The risk of a US recession next year is rising fast. The Federal Reserve has no margin for error.

Liquidity is suddenly drying up. Early warning indicators from US 'flow of funds' data point to an incipent squeeze, the long-feared capitulation after five successive quarters of declining corporate profits.

Yet the Fed is methodically draining money through 'reverse repos' regardless. It has set the course for a rise in interest rates in December and seems to be on automatic pilot.

"We are seeing a serious deterioration on a monthly basis," said Michael Howell from CrossBorder Capital, specialists in global liquidity. The signals lead the economic cycle by six to nine months.

"We think the US is heading for recession by the Spring of 2017. It is absolutely bonkers for the Fed to even think about raising rates right now," he said.

The growth rate of nominal GDP - a pure measure of the economy - has been in an unbroken fall since the start of the year, falling from 4.2pc to 2.5pc. It is close to stall speed, flirting with levels that have invariably led to recessions in the post-War era.

"It is a little scary. When nominal GDP slows like that, you can be sure that financial stress will follow. Monetary policy is too tight and the slightest shock will tip the US into recession," said Lars Christensen, from Markets and Money Advisory.

If allowed to happen, it will be a deeply frightening experience, rocking the global system to its foundations. The Bank for International Settlements estimates that 60pc of the world economy is locked into the US currency system, and that debts denominated in dollars outside US jurisdiction have ballooned to $9.8 trillion.

The world has never before been so leveraged to dollar borrowing costs. BIS data show that debt ratios in both rich countries and emerging markets are roughly 35 percentage points of GDP higher than they were at the onset of the Lehman crisis.

This time China cannot come to the rescue. Beijing has already pushed credit beyond safe limits to almost $30 trillion. Fitch Ratings suspects that bad loans in the Chinese banking system are ten times the official claim.

The current arguments over Brexit would seem irrelevant in such circumstances, both because the City would be drawn into the flames and because the eurozone would face its own a shattering ordeal. Even a hint of coming trauma would detonate a crisis in Italy.

To be clear, the eight-year old US cycle has not yet rolled over definitively. The picture remains fluid, hard to read in a world where key signals have been distorted by central bank repression. The third quarter will almost certainly look a little better. 

"We are getting closer and closer to a recession, but we are not quite there yet, looking at our forward-indicators," said Lakshman Achuthan from the Economic Cycle Research Institute in New York.

"I can understand why people are getting worried. We have been seeing a 'growth-rate' cyclical downturn for the last two years. The longer this goes on, the less wiggle room there is," he said.

"We are sure there will be no recession this year or into the first two months of 2017, but beyond that there are worrying signs. The deterioration of our leading labour market index is very clear," he said.

Mr Achuthan thinks it is still possible that US growth will pick up again for another short burst - lifted by a global industrial rebound of sorts - before the storm finally hits.

David Fuller's view

Well, we have certainly been warned.  AEP even treats us to a sobering quote from Dante Alighieri: “lasciate ogni speranza, voi ch’entrate’” (abandon all hope, you who enter here)

So what should we make of AEP’s colourful warning?  I am hoping it is over the top.  However, I am now more cautious, as subscribers will know, than at any time since the bull market on Wall Street commenced in 2009.  We can only guess about the future but I would not be surprised to see a choppy three to four years during which leading economies are hopefully able to make the transition from record low interest rates due to QE, back to a normalisation of rates at somewhat higher levels.  The risk of a cyclical bear market of 20 to 30 percent for the US S&P 500 Index during this period is high. 

Hopefully, this is too bearish.  More importantly, keep a close eye on the US market because it has seldom been more influential.  It is too big to lead but while it remains firm, risks are manageable and many shares will still perform, or at least pay their dividends without too great a risk of profit erosion.  However, when US indices show initial evidence of downtrends, risks will have increased, not least in most other stock markets.  A factor in this weakness could be a too strong US Dollar Index.    

Here is a PDF of AEP's column.