The global economic outlook is shifting, which could lead to new turbulence in markets and Washington in 2019.
The past year was marked by strong U.S. economic growth, supported by a burst of fiscal stimulus from federal tax cuts and spending increases. That, in turn, underpinned profit growth and the Federal Reserve’s decision to dial up its campaign of short-term interest-rate increases.
Most private economists expect U.S. growth to slow in 2019, in part because the initial impetus of fiscal stimulus is set to wane, meaning slower profit growth and more calls for a pause in Fed interest-rate increases.
A growth slowdown is unlikely to please a president who made much of the growth pickup in 2018. President Trump has blamed his choice to run the Fed—Jerome Powell—for working against his policies to charge up the economy.
While the White House has celebrated the growth rate—which hit around 3% in 2018—the Fed has had its eye on another indicator, the inflation rate, which has returned to the central bank’s 2% target after running below it for most of this expansion.
The Fed’s decisions in 2019 will hinge on what happens next for inflation, rather than the pressure coming from the White House. If the Fed believes inflation has stabilized at 2%, it will pause the rate increases. Recent soft inflation readings and comments by Mr. Powell suggest the probability of such a pause next year is rising.
But officials aren’t sure they’re there yet, and another rate increase in December is highly likely. The central bank’s target federal-funds rate was a little over 2% in November. In normal times, it would be closer to 4%. The Fed’s models thus suggest the rate needs to keep moving up, though Mr. Powell has limited faith in the models.
The unemployment rate—at 3.7% in October—sits near a 50-year low. When unemployment gets so low, it has tended to be a sign that economic resources are running tight. In the 1960s, low unemployment was followed by a decadelong run toward double-digit inflation. In the 1990s, low unemployment came with an epoch of asset bubbles that ended badly.
A new direction?
Maybe this time will be different.
Inflation showed signs of stabilizing around 2% in the second half of the year, possibly dipping below the target as oil prices fall. In the Treasury inflation-protected securities market, where investors buy and sell U.S. Treasury notes that compensate them for future inflation, expected inflation has been heading down since May. Meantime, it is hard to call out an asset bubble when stock prices are effectively unchanged on the year, and many measures of leverage in the financial system are subdued compared with the 2000s.
Two big uncertainties hang over the domestic economic outlook.
The first is fiscal policy. Don’t expect Mr. Trump’s tax cuts to be extended or widened in a divided Congress, but the outlook for spending policy is a big unknown. In February, lawmakers and the White House agreed to boost spending by $300 billion over previously imposed caps, which led to a surge in spending on military and other discretionary programs. By September, the federal spending surge will have run its course.
Will a White House eager for strong growth going into an election year agree to another spending boost? Will it work with Democrats leading the House to produce one? Will the budget deficit—a concern of Republicans when Barack Obama was president—register with them now? It is expected to hit $1 trillion in the fiscal year ending in September. The answers to those questions need to get resolved in the next few months.
The answers will be shaped by other fights between Republicans and Democrats on issues including immigration and border security. Fights over funding a border wall could impede agreement on broader spending plans. Meantime, a national showdown—or perhaps compromise—over the debt ceiling looms around midyear. Republicans used the debt ceiling—which bans borrowing over prescribed limits—as a lever to demand spending cuts from Mr. Obama, but might now be inclined to do away with it or look past it.
The second economic uncertainty involves business investment. Mr. Trump’s tax cuts and regulatory reductions were meant to encourage businesses to invest more in the U.S. and less in other countries—most notably China—that produce much of what Americans consume.
The success of his whole agenda hinges on their willingness to do so. More business investment would increase the economy’s capacity to produce goods and services, confirming Republican assurances that the nation’s speed limit is more than the anemic 2% growth rate that prevailed during most of Mr. Obama’s tenure.
The evidence on business investment so far is mixed. It grew at a boomy 11.5% annual rate in the first quarter, according to the Commerce Department’s broadest measure of economic activity, but then slowed to a modest 2.5% rate in the third quarter.
One reason for the slowdown is in the energy sector, where oil prices are falling. When oil prices drop, so does investment in energy structures, which was down in the third quarter after an 18-month run higher, according to the Commerce Department. Oil’s continued drop portends more trouble for U.S. fracking regions like Texas and North Dakota.
A broader threat to business investment is the rest of the world. Global economic growth accelerated in sync in 2017. In 2018, as the U.S. accelerated further, Europe, Japan and China all slowed. These economies have their own problems. China is dealing with a slowdown from a domestic investment boom. Europe contends with fiscal woes in Italy and the U.K.’s separation from the European Union. Japan is plagued by an aging population and chronic slow growth.
Battles over trade
One common denominator for the world has been Washington’s confrontational trade stance.
There are many fronts in Mr. Trump’s trade battles, including U.S. steel tariffs, the conflict with China, threats of tariffs on imported cars, retaliation from U.S. trade partners and uncertainty about the future of the North American Free Trade Agreement.
The effects are wide-ranging. World trade volumes have slowed. In Germany, exports contracted in the third quarter, leading to a broader contraction in overall economic output. Japan worries about the effects of a Chinese slowdown on its own exporters.
U.S. businesses aren’t walled off from this. They’re grappling with rising prices for imported components hit by tariffs, uncertainty about how to manage the global supply chains that bind them to other economies and disruptions in export markets.
Lower taxes and less regulation were meant to make investment in the U.S. more appealing. Mr. Trump’s trade confrontations might be making investment everywhere—including the U.S.—less so.
He has now called a temporary truce in the battle with China. His broader investment and growth agenda, and the outlook for 2019, will depend heavily on whether that source of tension is resolved or instead spirals into a full-on trade war.
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