The decade-long economic expansion, set to become the longest in U.S. history next month, faces an existential question: will it stop by the year next or continue to move forward at the same modest pace that has brought it here?
Nothing about this hesitant recovery from the Great Recession of 2007-09 has been normal, and that makes forecasting its demise particularly tricky.
On the one hand, the expansion is showing telltale signs of old age, such as the unemployment rate of 3.6%, a 50-year low; the start of a slowdown in corporate profit growth; and a growing debt problem – this time within companies. There is also the wild card of an escalating trade war with China.
At the same time, inflation is subdued, interest rates are still relatively low, and household balance sheets are healthy, hardly conditions that have traditionally started a downward spiral.
Simply put, the mantra for this economy has been slow and steady. It never really took off like previous rebounds until recently – much to the frustration of many American economists and workers. But that means he hasn’t developed the kind of excesses that have doomed past recoveries, possibly giving him a longer lifespan.
“We jogged, not sprinted,” says Mark Zandi, chief economist at Moody’s Analytics.
Economists, in turn, are divided over whether a recession is looming, generally viewing the question as a tossup.
People polled this month by Wolters Kluwer’s Blue Chip Economic Indicators put the likelihood of a slowdown in 2020 at 38%, according to their average forecast. Economists polled by the National Association of Business Economics in May predict a 60% chance of a recession by the end of next year.
âI think the economy is on a razor’s edge,â Zandi says. “It can go either way.”
Jacob Oubina, senior economist at RBC Capital Markets, is more optimistic. âThe risk of a recession is very, very, very low,â he says.
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Here’s a breakdown of the future direction of the economy:
More room to run:
Low inflation and interest rates: The seeds of most recessions are planted as economic growth strengthens, causing inflation to soar. This, in turn, prompts the Federal Reserve to raise short-term interest rates to temper increases in consumer prices. Typically, the Fed raises its policy rate too aggressively, cutting borrowing and economic activity, hurting the stock market and causing the next recession.
Last year, the economy grew relatively rapidly by 2.9%, resuming its lukewarm average pace of 2.2% during most of the expansion, largely due to federal tax cuts. and the increased spending led by President Donald Trump. Responding to the acceleration and a steadily declining unemployment rate since 2009, the Fed has raised rates nine times since late 2015, including four times last year.
But the Fed’s preferred measure of inflation, which excludes volatile food and energy costs, stands at 1.6%, well below its target of 2%. Many economists cite long-term factors such as discounted online shopping and globalization.
With inflation contained and global risks rising, the Fed did an about-face late last year and did not forecast any rate hikes this year. Now the markets are fixing up to two rates cuts in 2019, even if the Fed’s key rate remains historically low in a range of 2.25% to 2.5%.
âOverall, the inflationary environment remains benign,â said Sarah House, senior economist for Wells Fargo, in a note to clients.
Low household debt, high savings: The 2007-09 recession was fueled by a massive build-up of household debt, particularly mortgages but also credit cards and auto loans. Still, the downturn prompted Americans to sharply cut and pay off those bonds. Although debt has rebounded in recent years, household liabilities as a percentage of equity are at their lowest since 1985, according to RBC.
Likewise, Americans have saved a relatively large share of their disposable income since the recession, rising to 6.2% in April, compared to a range of 2.7% to about 4% in the mid-2000s.
âPeople are more careful,â says Oubina. This leaves workers in a better position to continue spending and withstand temporary layoffs or other economic shocks.
No big bubbles: The last two recessions are largely the result of bubbles. Shares of internet companies soared in the 1990s before falling in 2000 and dampening technology investment. And soaring house prices in the mid-2000s sparked a crash when subprime mortgage borrowers could no longer make their payments, leaving banks with hundreds of billions of dollars in bad debt on their books.
There are no similar examples of heavily overvalued assets in the economy today, although the build-up of corporate debt (see below) is causing some concern.
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Productivity growth: Productivity, or output per worker, eventually rebounded from an anemic pace during most of the recovery, increasing 3.4% annualized in the first quarter. Strong productivity growth allows firms to raise wages without passing higher labor costs onto higher prices, or without suffering a sharp decline in profits. Oubina attributes the company’s investments to labor-saving technology.
But Zandi believes the gains are only a temporary boost from the fiscal stimulus and spending, which has increased economic output without a similar increase in the number of workers.
Works: Job growth has slowed from an average monthly rate of 223,000 in 2018 to 164,000 so far this year. It’s a noticeable downdraft, but it was widely expected as the effects of the federal stimulus wear off and low unemployment makes it harder for businesses to find workers. And the pace of wage bill gains remains well above the roughly 85,000 needed to continue lowering the unemployment rate, Oubina says.
An increase in layoffs and unemployment is invariably a precursor to any recession, Zandi says.
There are also indications of a potential slowdown on the horizon:
The recession worries:
Very low unemployment: Historically low unemployment rates generally force companies to bid to attract workers. The stronger wage growth is passed on to buyers through prices, accelerating the Fed’s rate hikes.
While average wage growth has exceeded 3% since mid-2018, the gains have yet to translate into higher retail prices for the reasons already cited. Zandi, however, believes it will likely happen as salary increases accelerate.
The dreaded inversion of the yield curve: For several weeks now, the yield on three-month Treasury bills – around 2.2% – has exceeded the 2.1% rate on 10-year Treasury bills. This is very unusual – usually an investor gets a higher rate for locking in money for a decade. Reversals mean investors don’t have much confidence in the economy and inflation will pick up in the long run.
Such episodes are invariably followed by recessions within an average of two years, according to Oxford Economics. The belief that the economy is slowing “may be a self-fulfilling prophecy,” says Joseph LaVorgna, chief economist of the Americas at Natixis, a research firm.
Additionally, he says, banks make money by borrowing from depositors at lower short-term rates and lending that liquidity at higher long-term rates to consumers and businesses. A reversal of this equation could squeeze banks’ margins and cause them to withdraw from loans, hurting economic activity.
Trade war: Trump has imposed a 25% tariff on $ 250 billion in imports from China, and China has retaliated by imposing tariffs on U.S. exports to that country. Zandi estimates that the struggle will reduce economic growth by around two tenths of a percentage point in 2019 and 2020 to 2.4% to 1.7%, respectively.
In other words, it will slow growth, but it is not an expansion killer.
But if Trump follows through on threats to impose tariffs on the remaining $ 300 billion in Chinese imports, it will crush business confidence, disrupt the stock market, reduce employment by 3.1 million. by 2021 and will likely trigger a recession, Zandi said.
Corporate debt bubble? It’s not a real estate bubble, but the financial system has created a different kind of foam. Banks and private equity funds have made loans to poorly rated companies, aggregated them into securities, and sold them to hedge funds, insurance companies and other players. This “speculative grade” corporate debt now stands at a record $ 4.8 trillion, according to UBS.
If corporate profits slow as the economy falters, the companies that borrowed the money could default, causing business financing to dry up. LaVorgna says it probably wouldn’t cause a recession, but could make one worse.
But Matthew Mish, head of global credit strategy for UBS, said, “It could snowball and feed itself” as banks cut lending.
Reduction in corporate profit margins: Another way that stronger wage growth can hurt the economy is to reduce corporate profit margins. This can cause companies to cut hires and investments and even lay off workers, Morgan Stanley explains.
In the first quarter, the margins of Standard & Poor’s 500 companies fell to 11% from 11.2% at the end of last year, according to FactSet. It’s still high, but it’s the lowest level since late 2017. LaVorgna wonders if this isn’t the start of further margin squeeze.