It Takes A War To Bring Down An Economy This Strong

Authored by Simon White, Bloomberg macro strategist,

The Iran war is the biggest risk to a US economy otherwise showing broad-based strength and a liquidity backdrop very supportive of asset prices.

The US economy is firing on all cylinders. The main cycles that drive economic growth are mostly in good shape, while rising excess liquidity is a tailwind for risk assets. However, as oil and gas prices rebound and missiles continue to fly, a protracted war with Iran is exactly what it would take to wipe out this wide base of resilience.

Economies are driven by underlying cycles, the most important of which for markets is that of liquidity. Excess liquidity, the difference between real money growth and economic growth, has turned up again and is at post-pandemic highs.

Global money growth has been strong, while since the attacks on Iran the dollar’s rally has been unremarkable. The tightening in rate expectations in the US and around the world has also been, overall, fairly marginal.

Excess liquidity was robust going into the conflict and has been relatively unscathed since then. The longer the war goes on, however, the greater the risk that tighter financial conditions and reaccelerating inflation will squeeze excess liquidity lower. The outlook for stocks and credit will quickly deteriorate.

The liquidity cycle isn’t the only one that’s important for markets and the economy. The business, housing, inventory, and credit cycles are also key. Most were turning higher at the onset of the conflict, yet all are at risk from the war.

The most closely followed is the business cycle. It had looked like it was heading south last year as leading data turned lower, but it has revived, with the data now pointing to a re-acceleration — the fabled no-landing scenario. There’ll be no chance of that if the conflict persists, though.

Signs of a slowdown in the jobs market are not a surefire indication that the business cycle is about to turn lower either. Corporate margins remain strong, cushioning the need for firms to make as many layoffs, and reams of government money continue to ripple through the economy.

The rise in the unemployment rate has largely been driven by a drop in the labour force as the clampdown on immigration continues, rather than any inherent weakness.

If firms were going to make layoffs, we’d normally expect to see hours worked turning lower, and temporary help declining. Neither are the case, with average weekly hours worked remaining steady and temporary help rising, not falling.

It’s not just the US business cycle that’s in an enviable place, the global cycle is also turning up. Almost all OECD country leading indicators are rising on a six-month basis, while bellwethers of global cyclical momentum, such as the exports of Taiwan and South Korea, have barreled higher on semiconductor demand.

Then there is the inventory cycle. It’s at an early stage in the US as firms have gradually begun to restock. Leading indicators, such as the ratio between business and customer inventory sentiment in the ISM survey, are turning up strongly from low levels.

Sales-to-inventory ratios have also been rising across all businesses and especially the retail sector.

The housing cycle hasn’t been as robust, but it’s by no means getting decisively worse. Higher mortgage rates have eroded affordability and long-term rate fixings have deterred many from moving home. Inventories have started to rise, annual price growth has slipped to 1.4%, while sales growth has fallen to zero.

But there are green shoots. Bloomberg’s Housing Surprise index has jumped higher and building permits, the best leading indicator for the sector, are growing. Further rises are expected since mortgage spreads have been tightening.

Fundamentals for credit also mainly look constructive. Bank lending standards are becoming easier, business loan charge-off rates are falling and the corporate financing gap has fallen. Moreover, layoff activity is contained, as judged by low jobless claims, reducing stress on corporate cashflows.

My model still expects credit spreads to persist on a net tightening path as global central bank policy remains very loose and the personal savings rate continues to fall.

Balance sheets at tech firms have deteriorated as they have spent and borrowed hand over fist on new data infrastructure to power the next generation of computing. But the most worrying shadow looming over credit comes from the private space.

Opaque and heavily exposed to the disruptible software sector after the rapid improvement in AI coding agents, private credit could be the grim reaper on its way for the credit market as a whole, and thereafter possibly the rest of the economy.

The latest anecdotes coursing through the market and shaking confidence are JPMorgan restricting lending to some private credit funds after loan markdowns, and investors looking to redeem 14% in Cliffwater’s $33 billion flagship private credit fund in the first quarter.

Still, it’s precisely because of a lack of transparency that private credit might be able to weather this hit to loan values, putting off the final reckoning to another day (if the private-credit boom follows every other cycle in history with an eventual bust).

Either way, it will take some doing to reverse such broad-based economic resilience. But a war would do it. The longer it goes on, the greater is the energy and food-led tax on spending that will eventually gut fragile sentiment, endanger company cashflows and increase the chance credit markets implode.

And the more that inflation becomes entrenched, the greater the tightening in global financial conditions from higher rates and slower real money growth. Risk assets and economies won’t stand much of a chance.