2019_03_29 — “A Post-Tax Overhaul Lower-Growth Equilibrium”
March 29, 2019
A Post-Tax Overhaul Lower-Growth Equilibrium
A post-tax overhaul lower-growth equilibrium
U.S. fiscal and monetary policy makers are dealing with an economy that is transitioning to a post-tax overhaul lower-growth equilibrium. In other words, the U.S. economy got a boost from lower taxes and regulations, but has slipped back into normal economic trend and profit growth. This is not necessarily bad, as long as expectations align with reality. The dollar’s steady advance over the last year, since global growth started topping out, has put a lid on inflation (a strong dollar means imported goods and materials are cheaper) and has facilitated global asset rebalancing with emerging market countries struggling to find favor. Exports have been solid and investment has held up relatively well considering the uncertainty around tariffs and trade negotiations with China. Nonetheless, the key to a sustainable U.S. expansion lies with the household sector, and unfortunately, private goods consumption remains lackluster.
The end of the real income squeeze should have put a floor under consumer spending, however, fragile household finances raise the bar for a swift revival in private demand; i.e., the consumer remains actually and psychologically vulnerable to the fear of tighter financial conditions. Consumer confidence is depressed relative to where it should be with such low unemployment and likely to stay that way until laborers see more evidence of a sustained increase in purchasing power without an increase in debt. The current political disputes amongst Republicans and Democrats and a new field of 2020 presidential candidates will worsen confidence and destabilize long-term planning. Expect consumer confidence to become untethered as the media publicizes Democratic campaign rhetoric about how bad things are and how much they need to change. Households still want to rebuild their savings buffers. Real-estate, home, and property prices have rallied well since the great financial crisis, much to the benefit of homeowners, and the chagrin of renters; but even this traditional wealth creator is cooling off as real-estate capitalization rates get squeezed tighter. On the other side of the balance sheet, unsecured consumer credit is expanding as lenders loosen requirements, market to more employed people, and market to people experiencing wage growth; but record levels of student debt along with memories of debt turmoil from a decade ago are keeping consumers cautious.
Social economists peg Millennials as being more experience oriented than possessions oriented (i.e., they are more likely to buy experiences than things), and to a large degree that is true; but such stereotyping also goes hand in hand with Millennials stage of life. Because Millennials are starting families and moving into their own homes later than previous generations, they don’t have the physical space to keep things; they have been forced into minimalism. Down the road, as Millennials purchase homes and raise families, goods consumption should increase.
With monetary policy rates still historically low, yet dollar exchange rates relatively strong (albeit in the middle of their 40 year range) and global growth slowing, the Fed needs a strong consumer to propel the economy before it can justify raising rates, especially since higher rates increase debt servicing costs and home mortgage rates. This hints at one of the real problems the Fed has faced for the last decade. In most economic recoveries, businesses and consumers recover in tandem, but over the last decade, businesses have sustained and recovered much better than consumers. In practical terms, only an acceleration of inflation, wages, or spending (often tied to wages and inflation) can prompt a more aggressive Fed.
On the other hand, if global growth does not recover and the U.S. economy stumbles, the Fed may feel compelled to reignite its battle with disinflation — a war it thought it won last April — and consider a lower Fed Funds Rate. The Fed’s aim is to match the cost of capital with real activity. When faced with higher prices, consumers will usually reduce savings in order to sustain their standard of living; and as we saw after the last recession, when faced with falling prices and low interest rates, consumers will increase their savings. This behavior can also be noted in Japan; when faced with low rates and little growth, consumers must save more money for retirement. Thus, it remains to be seen not only how the Fed will ultimately move, but how consumers and the economy will react. Remember that during the last trend of low and lower rates, real growth continuously underperformed expectations.
Michael Ashley Schulman, CFA
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Disclosure: The views and opinions expressed are those of Michael Ashley Schulman, CFA and are subject to change without notice. The views and opinions referenced are as of the date of initial publication, may be modified due to changes in the market or economic conditions, and may not necessarily come to pass. Forward-looking statements cannot be guaranteed; neither can backward-looking nor current-looking statements. This material is provided for informational purposes only and does not constitute an offer or solicitation to purchase or sell any security or commodity or invest in any specific strategy. It is not intended as investment advice and does not take into account each person’s or investor’s unique circumstances. Information has been obtained from sources believed to be reliable, but its accuracy, completeness and interpretation cannot be guaranteed. Past performance is no guarantee of future results.
