Given the manic spikes and dives in the stock market, the near-inversion of the yield curve (I’ll explain), the tanking of the price of oil, the Federal Reserve’s rate hikes, chaotic leadership on trade policy (and everything else), and lots of buzz about the “r-word" (recession), it’s a good time to evaluate the extent of risk factors in the current economy.
I’ll briefly summarize what I view as the key points, but the bottom line is that for all the noise, the strong labor market and rising real wages will still power the expansion over the near term. Post-2019, however, once the current stimulus fades, growth is likely to slow, but precisely how much, no one knows.
The stock market is clearly on shpilkes (Yiddish for “pins and needles”), and it is seriously tarnishing whatever reputation it has left for a rational aggregator of forward-looking information. In theory, current stock prices should reflect expectations of future earnings of the companies in the indexes, but how could these values jump 1 percent on Monday and tank 3 percent — a huge sell-off — on Tuesday? They couldn’t. Instead, they jumped when Trump tweeted out a truce in the trade war, and they tanked the next day when the Chinese essentially responded, “Yeah … that’s not quite how it went down.”
Look, I get it. As long as some traders, along with their algorithms, react to every tweet that springs from our dear leader’s thumbs, other traders/algos have to play along. But the fact is that there is very, very little information in anything Trump says, and we’d all be better off, in the sense of less whiplash, if we agreed on this point.
Until then, from the perspective of the larger economy, I don’t see the recent spike in volatility as a big deal. Somewhere in the noise is a signal reflecting the likelihood that growth and corporate profitability and likely to slow later next year, and that matters. Go ahead and watch the roller coaster if you must, but if it makes you sick, don’t say I didn’t warn you.
The market was also spooked by the flattening of the yield curve, meaning the shrinking difference between long-term and short-term bond yields. Such movements are driven by the Fed raising short-term rates and investors, worried about the near-term economy, demanding more long-term bonds (thus driving down long yields). Since yield curve inversions — long yields below short yields — are reliable predictors of future recessions (on average, a bit more than a year later), its flattening is not something you can shrug off.
But I think we’re focusing on the wrong message from the curve. We tend to think of it in terms of “are we headed for recession or not?” If the curve inverts, that’s bad; if not, we’re cool. But what if growth slows yet doesn’t cross zero? After all, falling from 3 to 1 percent GDP growth typically raises unemployment more than going from a little above to a little below zero.
The flat curve is thus sending the same message buried in the market noise: slower growth ahead.
Oil tanks: Though it’s rallied a bit from its recent lows, the price of a barrel is down by about a third since early October, driven largely by a supply glut amid some weakening of global demand. Cheaper oil used to work like a stimulative tax cut in the United States. But now, according to the Wall Street Journal: “As the U.S. has risen to become the world’s largest oil producer this year, a growing chunk of domestic investment, manufacturing output and employment has become tied to oil. Now, when oil prices fall, it risks hurting investment and hiring in important parts of the economy.”
That said, in the short run, real wages are closely tied to the price of oil, and I predict that if gas prices stay low or fall further, real hourly pay for middle-wage workers will grow from its current rate of about half a percent per year to 1.5 percent, a big jump that folks will feel in their paychecks. In other words, falling oil prices are a double-edge sword, with upsides and downsides.
The wage story links up with the biggest driver behind the current expansion: the job market. For the next few quarters, we can very likely count on strong job creation, low unemployment and the fortuitous collision between rising nominal wages and slower inflation (due to cheaper oil) to power consumer spending, which is 70 percent of the U.S. economy.
The other edge of the oil sword may ding the business investment side of the economy — the interest-rate-sensitive housing sector is another negative in this investment mix — so we’re into a bit of a tailwind/headwind dynamic.
The Fed: The Fed watches the stock market, but its client is the real economy — growth, jobs, wages, inflation, all of which look good to it right now (oil’s real too, but it’s a global commodity, outside the reach of a central bank). The most interesting and important variable in that mix is inflation, which has been far less responsive to labor market tightening than the Fed expected. Since price growth is so “well-anchored,” the Fed could — I’d guess, would — pause its rate-hiking campaign if any of these headwinds start to look particularly threatening. But for now, it will keep tapping the brakes with rate hikes, no matter much shade the president throws at it.
Which brings us to Trump. He inherited a growing economy, and he temporarily juiced that growth with a lot of deficit spending. But the juice tapers out toward the end of next year, and his misguided trade war isn’t helping (if anything, in tandem with tax cuts, it’s leading to larger trade deficits). Both of those problems are behind a lot of nervousness that characterize this moment. More deficit spending is, of course, a possibility, but I guarantee you the new House majority will be in no mood for more Republican tax cuts.
So: tune out the market volatility, keep on eye not just on recession probabilities but on slowing growth, watch oil and its impact on real wages (+) and investment (-), and for Keynes’s sake, don’t listen to Trump!