Earlier this week, we noted the bond market could be a harbinger of a 2018 recession. The yield curve has only flattened further over the past few days. The 10-year dropped another 15 basis points to 2.77 percent, suggesting the economy may be facing headwinds.
The stock market is also set to post its first losing quarter in over 5 years.
This action would seem to fly in the face of business-friendly tax policy and the increased budget, which should stimulate both business and consumer spending.
But as Rich Miller points out in this article in Bloomberg, the markets are a forward-looking discount mechanism, and we are entering the late stages of this current business cycle. This final push for growth might peter out and bring a recession just ahead of Trump’s re-election bid in 2020.
Hefty tax cuts, stepped-up government spending and robust global growth should help insulate the economy against a downturn over the next two years, in spite of last week’s stock-market swoon. That would allow the expansion that began in 2009 to become America’s longest ever.
But after that, watch out, economists warn. Fading fiscal stimulus, higher and rising interest rates, and cresting world demand could leave the economy vulnerable to a contraction — just in time for the presidential campaign.
“2020 is a real inflection point,” said Mark Zandi, chief economist at Moody’s Analytics Inc., in West Chester, Pennsylvania.
It’s not only President Donald Trump who needs to worry after claiming his policies of deregulation, deficit-widening fiscal measures and trade protectionism will lift the world’s largest economy out of a decade of mediocre growth. Investors should fret, too. A recession — or more accurately, the anticipation of one — is often the trigger for bear markets in stocks.
Economic observers admit they don’t have a great track record predicting downturns. Forecasting a 2018 recession is a “mug’s game,” given all the uncertainties involved, said Krishna Guha, vice chairman at Evercore ISI in Washington.
But what seems clear is this: The fiscal sugar rush that’s ginning up growth in the short run could be setting the stage for a letdown later, especially if the Federal Reserve feels compelled to take away the punch bowl before inflation and asset prices like stocks get too out of hand.
The trouble is that some of that fuel — the $300 billion boost to government expenditures — is slated to burn off after two years under the budget agreement passed by Congress. That’s led some economists to talk of a fiscal cliff in 2020, with falling outlays dragging down the economy.
The betting, though, is that lawmakers will act to prevent that. But even if they do, they’re unlikely to throw more accelerant on the economy. So the budgetary boost to growth will shrink from a half percentage point this year to a quarter point next year to basically a wash in 2020, said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York.
In the meantime, the super-charged spending raises the risk of overheating the economy by pushing unemployment further below its long-run sustainable level and leading, at last, to a pick-up in wages and inflation. And that, in turn, increases the chances that the Fed will overreact by jacking up interest rates, tipping the U.S. into recession.
The prospect of a “train wreck” in 2020 is palpable, as Fed efforts to prevent overheating may lead to rates that are too high for an economy suffering from the end of the fiscal sugar rush, plus an ebbing of global growth.
One potential warning flag: stock and other asset prices remain elevated even after last week’s selloff. As Powell himself has noted, it wasn’t faster inflation that led to the last two recessions. It was a bursting of asset bubbles.
Spurred by rising equity and property prices, household net worth as a percentage of disposable personal income has topped the highs seen before the past two economic downturns.
If the stock market continues lower, this could set off a self-fulfilling downward spiral, sending the economy into a recession.
