US rate hikes could tip economy into recession, warns Legal & General

Donald Trump's economic honeymoon could come to an end as soon as next year, senior City fund managers have forecast, with the US at risk of plunging into recession.

Nine years on from the start of the financial crisis, the US recovery may be overheating, Legal & General Investment Management economist James Carrick has warned. He has predicted a series of interest rate hikes will tip the US into a 2018 recession.

“Every recession in the US has been caused by a tightening of credit conditions,” he said, noting inflation is on the rise and the US Federal Reserve is discussing plans for higher interest rates.

Officials at the Fed have only raised interest rates cautiously, because inflation has not taken off, so they do not believe the Fed needs to take the heat out of the economy.

But Legal & General economists fear the strong dollar and low global commodity prices have restricted inflation and disguised domestic price rises. Underneath this, they fear the economy is already overheating.

As a result, they expect inflation to pick up sharply this year, forcing more rapid interest rate hikes.

That could cause a recession next year, they say. In their models, the signals are that this could take place in mid-2018.

“Inflation is picking up and that is the game-changer because it brings the Fed into play,” said Mr Carrick.

“That means we could get an increase in bad loans, which could cause the economy to head into reverse.”

His study of data going back to 1967 shows that every recession came after banks tightened credit conditions.

“We did have a big loosening of credit conditions in recent years, and now we are moving to neutral,” he said.

On his historical data “two to three years before every recession you had a big loosening of policy, about a year before the recession you’ve turned neutral, and then you see a tightening,” Mr Carrick said.

“I’ve been very cheeky, saying we are five quarters before the next recession. It is cheeky, but every recession in the US has been caused by a tightening of credit conditions.”

Mr Carrick added that rising rates will also strip the economy and financial markets of one source of insulation from unexpected political events, which has encouraged stability in recent years.