Moderate growth in the U.S. in the context of a wider global slowdown led by reduced consumer demand is going to impact Cayman, especially in the tourism sector, according to Lindsey Piegza, chief economist at Stifel Fixed Income.
The reduced willingness of the U.S. consumer to spend, including on holidays, hotels and restaurants, is certainly going to trickle down into the Cayman economy, Piegza said in a presentation on U.S. economic trends on June 28.
“If we are looking at the fundamentals of the U.S. economy, we are still very much talking about moderate 2-percent growth,” Piegza noted. “It is not an overly aggressive or robust recovery.”
While the Federal Reserve claims the economy is improving, Piegza highlighted a loss of economic momentum in the last quarter of 2017 and the first three months of this year after a downward revision to just 2 percent.
“The U.S. economy is still growing at a moderate pace, but we have not been able to maintain that more robust momentum” of more than 3-percent growth in the second and third quarter of 2017, she said.
Overall, an average growth rate of 2.2 percent since the financial crisis is the slowest period of growth in the U.S. since World War II.
“Going forward, we do expect the U.S. economy to maintain in positive territory but closer to 2 or 2.2 percent this year relative to 2.5 percent last year,” Piegza predicted. “More importantly, looking out to 2019, we expect further loss of momentum to 1.5 percent with the risk of a recession rapidly rising in the second half of 2019 and 2020.”
Part of the reason for this loss of momentum is Piegza’s assessment of some of the key sectors of the U.S. economy.
On the one hand, there is a long stretch of positive job creation, but the pace is slowing to 200,000 new jobs each month down from 275,000 in 2015. On average the U.S. needs to create between 200,000 and 250,000 jobs each month just to manage demographic change.
“At the time when the Fed is telling us things are picking up” and while the numbers are still positive, job creation is losing momentum, Piegza said.
The unemployment rate, meanwhile, is at a very low 3.8 percent compared to 10 percent in the aftermath of the financial crisis. However, the statistics do not tell the whole story of what is happening in the U.S. labor market.
The figures do not include the millions of Americans who are simply not counted as unemployed because although they want a job, they have given up actively looking for one. The corresponding, historically low labor participation rate is a reflection of this trend.
The Stifel economist said, “If we add in those discouraged workers that are sitting on the sideline, we are talking about an unemployment rate in the U.S. not of 3.8 but of 8 percent.
“That paints a much different picture.”
It is even more concerning that the discouraged workers are not near their retirement age. Most are in the age range of 20 to 55.
That there is something amiss with the unemployment rate statistics can also be seen in the lack of meaningful wage increases. Although incomes have improved by 2.5 percent on average recently, wage growth is not as high as expected.
“If the U.S. was really seeing a 3.8 percent unemployment rate and the labor market slack that that implies, we would easily talk about a 3 to 3.5 percent wage growth and a very robust consumer spending trend,” Piegza said. “But instead consumers are pulling back.”
After a pick-up in spending in 2017, U.S. consumer spending was less robust in 2018 as tax reform did not lead to the expected improvement in household spending power. Americans simply did not see a meaningful change in their after-tax, take-home pay following the tax reform and, therefore, had to moderate spending.
Businesses were also more optimistic in 2017 in the expectation of a pro-business agenda and tax reform. The inventory cycle and penned up demand also supported corporate investments at that time.
But, as in the consumer sector, this momentum was short lived.
The expected effect of tax reform on the economy of 0.2 percent this year will be wiped out by the administration’s trade policy and the introduction of new tariffs, Piegza predicted.
However, she noted positive trends in corporate equipment and technology spending.
After three interest rate hikes in 2017 and two more rate increases in 2018, it may look like the Fed is raising rates aggressively. In reality, the Fed is not only drawing out the time line to move to a normalized interest rate environment, Piegza noted, it also still has a very accommodating interest rate policy as rates remain very low on a historic scale.
The median consensus among Fed officials suggests there will be two more rate increases this year. Yet, the opinions among the Fed’s staff are so widespread that one could argue there is no consensus.
And the Stifel economist said it will be difficult for the Fed to push through four rate increases in 2018 given the market fundamentals.
One reason is that there is going to be continued downward pressure on the long end of the yield curve and 10-year Treasuries.
Currently, the spread between 2-year and 10-year Treasuries is only 30 to 40 basis points. If the Fed increases rates by 50 basis points on the short end and there is no corresponding rate movement for longer maturities, an inverted yield curve could be the result.
This is relevant because an inverted yield curve has preceded every U.S. recession in post-WWII history.
Piegza said: “We do have an inverted curve priced in by the end of the year.”
Among Fed officials, there is a good deal of skepticism whether an inverted curve is going to drive a recession. Some monetary authority officials are arguing that quantitative easing has created the downward pressure on long maturities and therefore an inverted yield curve may no longer be a reliable indicator for a recession. Or that, even if there will be a recession, it will not be the result of interest rate policy but simply due to natural macroeconomic cycles.
“Either way, the majority of the Fed officials have stated they are not concerned about inverting the yield curve,” Piegza noted. “Their focus is stable prices and full employment.”
She believes an inverted yield curve may not be 100-percent reliable to predict a recession, but it certainly is a red flag.
Meanwhile, the Fed’s attempt to normalize its inflated $4.5 trillion balance may not be as far reaching as expected and is unlikely to return to its $1 trillion size that existed before the financial crisis.
Piegza argued that the vast majority of assets on the balance sheet are backed by liabilities that the Fed has no intention of reducing, like currency in circulation, foreign reserve deposits and deposits held by the U.S. Treasury. As a result, at the most the Fed is going to reduce the balance sheet by its holdings of excess reserves leaving a sizeable $2.5 to $3 trillion on the Fed’s books.