There is growing chatter about a US recession. Talking heads have popped up all over the media asserting confidently that the American economy is doomed to contract because its central bank is tightening monetary policy aggressively at a time when the surge in inflation, escalating energy costs and the horrors of the Ukraine war are undermining confidence.

Note that a recession is not just a couple of quarters of falls in GDP as some commentators say but something deeper – a downturn in incomes, employment, industrial production and services output that is prolonged and spread widely across much of the economy. Our view is that, first, a downturn of such a nature is not pre-ordained for the US. The headwinds that the pessimists point to are real and will certainly slow the economy – but there is no persuasive evidence yet that this slowdown will turn into an outright recession.

Second, we also believe that, should the US economy slow significantly or even enter into a recession, the impact on Southeast Asia will be mitigated by several other factors, allowing the regional economies to continue growing in 2023.

A US recession is not pre-ordained

The case for a recession is stated as follows. The Federal Reserve Bank is embarking on an extremely aggressive tightening of monetary policy, with sharp and rapid increases in interest rates combined with a substantial reduction in liquidity in the financial system. Since the 1950s, such patterns of tightening have frequently ended in recessions, hence the concern of the downbeat analysts. In addition, the world has just experienced an energy price shock of a magnitude not seen in decades. That shock has been followed by a painful increase in the price of food well. Since all this will hurt consumers’ pockets, they will be more cautious about spending while companies will cut back on production since the higher fuel and electricity costs could make some activities less profitable. Adding to the misery, is the great uncertainty businesses now face because of geo-political frictions whose impact on the economy is difficult to predict.

Some of these fears are already materialising – there is evidence of damaged confidence and some indications of slowing demand in the US.

  • Surveys have shown a dramatic decline in confidence. On the consumer side, the University of Michigan consumer sentiment final index in the US fell sharply in June to a record low of 50 in June from 58.4 in May. The US Conference Board survey of CEOs shows a plunge in confidence in current economic conditions. The NFIB Small Business Optimism Index in May has continued to struggle at multi-year lows as well.

  • The demand concerns are evident in the rise in inventories recently in some sectors as there is not enough demand to absorb all the stuff that has been produced.

  • With the average interest rate on a 30-year fixed rate mortgage now at the highest level since November 2008, there are also some signs that housing demand is slowing. That in turn has led to home builders becoming wary of future demand. So, housing starts fell 14.4% m/m in May 22 while the issuance of new building permits fell 7%.

The Conference Board Leading Economic Index fell by 0.4% in May, following a similar 0.4% decrease in April. This indicates weakening prospects for the US economy over the next couple of quarters, though the index is not at a level which predicts an outright recession.

The reason is that there is another side to the story, one which is more positive:

  • The really important point to note is that actual spending is not falling in line with the plunge in confidence. Real consumer spending, for example, has grown steadily through April this year even as consumer confidence was falling dramatically. This makes sense – labour markets are tight and jobs are plentiful and growing. That means households are enjoying income growth which helps sustain spending. Moreover, the under-spending of government handouts during the covid pandemic has led to about USD2 trillion of excess savings building up on households’ balance sheets. This is helping to fund consumer spending even in the face of higher living costs.

  • More telling is the fact that corporate spending has held up rather well. Take capital spending. The orders for durable goods have continued to hold up quite well, rising 12% y/y in May 2022. Within this, the measure of core capital goods orders has kept rising through the last few months of financial and political turbulence – despite the fall in CEO confidence mentioned above.

  • Moreover, firms also continue to hire workers at an impressive rate. In May, non-farm employment rose by an formidable 390,000. Rapid expansion of payrolls has brought total employment close to pre-pandemic levels, which seems to us to be a vote of confidence in the economy. It has certainly been enough to produce a strong labour market, with low unemployment. There are also signs that labour unions are gaining clout vis-à-vis employers as a result – unions have won some major political battles against big companies in recent weeks. That suggests that labour’s ability to bargain for higher wages will improve in coming months, contributing to higher real wages.

Would companies make such big bets on the future if conditions were really as bad as they tell the surveys? There are many reasons for capital spending to hold up despite higher interest costs in the economy – and to create the powerful multiplier effects of investment spending will help buffer the economy.

  • Some capital spending had been held up by supply chain issues or by uncertainty created by the pandemic. This pent-up demand for new capacity is now likely to be released. Capacity utilisation in the industrial sector was at 80.86% in May, its highest level since January 2008.

  • There is also a major push by corporate America to decarbonise in line with the commitments that they have made in support of the climate change agenda. That requires investment in new equipment. The shift to renewable energy, for example, requires investment of tens of billions of dollars in ultra-high voltage electricity grids around the world.

  • But the most compelling reason is that there are exciting new technologies that offer considerable returns. The advances in computing and communications have unleashed new possibilities in a range of areas such as robotics, artificial intelligence and cloud computing which in turn is spurring demand for semiconductors and the equipment to manufacture semiconductors. Outside the info-comms sector, capital spending is also being stimulated by the progress in solar and wind power as well as the expanding scope for commercialising advances in bio-medical sciences and new materials. With so much technical progress, a failure to invest could lead to competitors taking away market share – in many areas it is a case of invest or die.

Thus, even with the rising cost of capital, we believe that capital spending will hold up better than expected – and that is why the data on capital goods orders has remained firm.

Finally, recessions are caused when such decelerations in an economy are amplified by other vulnerabilities – such as a real estate crash or financial stresses that dislocate the provision of credit in the system. Such imbalances do not appear to be present in the American economy as far as we can judge. Moreover, there are countervailing factors that provide some relief to the economy as well.

A recession would be possible only if there were to be more severe shocks that would knock capital spending or cause oil prices to spike much higher. Another downside risk is if the Chinese economy failed to recover as expected from its recent malaise. Currently, the balance of evidence weighs against more severe shocks which means we will get a slowdown in the US but not a recession.

If there is a recession, how will Southeast Asian economies fare?

The US economy is still the single most potent driver of global demand in the world. So, a slowdown there will certainly hurt export growth in our region. Nevertheless, there are countervailing factors that will provide us with some buffer.

First, there is the relaxation of pandemic restrictions in the region, which is only now gathering momentum in Southeast Asia unlike the US and Europe where the relaxation started in earnest last year. This is providing a wide-ranging boost to economies.

  • With restrictions on activities being lifted, consumers are spending again and companies are hiring so as to service that growing demand.

  • Tourists are returning in force. Thailand, whose economy depends substantially on tourists, has reported 2 million tourists to date this year. But with the removal of virtually all remaining restrictions in July, they expect foreign arrivals to grow to 1.5 million a month. Since directly and indirectly, tourism contributes almost 20% of GDP, this turnaround will provide a strong uplift to Thailand’s economic recovery. Similarly, other tourism-dependent economies such as Malaysia and Indonesia will also benefit.

  • The opening of borders is also allowing the return of foreign workers to labour-importing economies such as Malaysia, Singapore and Thailand. This will help alleviate labour shortages in sectors as varied as plantations, manufacturing, restaurants, hotels and logistics, enabling a faster return to pre-pandemic levels of production.

  • The relaxation of restrictions is also helping to ease supply chain dislocations which again enables the normalisation of economic activities.

A second major offsetting factor is the likely rebound of the Chinese economy now that China has brought recent upticks in covid infections under control and can therefore step down some of the stringent restrictions that hurt economic activity. Some of the calibrated stimulus measures enacted by the authorities should also start taking effect. All this will add to global demand and support commodity prices.

A third reason to for Southeast Asia’s resilience is the likely improvement in investment. The prospects for both domestic and foreign investment have been helped by reforms in the region such as relaxation of caps on foreign investment in Indonesia and the Philippines and Indonesia’s expected labour market reforms. Consequently, the foreign investment pipeline is looking good. Foreign investors are also drawn by the possible synergies from new trade agreements such as the Regional Comprehensive Economic Partnership. We also expect the reconfiguration of supply chains to resume now that the worst of the pandemic seems to be over. This should result is some production being relocated from China to countries such as Vietnam and Indonesia. In addition, infrastructure spending is set to revive after the disruptions caused by the pandemic.

Conclusion: what are the implications for the region?

Slower growth in the US and other large developed economies will dampen the demand for regional exports from these developed countries. But this will be mitigated by the revival in China and the still-firm prospects for demand for tech goods and components. Southeast Asia’s improving supply-side fundamentals will also help sustain investment spending.

Overall, there is reason for caution but not for extreme pessimism.