Is the US headed for a recession? Or has it simply hit a rough spot? What could be the potential implications of a US recession for Pakistan? Recent US economic indicators are, according to analysts, pointing to a direction where the American economy could be in recession early next year as a worldwide selloff jolted equity markets in the wake of a weaker-than-expected jobs report.

This was despite the US having defied many such predictions in recent years. The International Monetary Fund (IMF) has also slightly downgraded its forecast for US growth to 2.6pc in 2024 in the July World Economic Outlook update from the 2.7pc it had predicted in April.

The weak US employment report, featuring a post-pandemic high in the jobless rate, has rekindled worries that a potential recession might dash the Federal Reserve’s desired soft landing for the economy. A projected hard landing of the US economy amid recession risks caused stock markets across the globe to tumble.

The US Federal Reserve’s decision last month to maintain interest rates, despite other central banks like the Bank of England and the European Central Bank lowering theirs, has added to the uncertainty. It followed a batch of underwhelming reports on the economy, including worsening US manufacturing activity — one of the areas hurt most by high rates.

‘Since debt sustainability is our most pressing challenge, a slowdown in global economic activity, which leads to a drop in interest rates, may prove helpful’

JPMorgan Chase boosted the chances of a US recession to 35pc by the end of this year, up from 25pc last month. US news “hints at a sharper-than-expected weakening in labour demand and early signs of labour shedding,” JPMorgan economists wrote in a note to clients. The team kept the odds of a recession by the second half of 2025 at 45pc.

This modest increase in their assessment of recession risk contrasts with a more substantial reassessment they made of the interest rate outlook. “JPMorgan now sees just a 30pc chance of the Federal Reserve, and its peers, keeping interest rates ‘high-for-long,’ compared with a 50-50 assessment as recently as two months back,” reported Bloomberg.

A Reuters report mentions that “The historical relationship between a rise in the unemployment rate and an economic downturn is captured by the so-called Sahm rule that says a recession is underway when the three-month moving average of the unemployment rate rises half a percentage point above its low from the previous 12 months. To date, the rule has never been wrong.”

The US media quoted Michael Strobaek at Lombard Odier as saying volatility will persist in the coming months. He emphasised geopolitical risks in the Middle East that have increased after the assassination of Hamas leader Ismail Haniyeh and how the prospect of a conflict in the region that impacts several countries, including the US, is causing concern.

“The US presidential election campaign should also prove a focal point of uncertainty for markets in coming weeks,” he said.

Implications for Pakistan

Ali Farid Khawaja, chairman of KTrade, points out that a US recession essentially triggers a global recession. “In the past, we have seen this lead to a run to safety and a pullback of capital from emerging markets. The cost of risk increases, which makes it more difficult and expensive for Pakistan to borrow from the global markets.

“However, the Fed has managed recent crises, such as Covid, by cutting down interest rates. So all eyes will now be on the Fed’s September meeting for a larger rate cut to defend the markets.”

Former CEO of the Knightsbridge Capital Group, Samir Ahmed, who is currently serving as Director of the Rausing Executive Development Centre at the Lahore University of Management Sciences, argues that a recession in the US will not have a huge impact on Pakistan’s economy.

“If it (the US recession) results in weak demand, it may potentially lower exports for Pakistan. If it results in lower interest rates in the US, then a potentially weaker dollar will follow.

“So, on a relative basis, it’s better for the rupee. It may also give us room to reduce our interest rates since one of the calculations in the slow reduction of policy rates by the State Bank is the potential weakening of the rupee,” he concludes.

Bristol University economist Ahmed Jamal Pirzada points out that the latest data by the US Bureau of Labour Statistics has increased concerns about a global recession.

“Over the last year, the US unemployment rate has increased from the lows of 3.5pc in July 2023 to 4.2pc in July 2024. The economic environment in the US may worsen since the US central bank decided against cutting the interest rates to ensure inflationary pressures are fully under control,” he says.

This is a bag of both good and bad news for Pakistan, Mr Pirzada argues. “As the global economy slows down and central banks across the world cut interest rates, this may decrease pressure on the exchange rate, thus allowing the State Bank to reduce interest rates faster than previously planned.

“Moreover, while Pakistan’s credit risk continues to remain high, the country is effectively blocked from international financial markets. If the State Bank decides to keep interest rates high for longer, the drop in both global equity and bond markets could potentially encourage investors to invest in government bonds.”

On the other hand, he adds that the slowdown in global economic activity also has significant implications for Pakistan’s export performance, specifically in terms of the value and quantity of Pakistan’s textile exports.

Overall, he feels, “Since debt sustainability is the most pressing challenge Pakistan faces at the moment, a slowdown in global economic activity which leads to a sharp drop in global interest rates may prove helpful.”

Published in Dawn, The Business and Finance Weekly, August 12th, 2024