Record-Long U.S. Economic Expansion

Previous expansions were ended by much higher short-term rates: for example, 5.25% in 2007, 6.5% in 2000, 9.8% in 1989, 19% in 1981, and the 1960s expansion ended with federal funds at 9% in 1969.

Our point is that it is pretty hard to argue that 2.40% short-term rates will be the straw that breaks the back of this record-long economic expansion.  What is so wrong with a 2.4% interest rate when large corporations are willing to pay out an average dividend of just a shade under 2%, and inflation is running close to target, somewhere between 1.5% and 2%?  So, what are the prime candidates for a policy mistake this time around if the Fed is not going to be the culprit?

First: Trade Wars and Weaponizing Tariffs.

Tariffs are a tax.  This Administration has used tariffs as a weapon in its trade wars to attempt to force concessions from countries around the world – China, Mexico, Canada, and now the focus turns to Europe.

One can argue who pays the tariff-tax and which countries are hurt the most, but global trade is clearly decelerating.  The US and China are the number one or number two trading partners of most other countries, and both the US and China are seeing their imports decelerate or even decline in some cases.

When global trade slows, so does global growth.  We doubt the trade wars and weaponization of tariffs are enough to cause a U.S. recession, but slower real GDP growth does seem to be in the cards.

Second: Another Government Shutdown and Debt Ceiling Crisis?

The U.S. Federal Government will run out of funding on September 30, 2019, if new spending legislation is not agreed to and signed into law.  Extraordinary measures to avoid a breach of the debt ceiling of $22 trillion are not likely to be effective past September.  Thus, a funding and debt ceiling crises are in the making.  If President Trump, the Republican-led Senate and Democratic-led House of Representatives cannot agree to legislation by September 30, the year’s second Federal Government shutdown may commence.

There is still plenty of time to avoid a crisis, although typically deals are not cut until the final hour. If a shutdown and debt ceiling crisis does hit, it may last longer and do more economic damage than previous episodes.

While neither a shutdown, debt ceiling crisis or the trade wars on their own would be likely to cause a recession, their combination could be the trigger.

Finally, would we change our forecast of decelerating U.S. economic growth for second half 2019 and 2020 depending on the magnitude of Fed rate cuts in 2H/2019?  No.

Our perspective is that the seeds of an economic deceleration from a 3% real GDP path down toward 2% and maybe a little weaker have been sown by the uncertainty over the trade war and weaponization of tariffs.  And, lowering short-term interest rates from 2.4% to 1% or even back to zero will make no difference for business investment decisions.  Business investment plans have been thrown into disarray due to supply chains being destabilized by the shifting trade wars, from China to Canada and Mexico, and on to Europe.  Businesses also have to decide whether to plan on the tariffs already imposed as likely to become permanent, which we think they are, since no deals with either China or Europe are in sight.  This is a heavy burden for the global economy, and all multi-national corporations have to manage these risks, and lower short-term interest rates are not going to help.