Economic forecasts have become almost as bad as politics. One set of forecasters is ready to call gloom and doom while another suggests we are on the verge of new records in the equities markets. One set wants to talk about the need for negative interest rates, while just a few months ago there were calls to raise rates.
Inverted yield curves would suggest a recession is around the corner, but at the same time the country is running at less than 4 percent unemployment. Trade factors are an issue, with both imports and exports hit by our own or another country’s retaliatory tariffs. Middle East political troubles may increase oil prices, but that would provide a helpful shot in the arm to our own oil sector.
There are so many conflicting signals. Yogi Berra probably summed it up best when he said, “It’s tough to make predictions, especially about the future.”
The inversion of the yield curve, discussed several times in past Market Intel articles, is often cited as a bellwether of coming economic downturns. During the past few months that inversion has become more pronounced, even though the Federal Reserve decreased the federal-funds rate. The Fed in August decreased the overnight rate by 25 basis points, but the 10-year Treasury note decreased by 50 basis points. The fed-funds rate decreased to 2.13 percent and the 10-year rate decreased to 1.63 percent.
That puts the ratio of the fed-funds rate to the 10-year Treasury at more than 1.3. The last two times the ratio was that inflated was in 1974 and in 1981. For the 1974 event the fed-funds rate was 9.65 percent, with the 10-year rate at 6.74 percent. To drive home how different this time is, the 1981 event saw the fed-funds rate at – prepare yourselves youngsters – at 18.52 percent and the 10-year Treasury was at 14.10 percent. Reviewing those numbers puts the push by some for the Fed to decrease interest rates further. In a somewhat different perspective it raises the question of how much those “inflated” interest rates are holding things back.
As we all know, consumer spending drives the general economy. Personal-consumption expenditures account for more than 70 percent of the gross domestic product. But within that general category are some things that change with the economic cycle and some that don’t. Consider a person’s spending on food, energy, trips to the doctor or diapers. The economy can improve or worsen; that person is still going to eat, turn on the lights, go to the doctor and diaper the baby.
Government spending – writ large in the sense of including federal, state and local levels – usually happens regardless of what goes on in the general economy. Those non-cyclical components of the economy will increase or decrease, but typically in a small range. The cyclical components of the economy include consumer spending on durable goods. A person can put off buying a new car, for example, when economic uncertainty is great. The cyclical components also include business fixed investment, inventories, exports and imports.
In the latest quarterly report those non-cyclical components of the economy added 3 full percentage points to gross-domestic-product growth. At the same time the cyclical components aggregated to an almost full-percentage-point drag. Imports, exports and inventories are all linked to tariff policies; thus it’s not surprising to see weakness in those components. What continues to impress is a strong consumer attitude. As long as consumer spending holds, most of those dire predictions should be viewed with a grain of salt.
With employment strong and continuing wage growth, consumers are staying confident and are willing to spend. But if we start to see more significant layoffs driven in part by weak trade numbers or a major oil-price increase, that attitude might change. Let the consumer become a little shaky and things will likely descend rather quickly.
Bottom line, finance data is concerning but given the level of interest rates it may not be sending the same message as it was in the past. Consumers continue to be “the engine that could.” Without question trade issues remain a source of potential trouble. Anyone working in a trade-related industry is probably going to work every day waiting for the other shoe to drop. If that worry begins to spread it will become a very different story.
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