Recession is a risk in 2019. But maybe one that policymakers can avoid.
People stand near a statue of George Washington, adjacent to the New York Stock Exchange, in the background, on Dec. 22 at the closed Federal Hall National Memorial in New York. Now in its 10th year, America's economic expansion still looks sturdy. Yet the partial shutdown of the government has added another threat to a list of risks.
Craig Ruttle/AP
It may be hard to believe with all the gyrations on Wall Street, but the outlook for Main Street is surprisingly upbeat, at least for the first half of 2019. The economy has so much momentum that a sudden U-turn seems remote, economists say.
“Employment’s still growing; wages are picking up; retail sales are strong;... there’s still some policy stimulus in the pipeline,” says Joel Prakken, chief US economist at research firm IHS Markit. “The very near term looks OK to me, but there are some storm clouds on the horizon.”
The divergence between the performance of the real economy and a jittery Wall Street is striking. The US economy, as measured by gross domestic product (GDP), probably grew 3 percent in 2018, economists say, which would be its strongest performance since 2005. Wall Street, by contrast, had its worst year since 2008.
Why We Wrote This
Many investors are concerned by recent economic signs in the US. But there's a different view, too. Some key indicators suggest slower but still positive growth. The real question may be how the government navigates the months ahead.
Why might Main Street’s optimism continue well into the New Year? Economists point to several factors. Among them:
- The global economy continues to expand. Although it has cut its 2019 forecast a touch, the Organization for Economic Cooperation and Development forecasts world GDP growing 3.5 percent, almost as strong as the estimated 3.7 percent for 2018.
- Trump tax cuts plus expanded federal spending helped juice the economy in 2018. Though not expected to be as strong, the fiscal stimulus is poised to continue this year.
- Interest rates remain low. Although the Federal Reserve has been raising short-term interest rates to ensure inflation does not get out of hand, it is still relatively inexpensive for companies and individuals to finance new business ventures.
- The US and China have so far avoided an all-out trade war. They are currently working on a deal wherein the US reportedly would bring down its tariffs on Chinese goods in exchange for Beijing opening up its financial and other sectors to foreign firms, reducing or eliminating the practice of forcing Western companies to share technology with Chinese partners, and buying more goods from the US.
Hope for a US-China deal
Both sides have signaled flexibility. China has already temporarily lifted tariffs on imports of US autos and purchased American soybeans. For its part, the Trump administration has delayed by 90 days a Jan. 1 plan to increase tariffs from 10 percent to 25 percent on $200 billion in Chinese imports.
“Deal is moving along very well,” President Trump tweeted Dec. 29 after a phone call with Chinese President Xi Jinping. “If made, it will be very comprehensive, covering all subjects, areas and points of dispute.”
Expansions have never gone on forever. And this one, nearly a decade old and the second-longest in US history, looks vulnerable as early as the second half of 2019.
“We basically lose all the positive stimulus from the tax cuts and the bipartisan budget deal by the second half of this year,” says Joseph Song, senior US economist with Bank of America Merrill Lynch. “So you're probably looking at trend growth somewhere around 1.7, 1.8 [percent]. And when you’re closer to zero percent growth, even a modest shock to the economy could push it down into negative territory.”
Not everyone sees the effect of tax cuts fading. Supply-side economists argue that corporate tax cuts will continue to boost business investment, which will keep the economy humming.
“The idea that we’re on a sugar high for one year, and then it’s all going to go back to where it was next year, is just not consistent with [economic] literature,” Kevin Hassett, chairman of the White House Council of Economic Advisers, told reporters in an on-the-record briefing two weeks ago. “Survey data suggests that the capital spending plans [of US businesses] over the next year are very strong.”
Recessions need a trigger
Many forecasters are calling for slower but still positive growth in key economies, notably the US (where worries include a cooling housing market) and China, where sagging factory activity was a factor as some global stock markets fell on the first trading day of 2019.
And recessions don’t just happen. Something has to trigger an erosion of demand or confidence among businesses and consumers. Sometimes it’s an investment bubble that pops, such as dot-com stocks in 2000 or the housing market starting in 2007.
This time, government moves could be the trigger. For example, if the government shutdown continues for the next three months, it will run into the deadline for the debt limit to be reimposed. Failure to authorize more spending in the months ahead could spook markets and rattle consumer confidence, economists say.
A more likely flashpoint is trade. Despite Mr. Trump’s upbeat tone, the United States and China remain far apart because they have different strategic aims, analysts say. The administration wants to bring down the US trade deficit with China while President Xi wants to use trade to spur China’s technological development, which may mean shutting out the very goods that the US excels at.
The more tariffs get applied, the higher the drag on the economy. If Trump extends the trade dispute with China to other major trading partners, they would retaliate and a trade war would ensue, dramatically slowing economic growth for all the nations involved. “If the White House takes it another step and starts to put tariffs on autos, I think that’s when you begin to worry about ... recession,” says Mr. Song.
Risks from the Fed’s tightening
A third trigger could be a mistake by the Federal Reserve. The odds of a misstep are higher this time, some economists say, because the Fed is trying to tamp down the inflationary effects of the government stimulus in the first half of the year while worrying about a slowdown in the second half.
“This is not our baseline outlook, but I do worry that stimulus is masking a greater underlying tightening in financial conditions than many think,” says Michael Gapen, head economist at Barclays Investment Bank, in a recorded interview for investors. That could lead the Fed to raise interest rates at the wrong time, he adds, increasing the odds of recession.
It might seem surprising that a downturn could occur when employment is so strong. Alas, jobs are a lagging indicator. If one counts the 1980 and 1981 recessions as a single downturn, then every recession since World War II has begun when unemployment was at lows similar to today, points out Mr. Prakken of IHS Markit.
The best predictor of a coming recession is the stock market, but its wild gyrations can make it difficult to read. On Dec. 24, the S&P 500 index fell to nearly 20 percent below its Sept. 20 peak – a line that, if breached, might signal the start of a bear market and a likely recession ahead. But since then the index has moved back up, to about 14 percent below its peak.
Similarly, the Dow Jones industrial index had its worst Christmas Eve plunge in history and its best-ever point gain on the day after Christmas.
“We’re careful not to get too carried away by these moves in stock prices even though they’re fairly substantial,” Prakken says. Such volatility may slow growth by increasing uncertainty, but it’s unlikely to trigger a recession by itself, he adds.