US Macro Economic Landscape Growth, Interest Rates and Recession - - PowerPoint PPT Presentation

US Macro Economic Landscape

Growth, Interest Rates and Recession Risk

Satyam Panday, Ph.D. Senior Economist, S&P Global Ratings

March 2019

Current U.S. expansion is now 117 months old…

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…And expansions do not die of old age.

Duration of U.S. Expansions since World War II (months)

63 117 20 40 60 80 100 120 140 1980-1981 1958-1960 1970-1973 1945-1948 1954-1957 1949-1953 1975-1980 Average 2001-2007 1982-1990 1961-1969 2009-Present 1991-2001 Expansion Duration: Months

Duration of Expansions Since World War II

US growth looking handsome in comparison

6.2 6.3 6.4 6.5 6.6 6.7 6.8 6.9 7.0 7.1 0.5 1 1.5 2 2.5 3 3.5 4 2015 Q1 2015 Q3 2016 Q1 2016 Q3 2017 Q1 2017 Q3 2018 Q1 2018 Q3 (%, y/y) (%, y/y) Japan Eurozone US China (RHS)

Synchronized growth of 2017 faded in 2018

Pace of growth has been moderate but stable in the U.S.

real GDP growth (annual average)

…and growth likely will transition to estimated long-run trend rate of 1.8% beyond 2020.

Contribution to GDP Growth (percentage points)

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Consumers continue to carry the load…

…but swings in growth in 2018 & 2019 will largely come from business investment & govt. spending.

• 1.0
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0.0 0.5 1.0 1.5 2.0

• Pvt. Consumption

Business invesment Residential investment Government Exports Imports percentage points

Percentage contribution of components to GDP growth

2016 2017 2018 (f) 2019 (f) 2020 (f) Source: Oxford Economics, S&P Global forecasts

Unemployment rate has fallen below the Fed’s estimate of Natural Rate

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Feds NAIRU = 4.

…Unemployment rate (3.8% in Q4 ‘18) will likely fall as low as 3.5% by 2019 H2.

2 4 6 8 10 12 14 16 18 Data as of Jan 2019 U3 rate (Standard) U6 rate (Broad) Source: BLS %

Labor crunch broadly…particularly for lower skilled jobs

Skills mismatch cuts both ways as more and more share of the population gets educated and labor market gets tighter.

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1 1 2 3 4 5 6 7 2001 2002 2003 2004 2005 2006 2008 2009 2010 2011 2012 2013 2015 2016 2017 2018

No of Unemployed for Every Job Opening

1 (2.0) (1.5) (1.0) (0.5) 0.0 0.5 1.0 1.5 2.0 2001 2002 2003 2004 2005 2006 2008 2009 2010 2011 2012 2013 2015 2016 2017 2018

High Skill Jobs Vs Low Skill Jobs

High Skill Low Skill High-Skill Jobs: Dec'18 @1.3 Low - Skill Jobs: Dec'18 @1.9

Source: BLS

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Household deleveraging has stabilized…

Household aggregate debt to income ratio

Q4 07, 124.2% Q3 18, 91.1% 0% 20% 40% 60% 80% 100% 120% 140% Q4 54 Q4 57 Q4 60 Q4 63 Q4 66 Q4 69 Q4 72 Q4 75 Q4 78 Q4 81 Q4 84 Q4 87 Q4 90 Q4 93 Q4 96 Q4 99 Q4 02 Q4 05 Q4 08 Q4 11 Q4 14 Q4 17 home mortgage + consumer credit % of Disposable Personal Income

Source: The Federal Reserve's U.S. Financial Accounts Z.1 Releases, September 2017 and S&P Calculations Note: Households represent "Households and Non-profit Organizations". This group's total liabilities (which includes other debt liabilities besides just home mortgage and consumer credit) as a % of disposable income was 102% in third quarter 2018.

Estimated Output Gap Suggests Cyclical Recovery is Over…

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1983 Q1 1983 Q4 1984 Q3 1985 Q2 1986 Q1 1986 Q4 1987 Q3 1988 Q2 1989 Q1 1989 Q4 1990 Q3 1991 Q2 1992 Q1 1992 Q4 1993 Q3 1994 Q2 1995 Q1 1995 Q4 1996 Q3 1997 Q2 1998 Q1 1998 Q4 1999 Q3 2000 Q2 2001 Q1 2001 Q4 2002 Q3 2003 Q2 2004 Q1 2004 Q4 2005 Q3 2006 Q2 2007 Q1 2007 Q4 2008 Q3 2009 Q2 2010 Q1 2010 Q4 2011 Q3 2012 Q2 2013 Q1 2013 Q4 2014 Q3 2015 Q2 2016 Q1 2016 Q4 2017 Q3 2018 Q2 2019 Q1 (f) 2019 Q4 (f) 2020 Q3 (f)

% of GDP

Source: BEA, Oxford Economics, CBO, and S&P Global Economics Forecasts

But Alternative measures of spare capacity suggest there could still be some ways to go to complete a normal cyclical recovery…

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• Industrial Capacity Utilization (%)

Employment to Population Ratio: 25-54 yrs

…Scope for demand led growth remains till at least this year.

62 67 72 77 82 87 (%) Capacity Utilization: Total Industry

70 72 74 76 78 80 82 84 (%) Employment Population Ratio: 25 - 54 years

Core Inflation is Near Where The Fed Wants It To Be…

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 Data as of Nov 2018 Personal Consumption Expenditure Price Index (PCE index) core-PCE index (PCE excluding food and energy) The Fed's inflation target Source: Bureau of Labor Statistics Note: The Fed's inflation target is 2%. The Fed's preferred measureof inflation is the core-Personal Consumption Expenditure (PCE) inflation Data is year over year percentage change %

…But the Asymmetry Around The Target Is Hard To Miss.

The Fed is On a Long Pause; The Bar to Change Policy Rates On Either Direction Is Very High

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32% 34% 36% 38% 40% 42% 44% 46% 48% Q3 83 Q3 86 Q3 89 Q3 93 Q3 96 Q3 99 Q3 02 Q3 05 Q3 08 Q3 12 Q3 15 Q3 18

Note:Dashed lines show standard deviation above and below the mean (Q318=46%) (Percentage of GDP) Source: Board of Governors of the Federal Reserve System

Non Financial Corporation Total Debt as % of GDP

1.0 2.0 3.0 4.0 5.0 6.0 7.0 Q3 83 Q3 86 Q3 89 Q3 93 Q3 96 Q3 99 Q3 02 Q3 05 Q3 08 Q3 12 Q3 15 Q3 18

Note:Dashed lines show standard deviation above and below the mean (Q318=3.8) EBIT/ net interest and miscellaneous payment Source: Board of Governors of the Federal Reserve System, U.S. Bureau of Economic Analysis

Interest Coverage Ratio

4% 6% 8% 10% 12% 14% 16% 18% Q3 85 Q3 88 Q3 91 Q3 94 Q3 97 Q3 00 Q3 03 Q3 06 Q3 09 Q3 12 Q3 15 Q3 18

Source: Board of Governors of the Federal Reserve System (Q3 18=12%) Percentage of Gross value added, 4-quarter average Note:Dashed lines show standard deviation above and below the mean

Non-financial corporate profit margins

20 25 30 35 40 45 50 Q3 85 Q3 88 Q3 91 Q3 94 Q3 97 Q3 00 Q3 03 Q3 06 Q3 09 Q3 12 Q3 15 Q3 18

Source: Board of Governors of the Federal Reserve System (Q3 18=30.56%) (%) Note:Dashed lines show standard deviation above and below the mean

Short-term debt as a percentage of total debt

A Quick Look at where Non-Financial Corporates Stand in the current Business Cycle

Flat To Almost Inverted Yield Curve

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1 2 3 4 5 Recession T10Y3M mean+/- 1 stdev mean+/-2 stdev

Source: Federal Reserve Bank of St. Louis. Data through February 2019.

Percentage points

Recession Probability Climbing But Below Past Thresholds

Probability of growth slowdown six months ahead Suggested by leading indicators

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

1Q 2007 2Q 2007 3Q 2007 4Q 2007 1Q 2008 2Q 2008 3Q 2008 4Q 2008 1Q 2009 2Q 2009 3Q 2009 4Q 2009 1Q 2010 2Q 2010 3Q 2010 4Q 2010 1Q 2011 2Q 2011 3Q 2011 4Q 2011 1Q 2012 2Q 2012 3Q 2012 4Q 2012 1Q 2013 2Q 2013 3Q 2013 4Q 2013 1Q 2014 2Q 2014 3Q 2014 4Q 2014 1Q 2015 2Q 2015 3Q 2015 4Q 2015 1Q 2016 2Q 2016 3Q 2016 4Q 2016 1Q 2017 2Q 2017 3Q 2017 4Q 2017 1Q 2018 2Q 2018 3Q 2018 4Q 2018

growth<1.5% growth >1.5% and <2.5% Note: In order to generate the estimates, we use an ordered-Probitmodel (data from 1967 to 2018) with Leading Economic Indicator Index (OECD) and Chicago Fed's National Activity Diffusion Index as predictors to estimate two-quarter out probabilities of growth categories: continuation of >2.5%, moderate slowdown to 1.5%-2.5%, or slumping to <1.5%. Probabilities sum up to 100%, thus probability of >2.5% growth rate is now below 50%. Source: OECD, Chicago Fed, St.Louis Fred and S&P Global Economics calculations

Policy-related economic uncertainty index is elevated

50 100 150 200 250 300 Jan-85 Jan-87 Jan-89 Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13 Jan-15 Jan-17 Jan-19

index

Note: Policy-related uncertainty index is a weighted combination of three underlying components: news coverage, temporary tax measures, and economic forecaster disagreement. Source: Baker, Bloom and Davic; www.policyuncertainty.com

Downside Risks to Baseline Growth Forecasts

– Trade policy-- tensions risk turning to much severe trade war; stranded assets problem; China, EU (auto) – Fiscal policy– turns into sudden headwind: A divided Congress must

• 1. Approve the USMCA
• 2. Raise the debt ceiling, and
• 3. Pass FY2020/21 budget

– Export slowdown; policy risk abroad; Emerging markets rattle again – Will growth in investment stall? Regulatory costs increase in Tech? Interest sensitive sectors such as housing? – Oil Prices– cuts both ways; welfare shift from consumers to domestic producers, less to foreign producers than used to be because of shale revolution – Equity market correction (persistent)- business confidence down, consumer sentiments down – In our most likely downside scenario (based on ordinary risk– not extraordinary risk– surrounding our baseline forecasts), growth would slow to 1.4% this year and 0.9% in 2020 before bouncing back to 2% in 2021.

• a broad loss in confidence and growing risk-aversion would lead to a drop in real investment, the equity

markets, and consumer spending more than in our baseline.

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Deteriorating fiscal space amidst pro-cyclical stimulus

Will there be political will for fiscal stimulus in the next recession?

2 4 6 8 10 12 (12) (10) (8) (6) (4) (2) 2 4 6 8

1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

(%) (% of GDP)

Budget balance (LHS) Unemployment rate (RHS, inverted)

Productivity Growth is the key in determining 2% vs. 3% economic growth, given demographic dynamics (Aging)

0.5 1 1.5 2 2.5 3 3.5 1956-1965 1966-1975 1976-1985 1986-1995 1996-2005 2006-2015 2011-2017 average annual growth % Labor Productivity Growth Nonfarm Business Sector Average 1956-2017

Source: BLS and S&P calculations