To be sure, in the 10th year of this cycle, there are significant issues facing the global economy: a slowing secular growth trend in emerging markets and the anchoring of low inflation expectations on a global basis come to mind. These are long-term, secular issues that have no quick resolution. From a cyclical standpoint, however, U.S. rates and trade policy are the key uncertainties. The fact that they are “man-made” — in that one could argue that it didn’t have to be this way but for the misguided will of certain policymakers — makes them even more interesting.
After the market shellacking of November, if you have poked your head out of the bunker of late, it would seem that we are on the verge of resolving both of these issues now. Way too many lights on the lawn, maybe Christmas came early this year?
The other day, Jay Powell, the U.S. Federal Reserve chair, was talking about U.S. rates being just below neutral. Global markets heard what they wanted to hear and took off.
Then Trump goes to the G-20 and comes back with a bag of goodies. He has cut a deal with China’s President Xi Jinping, and the world has a 90-day reprieve while U.S. Trade Representative Robert Lighthizer and Chinese Vice Premier Liu He figure out how to make the trade issue go away.
Unfortunately, I don’t think it is going to be that easy. And the biggest challenge on both fronts remains the strength of the U.S. economy, which continues to do quite well despite the tightening of financial conditions.
Take the Fed for one. There is no doubt in my mind that the Fed will have to stop tightening at some point. In fact, I believe they should not have started down this path as aggressively as they did in the first place. But having started down this path — with unemployment remaining low, wage pressures rising in the near term, and the overall growth rate still strong — a doctrinaire Fed is still somewhat hamstrung. They will stop, but not before they have tightened a few more times and the U.S. economy has been bashed down back to its trend growth rate of low 2%. That, in my view, won’t happen until late in the first half of 2019.
Trade Policy and Tariffs Will Have Long-Term Consequences
The trade policy and tariff issue is even more complicated. There are long-term geopolitical undertones and near-term political advantage to be had with the current policy. Yes, there are long-term consequences of these policies, but they have not started biting just yet. Scan any newspaper and you will find preposterous assertions that the U.S. has an incoming advantage in the trade war. With trillion-dollar fiscal deficits as far as the eye can see, that is as far from the truth as possible, but from a political standpoint at the moment it does not seem to matter much. Politics continues to trump economics.
However, this too will change. But only after the U.S. economy has slowed back to trend and flirts with the prospect of going below trend. That would be the turning point, and a new economic reality would lead to a different political calculus.
The bottom line, in my view, remains that we need to resolve both the rates and trade issues for us to get to the next level. But for both of these issues to be resolved, we need to see the U.S. economy slow in a more pronounced fashion than it has so far. That time will come for sure, I have no doubt in my mind, but it is not today. More likely in the early summer of 2019.
People have put up their lights, but Christmas is still a few weeks away.