Morgan Stanley: Risk of a global recession is 'high and rising'

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The downtrend in some global economies is becoming contagious as weakness in the manufacturing sector begins to spread, according to Morgan Stanley, which warned clients that "the wheels for a slowdown are in motion."

"Even as we have been revising our growth projections lower, we continue to highlight that the risks remain decidedly skewed to the downside," Chetan Ahya, the bank's chief economist, warned in a note published Tuesday. "We expect that if trade tensions escalate further ... we will enter into a global recession (i.e., global growth below 2.5%Y) in three quarters."

The risk of tighter financial conditions, which would trigger a global recession, "is high and rising," he added.

Despite claims that the U.S. remains an exception to the global deceleration, the effects of the international slowdown are already filtering into American data, the economist wrote. Ahya highlighted the "significant loss of momentum" in payrolls data in the past seven months, falling to 141,000 on a six-month moving average in July from 234,000 in January.

But recent manufacturing barometers have also been of concern. The IHS Markit Manufacturing Purchasing Managers' Index fell to 50.4 in July, down from 50.6 in June, its lowest level since September 2009. Signals above 50 indicate expansion while those under 50 represent contraction.

"Falling business spending at home and declining exports are the main drivers of the downturn, with firms also cutting back on input buying as the outlook grows gloomier," Chris Williamson, chief business economist at IHS Markit, said on Aug. 1. "US manufacturers' expectations of output in the year ahead has sunk to its lowest since comparable data were first available in 2012."

A gauge of employment within that report fell to the lowest since mid-2013 in July.

Corporate investment and other labor market metrics could see even further downside if trade and tariff headwinds don't subside, the Morgan Stanley report found.

"Rising tariffs will likely exacerbate the existing downward pressures on corporate margins and profitability. Hence, corporates could soon move to the next stage, cutting back on hiring," Ahya added. "As it is, consumer sentiment has taken a hit in August and the drop was very clearly driven by the announcement of further tariffs and to some extent the resulting stock market volatility."

August has thus far proven one of the stock market's most volatile months in recent memory with more than half of trading days seeing swings in the S&P 500 of 1% or more. The broad 500-stock index, though still up more than 15% this year, is down more than 2.5% for the month as investors juggle new recession warnings from the bond market and decent-to-good prints on U.S. employment.

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