The noise level in Washington DC is as impressive as always. The impeachment trial dominates the media with accusations flying back and forth between President Trump and Democrats in Congress. Yet, recent weeks have been some of the most productive of the Trump presidency.
The updated North American Free Trade Agreement, Nafta, is finally moving towards ratification as President Trump made numerous concessions to the Democrats. This is important to American businesses; Trump had threatened to terminate Nafta to force action from Congress, and this uncertainty has now been removed. The Nafta 2.0-agreement includes language on data protection and other elements not known in 1994. The most talked-about measures concern the auto industry, including higher levels of input-sourcing from North America, and minimum wage requirements. The deal is expected to add manufacturing jobs in the US.
The “Phase One” trade deal with China still has not been publicized, but the presented framework requires China to buy more US agricultural products and oil, while President Trump has agreed to scale back some introduced and promised tariffs. The deal does not address the large, structural issues concerning China’s industrial practices, and Washington continues to push other countries to avoid using Huawei products in 5G-networks. But escalation is off the table for now, and farmers in the Midwest should see some financial relief.
President Trump has also made deals with the Democrats on domestic issues. The establishment of the Space Force comes with paid maternity leave for federal employees; a pet project of both Ivanka Trump and Democrats in Congress. The spending bill for the fiscal year 2020 will add further to the already ballooning deficits but also to economic growth in 2020.
Republicans have also continued to confirm conservative judges at an unprecedented speed. While much focus is on social issues, the new wave of judges is more likely to make a difference with regard to government regulatory powers and labor issues. Businesses are happy about this, labor unions not so much. The tax cuts from December 2017 are still on maximum effect with generous write-offs encouraging new capital investments. Wind-power subsidies have been extended.
President Trump’s most striking achievement has been on monetary policy. A year ago, Federal Reserve was on “auto pilot”, raising interest rates every quarter and reducing the balance sheet at full speed. Interest rates and yields were moving higher. Fast-forward a year, and Federal Reserve has cut interest rates three times – and has embarked on another program of bond purchases. While officially not quantitative easing, the Federal Reserve balance sheet is yet again expanding rapidly – and the stock market is loving it.
With efforts to push down prices on prescription drugs, and oil prices at a moderate “Goldilock”-level, President Trump has done pretty much all he can to optimize economic conditions in the run-up to the November 2020 presidential election.
The flurry of measures is likely to provide a tailwind to the US economy next year. The International Monetary Fund (IMF) expects GDP-growth of 2.1 percent in 2020. But the IMF has consistently underestimated US economic growth since President Trump was elected and is likely to do so again – provided Trump does not mess things up again with another trade war. Economic growth closer to three percent is not unrealistic. This is not only far beyond anything Europe can muster but is also likely to put even more pressure on an already tight labor market. Higher speed in 2020 increases the likelihood of a more pronounced slowdown later on.
Here are some of the highlights of the US economy heading into the next decade.
Interest rates and yields are down
The sharp reversal in monetary policy has also pulled down long-term yields. Federal Reserve has not only lowered the Federal Funds Target Rate, but the monetary-policy decision makers have also lowered their expectations of where interest rates should be in a neutral state. In September 2018 interest rates were expected to be at 3.0 percent in the longer run. That has now been cut to 2.5 percent. As a result, yields have been pushed down.
Lower government yields scale back the expected explosion in interest payments in coming years. In January 2019, the Congressional Budget Office expected federal net interest payments of USD 928 billion in 2029. In August 2019, that had been reduced to USD 807 billion, and the next projection will be even lower. For the 2020-2029 period, the projected net interest payments declined by more than USD 1.1 trillion between January and August.
A 30-year fixed mortgage yield reached 5.3 percent in December 2018 but has now declined to 4.0 percent. This has boosted the housing market. House-price appreciation has stabilized, and turnover in the housing market has increased substantially for both new and existing homes. This has added to housing permits, and housing construction is likely to increase next year. Homeowners have also been able to refinance, thus reducing interest payments.
The corporate sector has also benefitted from not only lower government yields but also from lower risk premia. Corporate indebtedness is the highest ever measured, and the tax package from December 2017 added further pain by limiting interest deductions. With lower interest rates and yields, the debt-financed share buybacks and M&A activity can continue, thus supporting the stock market. Decent economic growth, trade truce and lower interest rates is a great combination for equity prices. At least in the short run.
President Trump views the stock market as an important indicator of economic performance. If equities begin to slide in 2020, Trump is set to resume the attacks on the Federal Reserve to lower interest rates further. However, Federal Reserve is likely to remain on hold for a longer period of time.
Strong labor market
Fewer new jobs were created in 2019 than in 2018. This is a natural development mostly reflecting that higher wages have pushed up the cost of labor. Small businesses (NFIB) have long complained about the quality of labor, but the cost of labor is a growing concern. The latest NFIB-survey showed a dramatic increase in expected compensation plans to the highest level since 1986.
Expected higher labor costs are pushing businesses to invest in productivity-enhancing technology. Productivity growth has averaged 1.4 percent since President Trump was elected.
Unemployment continues an impressive run below four percent – the longest period of sub-four percent since the 1960’s. The benefits are broadly felt with unemployment among blacks and latinos at the lowest level measured. However, for President Trump there are some early warning signs. Unemployment has started to increase in the manufacturing-heavy states of Pennsylvania and Wisconsin – two of the states responsible for Trump’s 2016-win.
The ability to pull more people onto the labor market will be critical to avoid an overheating of the economy next year.
Households are in great financial shape
The continued improvement in the labor market is also reflected in the financial well-being of households. Hourly wages are increasing by more than three percent, and with continued healthy job gains, overall wage compensation is up around five percent. With only moderate inflation, this provides for solid real wage gains.
Housing wealth is increasing with overall household debt declining as share of disposable income and GDP. The strong income gains and moderate growth in consumption has also prompted a rather unusual upward trend in the household savings rate. Household savings have been increasing since November 2016. Normally, savings decline and indebtedness increases late in the business cycle. The lack of debt-fueled growth is a very important economic strength and could help prolong the current growth period even further.
Consumer confidence remains at elevated levels and indicates high growth in personal consumption. However, major structural problems remain for US households. Student debt continues to rise rapidly, adding financial burdens to younger households. Rents are also increasing faster than wage, which – again – primarily hit younger households in the cities. Retirement savings are generally too low – particularly for renters.
Record-high oil production
The United States has become the largest oil producer in the world with production just below 13 million barrels per day. On average, crude oil production is up 1.5 million barrels per day compared to 2018 and thus compensating the world market for most of the reduced production in Iran.
The shale industry has become more efficient, hence capital investments needed to extract (shale) oil has declined. For the first time in more than 40 years, the US has a surplus in the oil and oil-products trade balance. The Phase One trade deal with China is likely to push up exports of crude oil even further next year.
The slowdown in capital spending in the oil industry has pulled down overall corporate investments. Most shale companies are heavily indebted, which could become a problem down the road – but not until after the November 2020 election.
Manufacturing companies are not happy
The manufacturing sector has been hit hard by President Trump’s many trade wars. ISM manufacturing has been below the 50-threshold since August. The non-manufacturing sector has also seen a drop in confidence, but ISM still indicates moderate expansion in activity. Investments in machinery and structures have been declining due to lower corporate confidence and the lower investments in the oil sector.
The Nafta 2.0 should bring some clarity to North American markets, while the de-escalation of the trade war with China also adds relief. However, the ongoing technology battle with China remains a concern. With the global manufacturing sector showing some signs of a turnaround, even US manufacturers should have seen the worst by now.
Even better global conditions cannot hide that Boeing’s never-ending 737 Max disaster is visible in everything from new durable goods orders to manufacturing exports. Overall manufacturing performance is not likely to pick up until this has been resolved.
President Trump has made the revival of the US manufacturing sector a central piece of his economic program. However, employment in the manufacturing sector has only increased by three percent since inauguration. Not very impressive at all. Services remain the job engine of the US economy.
Huge trade deficit
Despite waging multible trade wars, the US trade balance remains deep in the red. The deficit has declined some in recent months but only after hitting a new record. Trade with China has declined, but imports from other countries have increased correspondingly. Vietnam has been the big winner in Asia. The EU trade surplus in goods has increased further from already high levels. However, this time Germany cannot be blamed. The trade deficit with the EU could become a target, if President Trump wants to show some action.
Fiscal policy is a mess
The federal deficits began to increase while Obama was still president, but the deterioration has continued as tax cuts have proved not to finance themselves through higher economic growth. Spending bills have added further to the deficit, and the latest bills are no different. Hence, public spending will add substantially to economic growth in 2020, but the economic return to the spending is pitifully low – and the fiscal outlook unsustainable.
Republicans have proved they mostly care about deficits, when a Democrat inhabits the White House. But tough decisions, particularly on health care and retirements, await future presidents.
Trump gets good marks on handling of the economy
The economy has been one of President Trump’s strengths, and voter approval has increased substantially since the trade truce with China was announced in October. With the latest deals, Trump has increased the likelihood of reelection. At least if the economy becomes a central campaign issue.
For Democrats, the strong economy adds another headache. Democrats are already fully engaged in a civil war between centrists aiming their message at the suburban swing voters, and the purists on the extreme left.
If employment continues to rise and households are feeling pretty good about their financial situation, Democrats have to recalibrate the policy message. Because despite all the noise from the White House and a fully justified impeachment, there just might not be enough angry Americans to put a leftist in power. The British election should be a wake-up call.