Why it’s so hard to forecast economy

The US economy has experienced its slowest recovery from a recession in the post-World War II era, and the longer it lasts the more evidence there is that normal cyclical patterns are missing. And their absence means market participants shouldn’t rely on them to divine the economy’s future.
Consider the myriad developments that are atypical, or even the reverse of normal economic and financial market behaviour. The Federal Reserve shifted from easing credit to tightening following past downturns, with its target federal funds rate normally raised within a year or so of the recession’s trough, eventually precipitating the next economic contraction. This time, the central bank kept its policy rate at the recessionary low of essentially zero until December 2015, 78 months into the recovery. And then, after nine quarter-percentage point increases, it reversed course early this year with three rate cuts.
Far from Fed’s normal worries about an overheating economy and inflation, the central bank frets that low and even declining consumer prices will spawn deflationary expectations. Buyers will hold off in anticipation of lower prices. Inventories and excess capacity will mount, forcing prices down. The price cuts confirm suspicions and purchases are delayed even further, sparking a deflationary spiral. The glaring example is Japan, with deflation in most years in past two decades and tiny real GDP annual growth of 1.1%.
Also, despite the plunge in 30-year fixed mortgage rates from 6.8% in July 2006 to current 3.7%, rate-sensitive single-family housing starts have been muted. They fell from a 1.8 million annual rate in January 2006 to 350,000 in March 2009 as subprime mortgage market collapsed, but have only recovered to 940,000. In past business recoveries, US household saving rate fell as consumer spending grew faster than incomes. In this expansion, it’s the reverse, leaping from 4.9% to 7.9% in November, retarding spending.
In earlier business upswings, a drop in the unemployment rate of anything like the plunge from 10% in October 2009 to the current 3.5% would have spawned massive wage inflation. This time, real wages are barely growing. Globalisation transported many high-paid manufacturing jobs to China. With the growing “on demand” economy—think Uber Technologies Inc. —many people trade flexibility in working hours for low pay. The payroll jobs that are being created are mostly in low-wage sectors such as retailing and leisure & hospitality.
For years, foreign policy was bipartisan and expanding trade was considered highly desirable. Now, globalists have been overcome by protectionists, spurred by voters upset over stagnant purchasing power and rising income and asset inequality in G-7 countries. Trump’s 2016 election along with the UK’s “Brexit” from the European Union are among the results. Then there’s also the demise of global trade deals, which are being replaced by bilateral agreements or no pacts at all.
The US-China trade dispute will no doubt persist because China, with a declining labour force as a result of its earlier one child-per-couple policy, needs Western technologies to grow and achieve its worldwide leadership ambitions. But the US is opposed to the technology transfers China wants.
The dollar’s slide from 1985 until 2007 encouraged US exports, curbed imports and gave US multinationals currency-related boosts to profits. Since then, the dollar index has rallied 33% amid a global demand for haven assets. And it should continue to, given the relatively faster growth of the US economy, its huge, free and open financial markets and the lack of meaningful substitutes for the greenback.
In this different economic climate, it’s hard to time the end of the current recovery. Still, it will end, due either to Fed overtightening or a financial crisis, like the 2000 dot-com blow-off or the 2007-2009 subprime mortgage collapse. In the current excess supply-savings glut-deflationary world, it’s likely a recession will unfold due to a shock before the Fed overtightens.
No financial crises are in sight, but there are possibilities such as excess debt in China and among US businesses, a trade war escalation, consumer retrenchment resulting in widespread deflation, and disappointing corporate profits measured against sky-high stock prices. Watch for specific imbalances, not typical past patterns.
—Bloomberg