.

Welcome to Merrin Talks Money, the podcast in which people who know the markets explain the markets. I'm Merrin Somerset Webb. This week, I'm speaking with Peter Bereson, Chief Global Investment Strategist at BCA Research. That means he heads up the team at BCA that provides global economic and financial market analysis to its clients and helps them shape their investment decisions. Peter has been an economist for more than three decades, previously worked at the IMF, the International Monetary Fund, and at Goldman Sachs. So we wanted to get Peter on partly because we read a

all his work, religiously, Peter, by the way, religiously. We wanted to get him on to talk about the global economic outlook. Back in March, he was very clear that he felt the recession odds for the US were still high. His year-end S&P target is 4,450. That is quite a drop from the current level, which is still knocking around 6,000, a 25% drop, actually. Is he still bearish on the US? What impact does he think Trump's trade policies will have? Is there a bigger risk than trade?

And what does the end game for markets in the US and elsewhere look like right now? Peter, that's going to take an awful lot longer than the 35 minutes that we've got. So if you could talk really fast, I'd appreciate it. I'll do my best. Welcome to Merring Dogs Money. Thank you very much for coming on.

Why don't we start then with the U.S. economy and this recession risk? Your latest piece puts the recession risk for the U.S. at about 60%, right? But we have been waiting for this recession for a long time. Yeah, that's right. So back in 2022 and 2023, I was one of the few optimistic strategists making the case that the U.S. was not

and any great danger of recession. And then late last year, and certainly into this year, I moved into the recession camp. And the reason I did so was because I argued that a lot of the insulation that had protected the U.S. economy had worn thin. So back in 2022, there were millions of excess job openings. Anyone who lost a job back then could walk across the street and find new work, and that prevented unemployment.

from going up. There were over $2 trillion in excess pandemic savings. And so when the Fed began to raise rates, inflation rose. Households just kept on spending. Now things aren't so simple anymore. Those job openings have receded. The pandemic savings are gone. Consumer delinquency rates are rising. And on top of that, we've got all these

threats from the trade war, from the bond market. So I do think that the risks of a recession this year are higher than they would normally be. Yeah, although we do still keep seeing numbers that suggest things are just fine. And we know that consumer confidence levels are low, but consumers are still really spending in the US. And the recent job numbers were fairly encouraging, right? So we do keep seeing better than expected data just keeps going.

We do, although there has been a slowing in consumer spending this year. There's also been a slowing in the labor market. I know we got pretty good numbers on payrolls for May, but those numbers are likely to be revised soon.

What we've seen since the start of 2024 is that on average, past payrolls have been revised down by about 50,000. That doesn't even include the benchmark revisions we know from the census's quarterly data that was just released last week.

that payrolls were overstated by around 75,000 per month in the final three quarters of last year. So 50,000 plus 75,000 in future revisions basically gets you down to close to zero potentially on the May payrolls when all the data has been cleaned up. So I think we are still seeing it's not a dramatic slowdown, but there certainly is a slowdown that's taking place as we speak.

What about this idea that fast-falling immigration in the U.S. may turn into something of a supply shock and that you end up with a fairly dramatic reduction in the growth rate of potential workers, which could lead to rising wages, a tighter job market, etc.? I mean, a supply shock, really, in the same way as we've seen over the last four or five years, but in a different category. A lot depends on how quickly the slowdown in immigration occurs.

Of course, we have like millions of people being deported. That would be a supply shock. If it happens more gradually, then it's not entirely clear whether demand or supply will dominate. And the reason I say that is because if you reduce immigration, then of course, arithmetically, you're reducing labor supply. But those immigrants spend. They spend money on food. They spend money on clothing. They spend money on shelter. So they contribute to demand.

in other words. And in the near term, it's not really clear how you balance out those. Right. Well, let's look at the threats then. And one of the things that everyone worries about, of course, is the effective tariff rate we're going to end up with and exactly how that will impact the U.S. economy. How are you feeling about that at the moment as a recessionary risk?

Well, right now, the effective tariff rate in the U.S. stands at about 15%, which is quite high. I mean, we went into this year with an effective tariff rate of like 3%.

or so. So 15% is kind of in the same ballpark as to where tariffs were in the 1930s. But a much lower level of imports as a percent of GDP in the 1930s, so the impact lower. Well, imports as a share of GDP are about three times as high now as they were in the 1930s. So the fact that we have the same

tariff rate actually does more damage to the economy today because trade as a share of GDP is larger today than it was back then. So that is going to impact on growth. Well, if you look at the estimates that the Yale Budget Lab and others have done, if current tariff rates remain in place,

This will reduce household income by about 2% for the median U.S. household, which is not a trivial shock. 2% is a meaningful decline in income. Now, of course, the Trump administration is hoping that

that China ends up eating the tariffs rather than U.S. importers or U.S. consumers. We don't really see any evidence for that hope in the data. We now have a few months of data on Chinese import prices. This is data calculated by the U.S., not by China, by the way. And what we've seen is that basically Chinese import prices are down about 1%.

prior to the imposition of tariffs. So it's really U.S. importers that have been shouldering the burden of the tariffs. Consumers, not so much so far, but as we've heard from Walmart and others, if these tariffs remain in place, then they're going to have to pass on the cost of

of the tariffs to the ultimate buyer, the consumer. Okay, so there will end up being a feed-through into inflation. Yes, yes. In fact, the CPI swap market is saying that inflation is going to rise by around a percentage point over the next 12 months. That's a meaningful increase in inflation. But

You also think there's an even bigger risk, as you put it in a headline recently, lurking around the corner, something much worse than trade war. And I think everyone knows what that is. It's the dynamics of U.S. government debt, which are increasingly out of control and with the big, beautiful bill on the way that may get worse.

And that's your big worry at the moment. Yeah, I think the market has taken comfort in this kind of notion that Trump is pivoting away from tariffs and focusing on tax cuts. Now, of course, that would be good.

if the bond market did not react negatively to the prospect of more unfunded budget deficits. But what we've seen, both in the bond market and from the U.S. dollar, is that investors are getting a little bit skittish about the current level of deficits. We estimate that if the big, beautiful bill passes, the budget deficit will rise to

close to 8% of GDP over the next few years. From around 6.5% at the moment. From around 6.5%, yes, that's right. Now, it's supposed to come back down after a couple of years because of various cuts to social programs, but the reason those cuts were inserted later on into the 10-year budgetary horizon is because they're politically unpopular, so they might never actually end.

end up taking place, which is often the way things go in Washington. So the problem is that you've got a budget deficit, let's say seven and a half to eight percent of GDP, and you need something closer to three and a half percent just to stabilize the debt-to-GDP ratio. And so you've got this completely unsustainable trajectory in debt-to-GDP. And on top of that,

fairly high interest rates. And I think that's the big difference from where we were a few years ago. A few years ago, we also had high debt to GDP, but interest rates were very, very low up until 2022. Now we've got this toxic combination of high debt and

High interest rates. And as a consequence, the amount of interest that the federal government is currently paying stands at about 3% of GDP, up from around 1.5% of GDP per capita.

During Trump's first term. And if you look at where interest expense is going, if bond yields evolve with market expectations and the big, beautiful bill passes, we're talking about 6% of GDP in interest expense over the next decade.

That would be completely unprecedented in U.S. history. At that point, about one-third of government revenue would be going just to pay the interest on the debt. So something needs to break. This can't continue in its current form.

form. And yes, it sounds a lot like that story about the boy who cried wolf. People have been talking about a debt crisis for many years. It hasn't happened. But of course, in the story, the boy does get eaten at the end. And so I think that, unfortunately, is where we're heading. I don't know if it's this year or next year, but it's getting increasingly close.

We talk a lot about how the fiscal situation of the U.S. is unsustainable, same with the U.K., with other European markets, etc. But let's focus on the U.S. When we say it is unsustainable, completely unsustainable and something must change, what do we mean? What must change? How can it change?

Well, the deficit needs to come down. It's as simple as that. And that can happen either because spending is cut or because revenue goes up.

Now, in practice, I think it's very difficult to cut spending because most of what the government spends on is government programs such as Medicare and Social Security, defense. Not a lot of political support in cutting that. Certainly not social programs for Democrats and not social programs or defense programs.

for the Republicans. Raising taxes is a non-starter for many Republicans. The Democrats probably are a little bit more amenable to that. And so if you can't cut spending or raise taxes, all you can then really do is hope for growth. And unfortunately, that's sort of the direction in which the current administration is going. They're saying, we're not really going to cut the deficit in dollar terms, but we're going to grow the economy massively, uh,

And that's going to fix all our problems. Of course, if growth does go up to 3%, 4%, that would fix a lot of problems. But it's not clear where that growth is going to come from. As the administration itself has admitted, much of what is in the tax bill just goes towards extending the expiring tax cuts so existing policy doesn't change. And the other tax cuts, no taxes on tips, no taxes on overtime taxes,

the SALT deduction, that's generally focused on households. It's not so much focused on businesses. I mean, there are a few things for businesses in the bill, but it's mainly focused on households. So it's not really obvious why trend GDP growth would go up a lot as a result of the big, beautiful bill. In fact, it could be quite the opposite to the extent that these big budget deficits raise interest rates and that crowds out private investments. That could

reduce trend growth in the United States. When we say unsustainable, what is the end game question? Because, you know, it's perfectly true that there is no appetite to cut spending, there is no appetite to put up taxes, and it's not a given that growth will come through. So what is it, what level of yield, for example, what is it that might persuade an administration or force an administration to actually do something about the situation as it

currently stands rather than to wibble away about future growth. There has to be a crisis of some kind, right? What counts as a crisis? I don't know if you need a full-blown crisis. You could have something similar to what happened in both the U.S. and

Canada in the early 1990s, where yields were very, very high. The budget deficit was lower than it is today. But nevertheless, because yields were 7%, 8%, that was pushing up the interest expense on the debt quite a bit. And you had the

Tax cuts that George Bush famously was forced to introduce, breaking his new taxes pledge. And in Canada, we also had the GST, the government sales tax, general sales tax. And so revenue was found and the deficit declined.

And the bond vigilantes went away. That didn't really require a crisis, but it did require market pressure. You could, of course, have a more adverse scenario where there really is a crisis, where bond yields start rising. Investors panic, dump the bonds, and that causes the yields.

to continue rising. That could happen as well. But either outcome would probably lead to the final result, which is that the budget deficit goes down in one form or another. Via either spending cuts or the tax cuts are things that people have no appetite for until they're forced to have an appetite for it. That's right. That's right. Yes.

I'm guessing, Peter, that you are a little more pessimistic about the U.S. equity market than perhaps some of those more bullish commentators. Yeah, I mean, if you look at valuations right now, the S&P 500 is trading at about 21.5 times forward 12-month earnings.

And those over-earnings assume record high profit margins. So it's a pretty optimistic set of assumptions that are driving equity prices today. Now, of course, if earnings do rise from current levels,

That would be fine. But that hasn't really happened this year. Earnings estimates have sort of been flat. They went down in April. They recovered in May. But we're close to where we were in, say, January. I think it's unlikely that we would get meaningful increase in returns.

earnings estimates, unless growth really ends up being quite strong. And that is unlikely, given the slowing in the labor market, given the hangover from the trade war, and the fact that bond yields remain quite elevated. So I think probably in the best case scenario, if we avoid a recession, then the S&P goes up maybe 5% or so. But if we don't avoid a recession,

then you have to ask, how low could the stock market go? Well, let's talk then about where other people's optimism lies. And still, even now, a lot of it lies in AI on the huge potential for this sector to pull not just the stock market, but the economy along. The idea that we really will have the great productivity revolution we've been waiting for for so long. That will drive growth, that will drive company earnings.

that will make the valuations that we're paying today in the US look like nothing and everything will be absolutely fine. Where do you come down on the AI story? Well, right now we don't see the gains from AI in the productivity statistics at all. It's actually been really, really weak. Now, maybe AI does boost productivity. I think that's entirely possible. But even if it does, that's no guarantee that it will boost productivity.

profits, which is what matters for the stock market. And the internet period is a good example. U.S. productivity did increase in the mid-1990s and stayed fairly high for about a decade until about 2005. But it was only around 2005 that the profits began to finally materialize. And there was a long lag between productivity and profits. That could happen with AI as well.

Okay, so not madly optimistic there in the shorter term. The other thing I suppose to talk about is that there's an awful lot of reasons why foreign investors might want to start applying a slightly higher risk premium to the US than they have previously, or risk premium at all, given they haven't really considered there to be much risk.

You have the things that we've already talked about, the uncertainty around tariffs. We have the uncertainty around the debt and the fiscal position and, of course, the general uncertainty around the current administration. And then, you know, we all woke up this week around the world to the pictures of L.A. burning, whether which parts are burning or not burning or exactly how bad it is. It's hard to tell from far away, but nonetheless, you see the pictures.

And you look at that and you can see people who have an awful lot of money invested in the U.S. market. We were looking at these statistics the other day, by the way, and really interesting because it is only the last four or five years that foreign investors have really poured money into the U.S. And as the risks begin to accumulate or appear to accumulate, it might be quite a fast move out.

Yeah, I think that's definitely the risk for the U.S. dollar. And the dollar, despite the fact that it's weakened over the last few months, still remains a fairly expensive currency. And so if this notion of U.S. exceptionalism fades, it doesn't have to completely go away. But if investors decide that U.S. economy is going to be less exceptional than it was in the past, I

That will justify a smaller growth premium to U.S. assets, which means capital is going to flow out and the dollar could weaken further. So structurally, I am fairly bearish on the outlook for the U.S. dollar.

Okay, so if money flows out of the dollar, which currency and which market does it flow into? Well, I mean, of course, if the dollar weakens, it has to weaken against something. So most likely it'll be the euro, maybe even the Japanese yen. The Bank of Japan seems to be finally able to raise rates now that inflation increased and these deflationary pressures have abated.

might flow into other developed economies such as Canada, Australia. Now, it's true that all of these countries have their own problems to contend with. And so that doesn't mean that their currencies are going to skyrocket. But the margin they could strengthen vis-a-vis the U.S. if the –

underlying drivers that have compelled foreigners to buy U.S. assets become less appealing. And if money flows out of U.S. equities, and when you say you're mildly underweight equities, I think what you mean is that outside of holding fewer U.S. equities and would suggest holding fewer U.S. equities and cash and bonds, you're not talking about diversifying into other equity markets. But if you were diversifying

which equity markets would you consider to be attractive at the moment or interesting? In terms of where would that money go? You know, in a global recession, it's hard to see...

other stock markets doing well. If anything, most non-U.S. markets tend to be higher beta. When U.S. earnings estimates fall, they tend to fall even more in places like Europe and Japan. So you're not going to find a safe haven in most other major stock markets in a

and the dollar bear market resumes and valuations become more relevant for investors, then I think at that point, you're going to see Europe and other non-US markets outperform. But I think we have to get through the recession first.

Okay. I mean, our general feeling, I think, is that if U.S. markets fall by 25%, 20%, something like that, all other markets will fall too, of course, possibly even more. But the cheaper markets are likely to recover faster. Yeah. So Europe is cheaper. Japan is cheaper. China is cheaper. They also tend to be a little bit more cyclical. They tend to have more exposure to financials, materials, industrials. So sometimes it's a bit of a wash.

Okay. What about China? I think China is an interesting stock market. I mean, clearly China has done a fantastic job in terms of tech progress. Where I think the uncertainty still lies for investors is finance.

around corporate governance, politics, like are Chinese companies actually going to be able to make money for their shareholders? Or will all of this just be about maintaining economic stability and political stability? That's where the uncertainty lies. And I think that question mark over whether shareholders will capture the innovation coming out of China is a big question mark and does justify a discount for Chinese stocks.

Okay, so would you say that for you, maybe the Chinese market is always a trade, never a long-term hold? Right now, I would say it's more of a trade than anything else. If we have shifts in kind of corporate governance, then I think it'll go from being a trade to an investment. We have to see those shifts first.

When you think about markets, do you still think of them in terms of EM and DM, or do you have a different kind of category in your head? Yeah, I think that's becoming a bit of an antiquated label. I sometimes joke with our EM strategist at BCA, Arthur Burdakian, that maybe the U.S. is going to become an emerging market. Simply, if you look at how the dollar has traded, we've seen U.S. interest rates rise relative to those abroad. Usually that would...

signify a stronger dollar, but the dollar is weak. And because the US itself is having some of the same EM-related issues around debt and political stability that emerging markets have historically faced, whereas actual emerging markets today are in much better shape than they were a couple of decades ago when I was first working at the IMF and dealing with some of these issues. So yeah, I think you have to kind of go on a country-by-country basis now.

Yeah. And as you say, the so-called developed markets have no moral high ground on the political stability business at the moment. That's right. Yes. Across Europe, the UK, the US, etc. None of us are standing on particularly thick ice at the moment. Yes. Yes. Gold, silver, platinum, oil.

We're great gold bugs on this podcast and we're excited by the silver price now and we're excited by platinum. We're wondering what's going to happen in this market and if there is a safe haven out there, perhaps it's a yellow one. Yeah, I've generally been bullish on gold and I'm structurally still bullish. The price of gold is high, even in inflation adjusted terms, it's close to its all time at

peak. But I think when you're trying to value gold, and of course, it's difficult to value something like gold because it doesn't pay any income to its holders. I think what you have to do in that case is sort of look at gold holdings in relation to something like global wealth.

If you do that, what you see is that gold kind of looks cheap because global wealth has grown so much over the last 50 years that gold has not caught up. So as a share of global wealth, gold is much, much smaller today than it was in the early 1980s. Okay, interesting. I like that way of looking at it, share of global wealth. I'm not sure we've done those numbers before. We're going to do them. What about Bitcoin? Bitcoin?

We're talking the week beginning June the 9th and there's been positive Bitcoin news out of the US administration and the day we're talking Bitcoin is up 2% today. Are you positive long term on Bitcoin or indeed on any other cryptocurrencies? Well, I mean, Bitcoin is interesting because we just talked about global wealth and there's a large fraction of global wealth that people don't necessarily want to disclose. They want to maintain their wealth in as proxies.

private setting as possible. And Bitcoin does fulfill that demand. I wouldn't necessarily advise investors to own a lot of Bitcoin, but I can see the use case for it. Push comes to shove, I would choose gold over Bitcoin in the current environment. But certainly Bitcoin, I think at this point, does deserve to have at least a very small part in investors' portfolios.

Have you got any? I don't hold any, no. I've been sticking to gold. Yeah, well, I've got both. I've never been a big fan of Bitcoin, but I'm often wrong. So I like to hedge myself. So as we keep telling people, I get endless hate mail about being mean about Bitcoin, but I've actually got some. And half the people I talk to who aren't mean about Bitcoin just don't. Peter, is there anything we haven't talked about that you think we should talk about?

I think one question mark is around oil prices and where they go from here. I think if there's sort of a bullish case to be made for the U.S. consumer, that bullish case could at least in part hinge on the possibility that gasoline prices fall. And it certainly does seem as though OPEC is

is no longer able to maintain discipline. The Saudis, of course, understandably upset that countries like Kazakhstan have been exceeding their quotas. U.S. shale production still remains quite strong. Now, of course, the prices fall. For most shale players, you need oil of around $60 to $70 a barrel to make money by drilling. If oil prices were to fall into the $50 range,

That would shut down quite a lot of U.S. production. But nevertheless, I think it's worth stressing that gasoline prices have declined relative to where they were a year ago. And the margin that is helping the U.S. consumer, if that continues, that tailwind could increase. That's just worth monitoring.

And how much would that take down your recession risk? Probably not a lot because I think ultimately tariffs and bond yields matter more for the economy, but it would certainly help offset some of these headwinds. What could happen, Peter, to make you change your mind about coming recession? What could happen to make you positive on the U.S. economy, positive on growth, and crucially positive on the U.S. equity market?

We need to see a few things on the economic front. One, we would need to see Trump further dial back the tariffs, especially against China, which, you know, they've come down from 145%, but they're still close to 40% tariff rates on China. It's quite high. If the big, beautiful bill passes without the bond market reacting negatively. So in other words, if we get the fiscal stimulus without the adverse effects

bond market reaction, that would make me more positive. If we start to see AI

boost corporate profits in a more broad-based way, that would make me more optimistic as well. So I'm open-minded. My recession probability is 60%. It's not 100%. There's still a 40% chance where things can go right. And that's why I've been cautioning investors to wait until they see the whites of those recession's eyes before turning fully pessimistic.

Okay, well, let's hope that we see the whites when they're coming. We don't miss them. Indeed. Peter, what are you reading at the moment? Oh, gosh, I've been mainly listening to podcasts and things like that. And so a lot of great content on Bloomberg. I would certainly start there. Obviously, obviously. Thank you so much. Thank you for joining us today. My pleasure. Thank you so much.

listening to this week's Merrin Talks Money. If you like our show, rate, review and subscribe wherever you listen to podcasts. And keep sending questions or comments to merrinmoney at bloomberg.net. You can also follow me and John on Twitter or X. I'm at Merrin SW and John is John underscore Stepak. This episode was hosted by me, Merrin Somerset Webb. It was produced by Sam Asadi and Moses Andam. Sound design by Blake Maples and special thanks, of course, to Peter Bereson.

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