The Economic Outlook. What Are the Opportunities & Risks Ahead?

Transcription

1 September 25, 2018 The Economic Outlook What Are the Opportunities & Risks Ahead? Bernard Baumohl Chief Global Economist LLC 475 Wall Street Princeton, New Jersey (609)

2 Consumer spending to remain healthy this year, but will fade in 2019 & 2020 Factors that support current household expenditures þ þ The job market remains strong. Unemployment rate (3.9%), near 18 yr. low! Household wealth at a record high ($100.8 trillion) as the value of stocks, bonds and homes keep climbing. Factors that will dampen spending the next months? 1. Consumer optimism starting to wobble as inflation picks up. 2. Pay is now barely keeping pace with inflation. (CPI = 2.7%; Avg. hourly earnings = 2.9%) 3. After nearly 10 yrs. of shopping, consumer demand is becoming satiated. 4. Rising energy prices reduces discretionary spending. Offsets personal tax cuts. 5. Delinquency rates are climbing: Record high household debt & rising interest rates. 6. Demographic changes to alter the composition of spending.

3 On Watch: Household delinquency rates turning up! Consumer debt is manageable when rates are low, BUT becomes problematic once rates climb! Delinquency rates on bank credit card debt: All commercial banks Delinquency rates on consumer loans: All Commercial banks Federal Reserve begins to raise rates Dec. 16, 2015; Latest (seventh) increase, June 2018 = Dates the Fed lifted rates 25 BP Source: Federal Reserve

4 On Watch: Inflation has been accelerating faster than wages! Wages = Average hourly earnings in the private sector; % change over last 12 months Consumer prices; % change last 12 months There has been a clear erosion in consumer purchasing power! WHAT CONSUMERS DO NEXT IS CRUCIAL! They may choose to buy fewer goods and services? Borrow more to maintain their life style? Tap personal savings to keep their life style? Demand bigger pay increases from employers? Source: Bureau of Labor Statistics

5 See any signs tax cuts are accelerating business investments? Keep squinting! Business capital spending has been held back by: -- global trade tensions -- record non-financial corporate debt -- rising interest rate environment -- political tumult in the White House -- uncertain outcome of midterm elections -- worries this business cycle is close to peaking ISM New Orders - Manufacturing ISM New Orders - Services Above 50 indicates new order are expanding Below 50 indicates new orders are contracting Sources: Institute for Supply Management, National Federation of Independent Business 2018

6 Outlook for oil prices based on fundamentals: $45 - $60 bbl next two years US shale producers, OPEC & Russia to lift output, even as global economic growth slows BUT then add another $5 to $15 premium for geopolitical tensions! U.S. output surges close to 11 million bbl/day, making it the world s largest producer for the first time since 1973 U.S. oil exports now at a record 3 million bbl/day, cutting into OPEC s market share and revenues Break-even price for shale production keeps declining; biggest problem is shortage of pipelines to transport oil and NG. Shale oil mining will soon spread globally. Already underway in Latin America and Sub-Saharan Africa Increasing use of renewable energy sources reduces reliance on fossil fuel $/per bbl. Spot price of WTI oil - Annual averages FORECAST Sources: US Energy Information Administration,

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8 Forecast for U.S. GDP growth Economy to accelerate in But recession odds increase to 55% by Real growth by year (%) Recession Average annual growth rate since 1947 = 3.2% Sources: US Bureau of Economic Analysis,

9 Forecast for U.S. GDP growth Economy to accelerate in But recession odds increase to 55% by Real growth by year (%) Recession Average annual growth rate since 1947 = 3.2% % Federal Reserve Sources: US Bureau of Economic Analysis,, Federal Reserve

10 Forecast for U.S. GDP growth Economy to accelerate in But recession odds increase to 55% by Real growth by year (%) Recession Average annual growth rate since 1947 = 3.2% Federal Reserve White House Sources: US Bureau of Economic Analysis,, Federal Reserve, White House

11 Growth Leaders India China* Indonesia Viet Nam Moderate Growth Australia U.S. Israel Chile Peru Turkey* Sluggish Growth Canada Eurozone Japan UK Mexico Brazil In or Near Recession Venezuela Argentina Iran South Africa

12 Greatest hazards facing the economy! UNITED STATES Probability 65% Trump presidency in turmoil (Mueller investigation & midterm elections) Nov elections: GOP loses control of House (80%); Senate (40%) Democratically-controlled House launch impeachment hearings. (70%) Outcome of Mueller probe shakes consumer and business confidence (50%) President Trump resigns before his first term expires. (45%) 65% Interest rates (both short and long-term) climb faster than expected Wage-price spiral forces the Fed to tighten more aggressively. (60%) Investors demand a higher premium to finance years of trillion dollar US budget deficits. (70%) 40% US tariffs escalate into a full blown global trade war President ignores growing complaints by business leaders on current trade policy. World trade shrinks. Global economy enters recession. 75% GEOPOLITICAL RISKS - Black Swan Events (1) US - Chinese military clash in South China Sea and over Taiwan. (2) Tensions between Saudi Arabia and Iran lead to direct armed combat. (3) Israel and Iran (with its proxies) headed for war. (4) Russia and China launch destructive cyber warfare campaigns against the US.

13 Washington scraps all fiscal discipline and blows up deficits! US government to borrow at least a trillion dollars every year for the next decade. Investor appetite for US government debt is NOT infinite! They will demand more compensation (higher rates) for the extra risk. But rising rates will crowd out private sector borrowing! $ billion ,000-1,100-1,200-1,300-1,400-1,500-1, = 9th year of economic expansion Fiscal budget = $236 billion SURPLUS 2018 = 9th year of economic expansion Fiscal budget = $804 billion DEFICIT CBO forecast Sources: Congressional Budget Office,

14 Short term rates will continue to increase, but the bigger concern is a jump 10 yr. yields Forecast: Long-term rates (10 yr. Treasury) likely to peak at 4.10% in 2020 with fed funds rate to top out at 3.13% Yr. end fed funds rate % Neutral fed funds rate: % % Sources: Federal Reserve, Yr. end 10-yr US TR% Current Forecasts Current 1.88

15 Russia has been punching way above its economic weight! Russia s economy is SMALLER than Italy s! The country has failed to diversify away from oil; Energy provides 70% of export income. Distribution of wealth most unequal in the world; Discontent is rising among Russians. Its population is shrinking, leaving an older demographic and fewer ethnic Russians. Democratic reforms are not in Russia s DNA. Russia is so corrupt, it is simply incapable of restructuring its economy! Result: Only practical weapon against the West? Cyber warfare!

16 We are now in the midst of a Cyber World War!! CYBER attacks against the US: The ideal weapon It s cheaper! Can do lots of damage and is contact-free warfare. For a fraction of the price of a MIG-29, Russian, Chinese & North Korean hackers can sabotage US electrical grids, nuclear plants, communication networks and financial markets. Foreign Attacks on the Government Hackers have successfully penetrated the US electrical grid & nuclear plants (2018) US election facilities and voter records (2016, 2018) Democratic National Committee (2016) US Government Office of Personnel Management - stole 22 million accounts ( ) Theft of consumer ID: Under Armour million customer accounts (2018) Equifax million consumer records (2017) Yahoo - 3 billion accounts ( ) Source: Multiple sources

17 Exogenous shocks to become more common and more consequential! 1. Companies should undertake rigorous stress tests to determine their greatest vulnerabilities. Conduct what if scenarios: Introduce adverse hypothetical scenarios (e.g. events that can potentially disrupt your business (e.g., systemic power failure, shut down of internet, no access to credit lines ). How to cope under such dire circumstances and remain both operational and profitable? 2. Consider cyber theft insurance, install software patches, hire firms to hack into your system: Average time it takes a U.S. firm to identify a breach = 201 days Average time it takes to contain the breach = 70 days Average cost of a single data breach = more than $4 million (Source: IBM) 3. Geopolitical threat anticipation: Dedicate a risk management team to engage in geopolitical forecasting, especially where one has foreign exposure (e.g., supply chain sources, key investors, corporate offices, real estate assets, banking relationships). 4. Be proactive. Customers demand reliability of service --- or they ll walk! Focus on being agile. Prepare in advance a governance plan that can quickly be implemented to mitigate any harmful fallout from a decline in economic activity OR an external shock. Your firm s reputation is always at risk.

18 Bernard Baumohl Chief Global economist 475 Wall Street Princeton, New Jersey (609)