The 2020 presidential election is now less than a year away. Every political move in Washington is pointing towards the election. The ongoing impeachment process is a joker as we still don’t know how the swing voters will respond: Fed up with the “corruption” in Donald Trump’s White House? Or fed up with the political ”witch hunt” from the Democrats? Or just fed up with Washington in general?
The recent state elections in Virginia offered a view of the state of affairs in suburban America. Democrats took power in both chambers, building on gains in the 2017-election. Republicans held two-thirds majority in the House of Delegates going into the 2017-election. Democrats did not just win in the suburbs of Washington DC, but also in the suburbs in Richmond and Hampton Road. Republicans expanded control over rural areas, but elections are won and lost in the suburbs. Moreover, Republicans have also lost two gubernatorial elections in the Southern states of Kentucky and Louisiana.
This is not good news for the Republicans. However, the Democratic 2020-primary could produce a candidate so far to the left, that suburban moderates will hold their noses and vote for a president they dislike.
President Trump was elected to be disrupter-in-chief. He has done a brilliant job at that. Unfortunately, just breaking things is more fun in theory than in real life. A strong economy is President Trump’s most important selling point in the election. Which is the reason there is so much pressure on the Federal Reserve to lower interest rates further, and why the trade war with China has entered a phase of slow disarmament rather than continuous escalation.
Mini deals are Chinese dream come true
The announcement in mid-October of a framework for a trade deal between the United States and China was an act of necessity for both President Trump and President Xi.
President Trump went too far, when he in August introduced tariffs on almost all remaining Chinese goods. Rather than mostly inflicting damage on the Chinese economy, American consumers would have found themselves at the receiving end of the economic pain – just as the election year was heating up. Hence, Trump had to find a way out of the mess.
For China, the African swine fever is threatening to kill up to half of China’s estimated 400 million pigs. It is highly contagious, and the virus even survives being frozen. Pork is a stable in the Chinese cuisine, and the exploding prices on pork and other meats are driving up inflation. That increases the risk of social unrest. Hence, China needs American pork for consumption, and cheap soybeans to restart domestic pork production.
A limited “Phase One”-deal exchanging a halt to more tariffs, maybe some rollbacks, with Chinese purchases of agricultural goods and some other cosmetic concessions is a political win-win situation for both sides.
However, if China manages to move the process going forward from focusing on one comprehensive deal to a series of small deals, it has basically won the trade war. Mini deals means China could make concessions on numerous points and achieve a simultaneous rollback of tariffs, while preserving the core industrial strategy “Made in China 2025” and accept tariffs remaining on some of its exports.
It would be an excellent outcome for Beijing. This is also why there is so much infighting between President Trump’s advisers about how to proceed with even the “Phase One”-deal. The pressure from the American election season is helping China.
Manufacturing and agriculture are hurting
The ceasefire in the trade war is good news for the manufacturing sector. Although already-introduced tariffs continue to hurt businesses, the ceasefire should allow companies to better plan for the future. However, the status surrounding Chinese tech companies remains unsettled. It is not even certain President Trump would be able to include concessions on Chinese companies in a trade deal with regard to national-security concerns. There is a bipartisan majority in Congress ready to block such a move.
The latest confidence indicator from ISM manufacturing points to continued contraction in manufacturing production in October, but there was a sharp increase in the assessment of new orders, particularly new export orders. Similar increases in the assessment of new orders in other countries could indicate a turn-around in the global manufacturing cycle.
Unsurprisingly, investments in machinery and structures declined in Q3, and manufacturing production continued the negative trend in October. Auto production has been particularly hard hit as production has outpaced sales, leading to large inventories.
Lower production also reflects lower investments in the shale oil industry, although actual oil production is at the highest level ever with crude oil exports also at record levels. Hence, in September the US posted its first trade surplus in crude oil and petroleum products in 41 years.
The trade ceasefire should reverse some of the damage to the agricultural sector. The trade war has has been acutely felt in the agricultural heartland, but only in Iowa does it seem to constitute an electoral threat to the President; rural states are unlikely to vote for a Democrat next November, no matter what.
The slowdown in the manufacturing sector could impact the President’s approval ratings in the swing states in the industrial Midwest. Manufacturing employment has started to decline in the decisive states of Pennsylvania, Michigan and Wisconsin with overall unemployment creeping up. It is not yet a dramatic turnaround, but declining manufacturing employment is contrary to the election promises from 2016.
… but consumers are happy
However, the overall economy is doing well. Powered by rising employment, real wage gains, and record-high asset prices (both financial and housing) consumer confidence is high. Hence private consumption continues to grow at a pace of 2.0-2.5 percent. The supermarket giant Walmart beat earnings expectations in Q3 and is “prepared for a good holiday season.” Walmart is a good indicator for the American middle class.
American households have become so used to political noise from Washington that they have stopped caring about it in their everyday decisions. They spend, if they can, and they are more prudent in their savings and borrowing behavior than prior to the financial crisis.
Consumption growth should be strong enough to ensure a moderate growth in employment going forward as well.
The housing market has seen a strong turnaround amid declining mortgage yields with home sales up strongly since the start of the year, and improved homebuilder confidence pointing to more construction activity. Residential investments, which also include home sales, added to economic growth in Q3 for the first time in more than 2.5 years. It is likely to grow more in coming quarters.
The lower yields have also allowed recent home buyers to refinance, and some are likely to have moved from 30-year to 15-year mortgages. This has locked in lower interest payments for years to come, thus improving overall financial health. The increase in household debt is much lower than prior to the recession, and debt continues to decline as share of disposable income and GDP. Somewhat surprisingly, the household savings rate has been increasing since the 2016-election. Households have (on average) substantial resources.
Strong averages do not imply that all is good. Student debt is a growing problem for younger households, so are rising rents in the large cities. Many lower income families remain a pay cheque away from the poor house, and unforeseen health emergencies is the number one cause of family bankruptcies.
All these issues are important structural factors, which are reducing the growth potential of the American economy in the longer run. They have also already become part of the political narrative – not just from the most leftist of the Democratic primary candidates. However, structurally weak household finances are not likely to have a major negative impact on the current business cycle, although they could amplify an economic downturn.
Moderate growth should continue
Another source of growth is public spending. Federal and local-government spending contributed around 0.25 percentage points (pp) to overall GDP-growth between 2015 and 2018 after a period of austerity. The contribution this year could reach 0.5 pp and the outlook for 2020 is about the same. Of course, the flip side is a strong increase in the federal budget deficit despite the favorable growth conditions and record low unemployment. This is clearly not sustainable in the longer run.
Public spending combined with a growth in private consumption of 2.5 percent (which does not imply lower savings), should provide a baseline growth of around 2.3 percent for the American economy. Add growing residential investments to that, and subtract corporate investments as well as a negative contribution from net exports. Overall growth should stay above 2 percent. That is not too bad.
Unsurprisingly, the most important risk to an otherwise pretty benign outlook is another unexpected flare-up in the trade war with China. President Trump might be right on the substance in taking on China, but the political will to stomach the short-term pain from ubiquitous tariffs is not there. A decision about tariffs on European autos is overdue, but a trade war with the EU seems to be taken off the table for now.
The outlook for the American economy also implies that there is little reason (in the data) for the Federal Reserve to lower rates further. The “three cuts and done”-strategy has been defended by Federal Reserve Chair, Jerome Powell, in recent speeches and hearings. It is likely to prompt more angry tweets from President Trump. Indeed, Trump spent part of his recent speech at the Economic Club of New York railing against the Federal Reserve. Whether Powell can stay the current course amid strong political pressure remains to be seen.
Equity markets have shrugged off the message from the Federal Reserve as a “Goldilock”-situation is beginning to materialize: Moderate economic growth, low interest rates, and less policy uncertainty. What is not to like?
Unless trade wars escalate again, and President Trump forces another shutdown of the federal government, when temporary funding expires on 22 November. Never a dull moment.