President Trump was busy last week, falling out with one-time confidant and adviser Steve Bannon, and failing to stop the publication of Michael Wolff’s new bestseller Fire and Fury. 2018 could be a long year for this unpopular president if investigations into obstruction of justice gain traction, while Democrats are salivating about electoral prospects in congressional elections in November. Last week, though, he still found time to boast that the Dow Jones surge through 25,000 and record levels reached in US equity markets were down to him, and his focus on “jobs, jobs, jobs” and “making America great again.”
For the moment, he can certainly crow about the US economy, even though the momentum that returned to economic growth during 2017 happened regardless of his Administration. Economic growth picked up to a little over 3 per cent per annum in the spring, and stayed there through the summer. By the end of last year, it might have edged towards 3.5-4 per cent, though we should note that the renewed widening US trade deficit late last year will act as a drag on reported GDP growth.
Jobs have continued to expand, but at a decelerating pace, as we should expect this late in the economic cycle. With the December jobs report last Friday showing that 148,000 positions were created, the economy created on average 171,000 jobs a month last year. This compares to 187,000 a month in 2016, and 226,000 a month in 2015. Unemployment at 4.1 per cent is probing new depths, and could easily drop a bit further. Now with tax cuts approved, mainly for companies and better off households, the economy could get some additional momentum for a while.
One of the things economists will be watching closely is how long this expansion might continue. January 2018 marks the 103rd month of expansion from the last trough in activity in June 2009. It’s inevitable now that this expansion will become the 2nd longest on record at least. In May 2018, it will have run for 107 months, beating by a month the expansion that lasted from February 1961 to December 1969. By June 2019, if the expansion continues that far, it will be 120 months old, equalling the longest ever from March 1991 to March 2001. But will it break the record?
The average length off all 12 expansion cycles since 1945 has been 58.4 months, much longer than earlier in the century or going back to the 1850s. And in the three cycles since 1991, the average has been 95 months. Business cycles don’t die of old age, however. Something usually chokes them. Often it is the Federal Reserve raising interest rates and tightening financial conditions as inflation rises. On a few occasions, surging oil prices have brought expansions to an end. We could imagine that both of these will come into play to some extent over the next year or so, as well as other “shocks” related directly to the nature of Trump’s America.
One thing we know is that every Fed Chair, except Janet Yellen because she wasn’t in situ for long enough, has had at least one cyclical downturn to manage. The new Chair, Jay Powell, appointed by Trump, will be no exception. In 1970-78, Arthur Burns had to deal with both soaring inflation and a recession. Between 1979-87, Paul Volcker had to manage both a deep recession, which resulted from tough anti-inflation policies, and the savings and loan crisis in second tier financial institutions. Alan Greenspan, who ran the Fed from 1987 to 2006, had to deal with two recessions. Ben Bernanke had the 2008 financial crisis and the deepest recession since the 1930s on his watch. Powell takes over next month, with the economy on a roll and tax cuts kicking in, but with a poor outlook for the budget deficit because of the unfunded nature of Trump’s tax cuts, and with the external deficit widening. Wages have been remarkably subdued so far, but in states and industries with lower unemployment, there are tentative signs that wages and salaries are starting to pick up.
“Business cycles don’t die of old age. Something usually chokes them”Following the December jobs report, the markets anticipate an 80 per cent likelihood that interest rates will rise again by June, a 50 per cent chance of another rise by the autumn, and a 30 per cent chance of a rise in December. These odds are volatile, though, and it seems quite likely that market expectations will be revised up again before long. My own view is that we will see not three but four increases this year, pushing policy rates up by a percentage point to 2.5 per cent.
Oil prices have risen quietly but steadily to the highest levels for three years. Brent oil, for example, at almost $68 a barrel is up nearly 80 per cent from the late 2016 trough. If OPEC countries and Russia continue to restrict output as the global economy purrs, and already depleted excess inventories of crude oil fall further, there could be an upside surprise here despite the boost to supplies from US fracking.
Last but not least, Trump’s actions and policies could easily contrive to shorten the expansion. In general, his statements could be prejudicial to the rule of law and to the credibility of US institutions—hardly the kind of thing to make businesses confident or commit to future investment. Separately, Congress might start to look at stronger anti-trust measures in the technology sector. Although the much expected trade war between the US and China didn’t happen last year, it might yet. The White House has commissioned investigations under important sections of 1960s and 1970s trade legislation, and recommendations are going to come to Trump’s desk from late this month onwards. We could see action taken against individual products exported by China, such as steel, aluminium, or solar panels, as well as more general measures taken against China related to accusations that the latter plays unfairly with regard to technology transfer and intellectual property rights protection. Depending on how far the US goes, Chinese retaliation would be guaranteed.
Any or all of these could then weigh on the spending capacity and willingness of both households and companies, both of which have been saving less or borrowing more. The household savings rate was 2.9 per cent of disposable income last November, the lowest since 2007, while corporate liabilities have risen by 50 per cent since 2012, so that they now exceed the value of corporate assets. Watch this space.
