Overview of US Economy

The Fed is being accommodative of the US economy and is not attached to specific figures regarding the reaction of the economy to possible trade disruptions as well as how the economy’s growth continues to play out. As the unemployment rate continues to fall and the civilian employment-population ratio continues to climb, Chairman Powell has continued the strategy of his predecessor Janet Yellen by indicating that the Fed will continue to be dovish towards the economy and being data-sensitive to developments in the economy. Recent jobs data from the United States point to continued, if slowing, growth in hiring. However, a continuing trend is the muted growth in wages has caused some observers to point out that the US labour market still has some slack. One explanation for the muted growth in wages is that the participation rate in the US is low when compared to other OECD countries.

With the US’s Civilian EmploymentPopulation Ratio (E-POP) continuing to edge upwards to its highest levels since the recession, the expansion seems to be attracting more workers back to the labour market. For workers aged 25-54, E-POP is drawing closer to its prerecession levels, hitting a high for this expansion. Meanwhile, another measure of labour market activity, the labour force participation rate, is a little more interesting. While the overall labour force participation rate has declined to around 63% from pre-recession levels of 66% and has hovered there since, LFPR for

individuals aged 2554 slowly edged back to its pre-recession levels. The accepted explanation for this observation is the retirement of a large chunk of the American workforce (the “boomer” generation).

US Credit Market Forecast

As far as the credit markets are concerned, as interest rates are unreliable in showing the effects of credit growth, it is wiser to use an index of financial conditions to display how receptive the current business environment to borrowing. The Chicago Fed Financial Conditions Index shows continued easing of credit and financial conditions in the economy. This means borrowing individuals and businesses are finding an easier time borrowing money. Furthermore, credit leveraging is still at near cycle-low levels. The debt service payments to personal income ratio is still low relative to its historical value, and while it will surely return to pre-recession levels as interest rates increase, we have a while to go before that happens especially as the Fed, as previously mentioned, is dovish in its outlook. Finally, inflation as measured by PCE excluding food and energy has remained below target. From a financial and credit market viewpoint, there is little risk of tightening at this time.

A Downturn on the Horizon?

All of this paints a healthy picture of the US economy that is the most dynamic and robust economy in the world today. So what are the risks that threaten the US economy and what might trigger the next downturn?

The most obvious one is trade: trade uncertainty will hamper investment and thus growth. Companies uncertain of the effect of the potentially escalating trade war will defer said investments. Mexico has already been applying retaliatory tariffs against the US since June 1, while Canadian retaliatory tariffs came in effect on July 1. The product on which the tariffs are placed are significant and escalation may have severe effects on the economies of all NAFTA countries. While steel and aluminum are only a small part of Mexican and Canadian GDP, possible tariffs on automobiles are a much more significant part of Canadian and Mexican economies and may lead to a trade war as much wider and more retaliatory measures may come into effect. Devolvement of trade negotiations to this extent could mean a recession. However, even if no trade war proper erupts, uncertainty regarding future trade policy and supply lines could have a severe effect on firms’ choices to invest and hire, and that could be what tips the American economy to shrinking. One need only look at the example of Brexit to see that even before the country has finalized its exit from the EU, the lack of coherence from policymakers has significantly contributed to halting UK growth.

It is important to note that the effect of these tariffs will be concentrated in geographic locations that are economically exposed to the products/industries that eventually become part of any retaliatory actions. This has played into the Canadian tariff strategy as specific products are concentrated in the Congressional districts of prominent members of Congress. For example, Wisconsin, the home state of Speaker of the House Paul Ryan, is a large dairy producer and is home to the Toro Company which sells lawn mowers to Canada. Both lawn mowers and yoghurt are on the list of tariffs imposed by Canada. The effect of trade disruptions extend to changing firm investment decisions, as in the now-famous case of Harley Davidson planning to move some of its production capacity overseas to deal with the effects of the Trump tariffs. The decision of the Trump administration to proceed with tariffs on China has added even more uncertainty, with Trump saying that the tariffs, initially targeted at $34B worth of products including farming plows and aircraft parts, could eventually be expanded to $500B worth of imports. It is likely no coincidence that this is the current trade deficit that the US currently maintains with China. China, for its part, has retaliated by imposing tariffs on an equal dollar figure of products, including soybeans, almonds, and cars. As with Canadian and Mexican tariffs, the response here seems to target supporters of Trump, as it is geared towards parts of the country that produce these products and have voted overwhelmingly for Trump. It also reduces the ability of exporting companies to divert the products as there is a higher chance products like fish and produce might go bad in the time it takes to divert or clear them. Neither side has backed down, leading to both China and the US to propose and prepare for further tariffs

While the effects on trade could so far be muted, it is not out of the question that continuing trade disputes could continue to spiral out of control until it starts to affect investment and consumer decisions. And it is that scenario which could cause the next US recession.

Source from: MERatings