By NEMA Chief Economist Don Leavens, PhD
Over the summer, the U.S. economic expansion passed a 10-year milestone to become the longest stretch of uninterrupted growth on record. One reason for the record endurance is likely the expansion’s slow average growth pace compared to previous recoveries. Supply bottlenecks and inflationary pressures common with more robust recoveries only began to materialize late in the current business cycle, which has helped to sustain a decade of ultra-low interest rates.
The economy grew about 2.5 percent in the first half of 2019 compared to the same period a year ago. The unemployment rate has been at or near the lowest point in 50 years. Inflation remains below the central bank target. Stock market indexes have held within 5 percent of record highs. Profits and consumer demand are robust.
Someone returning from a long summer vacation without an internet connection must be wondering why the media headlines today warn of an impending recession. A similar atmosphere of panic prevailed in December 2018 after the Federal Reserve raised interest rates a quarter point.
Several factors account for the hype about a looming recession:
- First, the yield on 10-year bonds has dipped below the 2-year rate signaling that investors believe economic growth will slow significantly. Such interest rate inversions have preceded the last seven recessions
- Second, tariffs imposed on Chinese imports are fueling an escalating trade war. Uncertainty surrounding the duration of the tariffs and the prospects for a trade deal is expected to chill investment as businesses reassess supply chain strategies while waiting for longer-term trade policy clarity
- Third, major economies with large trade exposure, including China, Germany, and Japan are experiencing increasing economic weakness as rising trade barriers thwart trade flows. Foreign government and central bank actions to stimulate growth are helping to pressure the value of the dollar higher. The strong dollar and weakened global economies are expected to slow export demand, shaving economic growth prospects
- Fourth, the administration has acknowledged that tariffs will inflict costs on Americans and could lead to a recession. They argue that a recession is a relatively small price to pay for hammering out a fair-trade deal with China, which could lead to a more prosperous U.S. economy
While each of these factors has negative implications for economic growth, none of them alone would likely precipitate a recession. The yield inversion reflects investor sentiment that future growth rates will fall below current levels, keeping inflation and interest rates low. If growth falls below trend near 2 percent, then the economy could slip into recession should additional adverse events such as war or natural disaster occur. The broad-based $21 trillion economy demonstrated resilience in the face of the oil bust of 2014, Arab spring, the European recession of 2016, Brexit, and many other geopolitical events.
All expansions expire at some point. Optimists suggest that the Fed stockpiling of long-term debt distorts the meaning of an inverted yield curve since the hoarding of such debt has pushed down long-term interest rates. But arguments to the effect that it is different this time usually prove false. Some forecasts suggest a recession will commence in the second half of 2020. But for at least the last five years, some forecasts have pointed to a recession a year to 18 months out. And yet the expansion rolled on to set a record. The act of applying high tariffs on all imports arguably could kill the expansion. Something short of this extreme could imperil the expansion, but the status quo could also linger with companies eventually adjusting to evolving global trade policies.
A scenario of slower economic growth, lower interest rates, and rising tariffs has a relatively high probability in the near term. Industries such as manufacturing and agriculture with exposure to the trade sector will struggle. Yet solid fundamentals will likely see the expansion continue into next year. Beyond that, some confluence of events will end its record run eventually, but it may take longer than some are predicting.