The US economy is ‘late cycle’. You hear this a lot these days.
The terminology is interesting. Are there signals flashing that the US is on the cusp of a downturn? Is it simply a view that we are ‘overdue’ a recession?
Or might this be an example of the kind of term that is used lazily in financial commentaries which, seemingly innocuous, is in fact loaded with judgement?
Let’s consider the possibilities.
First, economic expansions do not have a predictable shelf life: just look at the variability of growth over time and across countries. The US economy was subject to large and frequent swings in GDP growth in the decades immediately after WW2, when the structure of the economy looked very different. By comparison, the average expansion since 1982 (excluding the present one) has lasted nearly twice as long. Were many people predicting this in 1982?
Looking around the world, Australia provides an example of a continuous economic expansion that has lasted for twenty-four years. This is despite more than one boom and bust in commodity prices and the 2008 global financial crisis.
The UK and Euro area each achieved close to fifteen years of continuous year-on-year growth in GDP until 2008.
Since the calendar isn’t a reliable predictor, we need to think about what causes recessions to assess their likelihood. And if we’re to say anything at all useful on this, the theory must go beyond shocks.
Most plausibly, recessions are caused by periodic and collective shifts in expectations, the result of which is a desire to reduce spending. Suddenly capital expenditure plans that once seemed a good idea are scrapped. Cautious individuals pull in their horns, or worse lose their income altogether. Tighter credit conditions – brought about by the central bank or risk-averse banks – may be a catalyst, but even if not, can exacerbate the downturn.
This chain of events may follow a period of exuberant optimism. The fear of missing out which had justified ambitious spending plans gives way to a different kind of fear – of staying afloat and covering the bills. The boom-bust misallocation of capital is the classic Austrian perspective on the business cycle.
When viewed through this lens, the risk of a US downturn does not seem any more elevated than usual, despite seven years of recovery and growth. The most cyclical components of expenditure – investment, housing and durable goods – remain low by historical standards when compared to GDP. Indeed, the worry has been secular stagnation and a lack of investment spending.
Despite the rhetoric around the presidential election, US households are, in aggregate, in better shape than for some time. Incomes are growing more rapidly, including for the lowest earners. The savings rate is in line with its average since 1990 and above the levels that prevailed from 1998 to 2008.
Household debt levels relative to income are greatly reduced, as are debt-servicing costs. More limited credit availability post-2008 has a silver lining.
The one source of booming investment and unbridled optimism – shale oil production – has already collapsed.
It is right to acknowledge where risks have increased. Rising corporate leverage is perhaps the most important. However, as many commentators have lamented, debt growth has by and large been used for acquisitions and share buybacks – but, importantly, not for excessive investment spending. Crucially, leverage in the financial sector has, in contrast to the wider corporate sector, declined with US banks much better capitalised today.
Other concerns focus on weakening profit margins, wider credit spreads and tighter credit conditions. A lower oil price and strong dollar made a significant impact on aggregate profit margins. But we should recognise the collapse in oil is a de-correlating shock: oil is an input cost for most businesses. The dollar may strengthen further, but it has already had a substantial move. As for credit conditions, the recent Fed survey did not point to a widespread tightening of lending standards. Outside of the commodity sectors, default rates remain low.
External economic weakness has weighed on US growth. Again, this may persist, or indeed, get worse. More recently, however, economists have been moving their forecasts for Europe and China higher, not lower.
Shocks, policy mistakes…and Trump
US growth has been remarkably consistent around 2% p.a. since the financial crisis. If pushed to place a bet on whether that growth rate will shift up or down in the coming years, we suspect most market participants believe the latter is more likely.
As the above might suggest, we are sceptical that deceleration is more likely than accelerating growth or continuation of the recent trend. The description ‘late cycle’ is therefore unhelpful at best, and very possibly misleading.
Of course, we have said nothing of shocks or policy mistakes. Shocks are inevitable. They are also unpredictable.
President Trump is a political shock. Time will tell if his election victory presents a macroeconomic shock. The general fear was that Trump would be bad for growth; the market appears now to think he might first engineer an economic boom. As for monetary policy, the indications are that the Fed would be happy for nominal growth to run higher, at least for now. It is therefore unclear if the next significant policy surprise will mean higher or lower growth.
The bottom line is that we can be sure there will be a recession at some future point, but we are very wary of accepting the ‘late cycle’ characterisation of the present US economic situation.