Fragile strength: should the US economy batten down the hatches?

January 2019  |  FEATURE  |  ECONOMIC TRENDS

Financier Worldwide Magazine

January 2019 Issue

The US economy appears strong at present. Corporate profits are rising, unemployment is at a level unknown since the 1960s and the stock market recently hit an all-time high.

However, despite this ‘economic miracle’, there are growing rumblings that it will not or cannot last.

Among those suggesting that the current US economic boom is essentially ephemeral are the International Monetary Fund (IMF), which has cut its global growth forecast due to trade tensions between the US and its trading partners, and the National Association for Business Economics (NABE), which cites trade policy as the greatest risk to expansion and predicts a US recession by 2020 (many business economists believe that a recession could begin as soon as the end of 2019).

“Economists rarely agree on anything, but the economy will likely slow noticeably in 2020 as a three-headed monster hits the economy,” says Ryan Sweet, director of real-time economics at Moody’s Analytics. “Monetary policy will be restrictive for the economy and fiscal policy will also be a drag. Add on tighter financial market conditions and that is a lot for an economy to digest.”

A downturn on the horizon is also forecast by the key economic and financial indicators yield curve and the unemployment rate gap – both of which signal a medium risk of recession in the next 12 months. “These indicators are generally the first warning bells,” adds Mr Sweet. “The unemployment rate gap – the difference between the actual unemployment rate and the non-accelerating inflation rate of unemployment (NAIRU) – suggests recession risks are rising.”

According to Joffrey Simonet, an economist at FocusEconomics, the US economy is increasingly vulnerable to a recession due to it being on an unsustainable “sugar high” following the 2017 tax cuts. “The cuts were enacted at the peak of the expansion cycle, precisely when governments should build fiscal buffers to prepare for the next crisis. These cuts might boost the economy in the short-term, but they also force the US Federal Reserve to raise rates faster, which will ultimately precipitate a recession. Equity markets have also long benefited from over $3 trillion injected through quantitative easing (QE), but this is currently unwinding.”

Downturn preparation

Should an economic recession in the US come to pass, business resilience will come sharply into focus, with memories of the financial crisis a decade ago unlikely to be far away.

“I do not think companies have learned much, if anything, since the last crisis,” says Mr Simonet. “For example, the Trump tax cuts were largely spent on share buybacks, whereas there is little evidence that they caused increases in capital expenditures. Companies should now focus on securing their credit lines over the long-term, locking in rates, and reducing leverage or building cash buffers. Diversifying their customer base and using hedging strategies are also solid options.”

Regarding the available policy responses to a crisis, Mr Simonet believes that the Federal Reserve will not have time to raise rates sufficiently to give it much breathing space by the time the next crisis hits. “Its balance sheet is still bloated,” he explains. “The fiscal position, meanwhile, is abysmal, and public debt is 40 points higher than in 2007. This means both fiscal and monetary stimulus measures will be highly constrained, and likely less effective.”

More sanguine as to resilience in the event of a recession is Mr Sweet. “Especially encouraging for the economy’s longer-run performance is that policymakers made substantial reforms to the financial system in the wake of the financial crisis,” he says. “The system is on much sounder ground than a decade ago and much less likely to suffer another crisis, at least not on the same scale.”

In the meantime

What, then, should we expect from the US economy in the short-term?

“The US economy will do well through the first half of 2019,” says Mr Sweet. “Fiscal stimulus will keep the economy on an adrenaline rush but the hangover will be felt toward the end of this year and into 2020. For now, the economy will keep growing above trend, pushing the unemployment rate lower. Wage growth will accelerate as the unemployment rate is headed into the low 3 percent range. We are currently in the best part of the expansion, unemployment is low, inflation is at the Fed’s target and GDP growth is above its potential. Enjoy this, as things will get bumpy.”

Similarly sombre is Mr Simonet: “The economy should remain solid for a few more quarters, thanks to stellar consumer confidence and higher federal spending. However, fading tax-cut effects, higher tariff rates on Chinese products from 1 January and rising interest rates will provide increasingly strong headwinds in 2019.”

While times may be good today, it would appear to be only a matter of time before the US economy is compelled to batten down the hatches in anticipation of a tougher economic climate, maybe even a recession.

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Fraser Tennant