Andres Carbacho-Burgos is a senior economist at Moody’s Analytics. Previously he was an economics professor at Texas State University.
Harlan Levy: Is the economy losing momentum?
Andres Carbacho-Burgos: That depends on which part of the economy that you look at.
In terms of employment, we’re not losing momentum yet. The labor market is still strong, and it’s getting close to maximum tightness right now, with an unemployment falling to slightly above 4 percent.
What we’re seeing now is a loss of momentum in other parts of the market – housing in particular. Recently we’ve seen a leveling off in residential construction and a slight decrease in home sales for two reasons: The first is that the housing market is increasingly supply-constrained. First, listings are at decade lows, and also residential construction is subject to bottlenecks, especially multi-family construction. The bottlenecks are mainly in skilled labor -- mainly specialty trained contractors, also truck drivers and similar positions closely connected to construction.
The second problem is that, even without the supply constraints, demand is lukewarm and hasn’t heated up yet, mainly because first-time home buyers are only about one third of the purchase market right now. In more prosperous times in the ’90s and the early part of the last decade they were around 40 percent of the market, which makes a big difference.
As a result you’ve had only moderate growth in purchase demand, so price growth has not taken off with constraints on supply.
The energy sector has stabilized but still hasn’t recovered from the 2014 energy price shock.
In general, investment in fixed capital in the U.S. is not as high as it should be with slow growth in global demand, particularly from Europe.
Right now the economy is simply slowing down. Once you see the labor market reach terminal tightness -- which will be indicated by the unemployment getting closer to 3 percent and by wage growth starting to accelerate -- then you’ll see the Federal Reserve starting to tighten interest rates much faster than they will do so now.
H.L.: What’s your outlook on bond prices?
A.C-B.: We’re predicting by early 2020 3-month Treasury bills will be at 3.4 percent, which means tighter credit across the board.
For example mortgage rates are slightly above 4 percent. By early 2020 they will be about 5.6 or 5.7 percent, which will lead to a significant slowdown, and, if any downside risk materializes, a recession.
H.L.: So what are the chances of a recession any time soon?
A.C-B.: If nothing really bad happens I would say the chances of a recession are no more than 20 to 25 percent.
There are a lot of downside risks that could materialize that would make the chances much higher, including serious policy mistakes by the Fed or in U.S. fiscal policy or a worsening political situation in Europe.
For example if there’s no deal on Brexit so that there would be a complete rupture between the United Kingdom and the rest of Europe. You never know. Economists don’t have a good record predicting adverse political events, such as Brexit.
H.L.: How dangerous to the U.S. and global economies and overall global stability are President Trump’s actions?
A.C-B: You have to distinguish geopolitical risk and actual policies. The geopolitical risks are that Trump’s rhetoric on North Korea and Iran are more than just bluster and that we might get into a war with either or both. But even that would not have a large initial effect on the U.S. economy. There would be a lot of financial uncertainty and possibly a stock market downtrend that would gradually filter down to the U.S in terms of reduced investment.
The geopolitical risks are relatively remote. The most risk is not from Trump but from possible Congressional action, including attempts to scale down the Affordable Care Act and the two proposed tax bills, both of which would involve a higher tax burden for middle-class families.
H.L.: Looking at some of the data, what does the Philadelphia Fed Business Outlook Survey for November tell you?
A.C-B: Economic activity in the Third Fed District -- Pennsylvania, Delaware, southern New Jersey -- slowed slightly but is still relatively healthy. Among manufacturers, inflation expectations fell slightly, possibly because oil prices look more stable and seemed to have peaked for the year and possibly because consumer price inflation is still slightly underperforming Federal Reserve expectations. It should be mentioned that exports from this Fed district go more to NAFTA countries and Europe than to the Pacific, so that slow economic growth in Europe and Mexico has dragged on export growth for several years now, but the local manufacturing sector still seems to be doing OK.
Orders for non-manufacturing businesses in the October survey slowed slightly but are still in moderate growth territory. Overall, the manufacturing and non-manufacturing surveys show the regional economy in moderate if unspectacular growth, with no dangers signs as of yet.
H.L.: What do you see in the labor market?
A.C-B: Soft wages have barely started to budge in response to the tight labor market, which is surprising. Many economists believe that once the jobless rate got to 5 percent or lower that wages would take off and would be followed by price inflation soon after. That hasn’t happened yet, but it still remains a substantial risk if the unemployment rate continues to fall.
H.L.: What do you see for the Consumer Price Index and the consumer?
A.C-B.: I don’t see any big danger of inflation any time soon. That’s because we don’t have any substantial wage pressure yet, and also because the Fed is pretty quick to respond to any rise in wages with higher interest rates. Also with regards to autos and houses we expect to see gradual if not great growth at least through 2019 and 2020.
H.L.: What about manufacturing and industrial production?
A.C-B: Industrial production will continue growing as it has over the past two or three years unless there’s an adverse development in Europe or in the North American Free Trade Agreement.
President Trump has been against the agreement, but negotiations are continuing. So there are fairly good odds that we’ll get a revised NAFTA which will pretend to address some of Trump’s criticisms but will not make any substantial changes to the agreement. That would be good.
The downside risk is if something worse happens. If Trump insists on negotiating more concessions than Canada and Mexico are willing to allow, you could see a break-up in the free trade area. Even that would not be a major negative event, because tariffs between the U.S. and Mexico and Canada were low even before NAFTA was signed.
One of the downsides is if the U.S. trade negotiation becomes completely unhinged, and you get not only a break-up of the agreement but also a possible trade war with Mexico and Canada. Again, that’s a very remote possibility, because we believe cooler heads will prevail, and because Trump suffers from shifting from one policy objective to another , so I doubt he can remain focused enough on NAFTA to really spoil a renegotiated agreement.
The trade war’s effects would be to seriously slow down production in the Midwest and in the Eastern industrial belt.
H.L.: Is the stock market losing momentum?
A.C-B: It’s always difficult to answer those questions. Most observers agree that the market is currently overvalued, meaning price-to-earnings ratios are abnormally high. In the future, if interest rates start to increase, the market will grow at a substantially slower pace, that is, if it doesn’t correct.
If you get stronger stock price growth, especially for another year, that will increase the probability of a correction. It’s likely if nothing seriously goes wrong in the global economy. If we get a negotiated Brexit and Europe and Asia continue to grow at a moderate pace, then another year of strong stock market growth is likely, increasing chances of a correction further down the line.
H.L.: Are you fearful for the future or optimistic?
A.C-B: I’m more neutral. The U.S. will continue on a path of moderate growth, and by “moderate” I mean Real [inflation-adjusted] GDP growth of slightly over 2 percent and not much more which would be anemic relative to the 1990s.
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