Global Slowdown
David
Shulman
Senior
Economist
UCLA
Anderson Forecast
March
2019
A year ago we were looking forward to a
synchronized global expansion; today we are staring a synchronized slowdown.
The U.S. economy is part and parcel with the global slowdown, an eventuality we
have been forecasting for over a year. After growing at 3.1% clip on a fourth
quarter-to-fourth quarter basis in 2018, growth will slow to 1.7% in 2019 and
to a near recession pace of 1.1% in 2020.
However by mid-2021 growth is once again forecast to be around 2%. (See Figure
1) Similarly payroll employment growth is forecast to decline from the 220,000
a month recorded in 2018 to about 160,000 a month in 2019 to a negligible
20,000 a month in 2020 with actual declines occurring at the end of that year.
(See Figure 2) In this environment the unemployment rate will initially decline
from January’s 3.9% to 3.6% later in the year and then gradually rise to 4.2%
in early 2021. (See Figure 3)
Figure 1. Real GDP Growth, 2011Q1
-2021Q4F, Percent Change SAAR
Sources: U.S. Department of Commerce and
UCLA Anderson Forecast
Figure 2. Payroll Employment, 2011Q1
-2021Q4, Millions, SAAR
Sources: U.S. Bureau of Labor Statistics
and UCLA Anderson Forecast
Figure 3. Unemployment Rate, 2011Q1
-2021Q4, Percent, SAAR
Sources: U.S. Bureau of Labor Statistics
and UCLA Anderson Forecast
Why
the Slowdown?
Consistent with our view for the past several
quarters we believe that the 3% growth in 2018 was a one-off based on the
fiscal stimulus coming from the tax cuts and spending increases, especially for
defense enacted in late 2017 and the lagged effects of the extraordinarily easy
monetary policy pursued by the Federal Reserve. With the effects of the fiscal
stimulus now waning combined with the partial normalization of interest rates
it seemed inevitable to us that growth would slow. Further the failure of
housing activity to provide a propellant for the expansion has been a distinct
negative. We will discuss these points in greater detail later. The slowdown in U.S. economic activity will
be exacerbated by concomitant weakness among our global trading partners.
Global Economy Stalling
Although 2018 started out strong for the
global economy, by yearend there seemed to be weakness everywhere. The weakness is being amplified by the
protectionist policies being employed by the Trump Administration and the
uncertainties associated with BREXIT. For example compared to 2018 German
growth is expected to slow from 1.5% to 1.3%, China from 6.6% to 6.2% and Italy
is for all practical purposes in recession. Although these declines in growth appear modest, recent data suggests
that there will be substantial downward revisions to the outlook once first
quarter data become available.[i]
The global weakness will be transmitted
to the U.S. economy by a less than robust export environment and a reduction in
corporate profits.
See Figure 4. Real GDP Growth for Major
Economies, 2018 -2020, Percent
|
Region/Country
|
2018
|
2019
|
2020
|
||
|
U.S.
|
2.9
|
2.5
|
1.8
|
||
|
Euro Zone
|
1.8
|
1.6
|
1.7
|
||
|
Germany
|
1.5
|
1.3
|
1.6
|
||
|
France
|
1.5
|
1.5
|
1.6
|
||
|
Italy
|
1.0
|
0.6
|
0.9
|
||
|
UK
|
1.4
|
1.5
|
1.6
|
||
|
Japan
|
0.9
|
1.1
|
0.5
|
||
|
Developing Asia
|
|||||
|
China
|
6.6
|
6.2
|
6.2
|
||
|
India
|
7.3
|
7.5
|
7.7
|
||
|
Americas
|
|||||
|
Canada
|
2.1
|
1.9
|
1.7
|
||
|
Mexico
|
2.1
|
2.1
|
2.2
|
||
|
Brazil
|
1.3
|
2.5
|
2.2
|
Source: World Economic Outlook,
International Monetary Fund, January 2019
This economic weakness has triggered a
major contraction in global interest rates making it difficult for the Fed to
conduct its normalization policy and has put a lid on long term interest rates.
Would you believe .09% for the German 10-year Bund and a negative .60% for the 2-year. (See Figure 5) Where in the recent
past we thought yields on 10-year U.S. Treasury would to top out over 4%, we
now think that a 3.25% peak is more likely as German interest rates work to
suppress U.S. yields. (See Fed discussion below)
Figure 5. Selected Global Interest Rates,
22Feb19, Percent
|
Country
|
2-Year
|
10-Yr.
|
|
U.S.
|
2.50
|
2.65
|
|
Germany
|
-0.60
|
0.09
|
|
France
|
-0.46
|
0.52
|
|
Italy
|
0.54
|
2.87
|
|
U.K.
|
0.74
|
1.15
|
|
Japan
|
-0.18
|
-0.05
|
Source: CNBC
A
Fundamental Shift in Fed Policy
The combination of the global slowdown,
the 20% sell-off in stock prices in the fourth quarter and still quiescent
inflation triggered a fundamental shift in Fed policy. Instead of penciling
three or four rate hikes next year, it now looks like it will be zero or one.
We are in the one rate hike camp for 2019 camp because we believe that
inflation will be less than benign. However,
because we are more pessimistic on the real economy than the Fed, we are
forecasting that there will be three rate cuts of 25 basis points each in 2020.
(See Figure 6) In this setting of very slow growth and an end to the Fed
normalization process coupled with very low interest rates in Europe and Japan
it is hard to see long term interest rates going much above 3.25%.
Figure 6. Federal Funds vs. 10-Year U.S.
Treasury Bonds, 2011Q1 -2021Q4F
Sources: Federal Reserve Board and UCLA
Anderson Forecast
Moreover it now looks like the Fed is
rethinking its balance sheet target. Instead or contracting its balance sheet
from the $4.5 trillion peak to $3 trillion or below, it now looks like the
shrinkage process will end this year with a balance sheet of around $3.5
trillion. (Figure 7) This change in policy will put less pressure on the long
end of the treasury curve.
Figure 7. Federal Reserve Assets,
20Feb14 – 20Feb19, In $billions
Source: Federal Reserve Board via FRED
Although there has been much discussion
of the potential for the treasury curve to become fully inverted (long rates
lower than short rates), we do not believe that will be the case. To be sure
the curve is currently inverted between one and five year maturities, but we do
not believe that the all-important 90- Day Treasury Bill to the 10-Year Treasury
bond will invert.(See Figure 8) Similarly we do not believe the 2-10 year
spread will invert on a sustained basis as well.
Figure 8. U.S. Treasury Yield Curve
22Feb19
Source: GuruFocus.com
Modestly
Higher Inflation
Inflation may not be as quiescent as the
Fed thinks. As a result of the very tight labor market wages are increasing at
a 3%+ clip and it is likely that the year-over-year gains will soon be running
around 4%. (See Figure 9) As a result, wage pressures, especially in the
service sector, will keep the core consumer prices increasing at a rate above
2%. (See Figure 10) Moreover it appears that the benefits from the collapse in
oil prices is now behind us and that will elevate the rate of change in the headline
consumer price index to above 2% as well (See Figure 11)
Figure 9. Total Compensation per Hour,
Percent Change Year Ago
Sources: Bureau of Labor Statistics and
UCLA Anderson Forecast
Figure 10. Headline Consumer Price Index
vs. Core CPI, 2011Q1 -2021Q4F, Percent Change a Year Ago
Sources: Bureau of Labor Statistics and UCLA
Anderson Forecast
Figure 11. Oil Price, 2011Q1 – 2021Q4F,
West Texas Intermediate, $/Barrel
Sources: Commodity Research Bureau and
UCLA Anderson Forecast
Investment
in Intellectual Property Remains the Bright Spot
The bright spot in the economy remains
investment in intellectual property. This sector largely consists of software
development, motion picture/TV production and corporate R&D. Although
slowing from a torrid 7% pace in 2018, this sector will continue to grow much
faster than the economy over the next few years. (See Figure 12) The continued
movement of corporate computing to “the cloud” and a host of new entrants into
motion picture production (i.e. Amazon, Netflix, and Hulu) are buoying this
sector.
Figure 12. Real Investment in
Intellectual Property, 2011Q1 -2021Q4F, Percent Change, SAAR
Sources: U.S. Department of Commerce and
UCLA Anderson Forecast
Housing
Starts Remain Below Underlying Demographic Demand
We reckon that the underlying
demographic demand for housing starts to be around 1.4 million – 1.5 million
units a year. We have yet to achieve that level for over a decade and we
forecast that it won’t be until late 2021 that housing starts exceed an annual
run rate in excess of 1.4 million units. (See Figure 13) There are number of
explanation for the housing’s failure to launch. They include the after effects
of the Great Recession, high levels of student loan debt, the aging in place of
baby boomers that is keeping housing units off the market, the concentration of
job growth in high cost metropolitan areas and environmental/zoning restrictions
that are restricting supply. We believe the main culprit is the last factor.
Figure 13. Housing Starts, 2011Q1
-2021Q4, Thousands of Units, SAAR
Source: U.S. Bureau of the Census and
UCLA Anderson Forecast
The
Twin Deficits: Federal and Trade
The consequence of the Trump
Administration’s tax and spending policy is a rising fiscal deficit. After
incurring a deficit of $836 billion in FY2018, the deficit will exceed a
trillion dollars a year through 2021 and beyond. (See Figure 14) Part of the
increase in the deficit is due to the surge in real defense spending, but as we
noted above that form of spending will soon level off at a high level. (See
Figure 15)
Figure 14. Federal Deficit, FY 2011-FY
2021, In $Billions, Annual Data
Sources: Office of Management and Budget
and UCLA Anderson Forecast
Figure 15. Real Defense Purchases, 2011
-2021, Annual Data, Percent Change
Sources: U.S. Department of Commerce and
UCLA Anderson Forecast
The flip side of the budget deficit is
the trade deficit. In a sense the U.S. is financing our budget deficit with the
trade deficit. How so? A trade deficit implies a capital inflow to finance it.
As a result the real trade deficit will increase from $920 billion in 2018 to
over a trillion dollars a year over the forecast period. (See Figure 16) So
much for trade protection reducing the trade deficit.
Figure 16. Real Net Exports, 2011 -2021,
In $Billions, Annual Data
Sources: U.S. Department of Commerce and
UCLA Anderson Forecast
Conclusion
Our forecast has been roughly consistent
for over a year. We forecast that real GDP growth will slow to below 2% in 2019
and around 1% in 2020 with a modest rebound in 2021. The jolt from the very
expansionary fiscal policies of the Trump Administration will soon exhaust
itself and there is a very real risk of a recession in late 2020. Meantime the
unemployment rate will continue to decline to 3.6%, before gradually returning
to 4%. Inflation will remain modestly above 2% and after increasing the Fed
Funds rate by 25 basis points mid-year, the Fed will embark on an easing policy
in 2020. By 2021 real growth will return to a 2% track.
[i]
See Lafourcade, Pierre and Arend Kapteyn, “Global growth now-cast: a (very)
preliminary estimate for Q1,” UBS, 18 February 2019.
