Patrick Zweifel, Chief Economist, Steve Donzé, Senior Macro Strategist
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When the US economy does roll over, there's little prospect of a fiscal safety net. America Inc is unlikely to come to the rescue either.
Is the US economy running headlong towards a cliff? The good news is that if it is, it’s got a way to go – there isn’t likely to be a reckoning for at least the next 12 to 18 months.
Unfortunately, when the economy does end up flailing over empty air like the cartoon character Wile E. Coyote, there’s little prospect of a fiscal safety net. As former US Federal Reserve chairman Ben Bernanke recently warned, President Donald Trump’s spending bonanza is badly timed, coinciding with record low unemployment. And the sugar rush from the stimulus is likely to fade around the same time as the Fed’s interest rate hikes will have the greatest impact on the economy, between late 2019 and early 2020.
The current US economic recovery is already the second longest on record. Since the previous trough in June 2009, there have been 108 months of unbroken growth. Only the March 1991 to March 2001 boom was longer. That’s got many people wondering how much longer this cycle can last.
An imminent end to the expansion is unlikely. That’s because previous downturns were typically flagged by two major developments that have yet to materialise. Those are, first, a boom in private sector, and particularly household, debt and, second, a collapse in the yield spread between 10-year and one-year US Treasury bonds.
At the start of the global financial crisis in 2008, the US household debt to GDP ratio stood at a shade under 100 per cent. It has since dropped to around 80 per cent, having levelled off during recent years. Even with rising interest rates, which push up debt servicing costs, US households are relatively comfortable.
The picture might be slightly less positive when it comes to corporate borrowing. Non-financial corporate debt is at a historic high of more than 73 per cent of GDP, up from post-crisis levels of just under 66 per cent. But here too there’s no reason for immediate concern. Trump’s tax reforms have boosted US corporate earnings while also removing incentives to take on additional debt.
Wiggle room
US Treasury bond yield differentials, 10Y - 1Y, basis points
*Optimal threshold determined such that the benefits of hits equals the costs of misses
Source: Pictet Asset Management, Thomson Reuters Datastream. Data from 01.10.1976 to 19.06.2018
Meanwhile, although spreads between 10-year and one-year Treasury bonds have been dropping with the tightening of Fed policy, there are no signs of immediate danger here either. Typically, our models show that a fall in the spread to five basis points suggests recession will unfold 18 months from that point. Right now, the spread is 63 basis points, which is roughly where it was in the mid-1990s, when the cycle had much longer to run.
Overall, the model suggests the contemporaneous probability of recession is just 3 per cent (although it’s worth remembering that recessions tend to be identified with hindsight and sometimes only after a delay of several quarters).
When the expansion does end, however, America Inc is unlikely to come to the rescue. That’s because American corporations appear especially reluctant to invest, preferring to save or return the cash to shareholders.
Our analysis of the US's financial balances shows that the public sector is the only one that has been in deficit in the most recent quarter, with all the others – domestic households and companies, as well as foreign investors – firmly in savings mode. Corporate America's financial surplus is particularly elevated, standing at 1.8 per cent of GDP, the highest since 2010 (see chart).
It's a balancing act
US quarterly financial balances, as percentage of GDP
Source: The Federal Reserve, Pictet Asset Management. Data covering period 01.10.1979 - 31.3.2018
Other data show a similar picture, with total non-residential corporate investment in the US standing at 12.8 per cent of GDP, below the average pre-crisis level of 13.2 per cent.
Such a distribution of financial balances is highly unusual at this point in the US economic cycle. It is usually seen in the immediate aftermath of a recession, when the government stimulates the economy with increases in public spending to offset a decline in spending and borrowing among households and businesses.
The imbalance is going to get worse from here – the IMF expects net US sovereign borrowing to hit close to 6 per cent of GDP next year. The question is who picks up the tab.
Given simmering trade tensions between Washington and its partners, it is unlikely that the US could count on foreign investors to finance its spending. For the accounts to balance, this leaves domestic companies and households having to take the slack. But by saving more, they’ll be consuming even less.
In extending its fiscal deficit, the government is outbidding companies for financing – in other words, the state is crowding out private investment activity, a phenomenon that tends to weigh on growth.
So while the government’s spending may help to prolong the current economic upswing, it could also exacerbate the pain when the recession finally arrives.
About
Patrick Zweifel
About
Patrick Zweifel
With over two decades of experience at Pictet, Patrick has been crucial in building the firm’s macroeconomic research capabilities. At Pictet Asset Management, he leads a team of 4 economists. Patrick plays a key role producing research that helps shape the global investment strategy of the firm and which is fundamental to the investment decisions of fund managers. His analysis helps identify structural imbalances and business cycle turning points through the use of proprietary quantitative models and leading indicators on activity and inflation.
Patrick’s interest for Emerging and Asian economies began following his work on International Economics for the World Bank and for the European Commission in the mid-1990s. He went on to teach econometrics and monetary theory at HEC Lausanne and HEC Genève until he joined Pictet Wealth Management in 1997, where once again he focused on Emerging Markets and Currencies and rose to Head of Macro Research. Patrick then joined Pictet Asset Management as Chief Economist in 2009.
Patrick holds a PhD in econometrics from the University of Lausanne.
About
Steve Donzé
About
Steve Donzé
Steve focuses on liquidity, the lifeblood of markets and economies. As Senior Macro Strategist and member of the Pictet Asset Management Strategy Unit he assumes lead responsibility for analysis and projections of global liquidity conditions. Alongside his strategy work, Steve co-manages a range of multi-asset investment strategies and serves on the tactical committee of the Pictet Pension Fund. He regularly engages in public debate on monetary policy-making, appearing in the Financial Times and Reuters.
Prior to joining Pictet Asset Management in 2007 Steve held positions at the Swiss Bankers Association and the Swiss Mission to the United Nations.
Steve holds a PhD from the London School of Economics and a Master’s degree from the Graduate Institute of International Studies.
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