US Macro Economic Landscape Growth, Interest Rates and Recession - PowerPoint PPT Presentation

US Macro Economic Landscape Growth, Interest Rates and Recession Risk Satyam Panday, Ph.D. Senior Economist, S&P Global Ratings March 2019

2 Current U.S. expansion is now 117 months old… Duration of U.S. Expansions since World War II (months) Duration of Expansions Since World War II 1991-2001 2009-Present 117 1961-1969 1982-1990 2001-2007 Average 63 1975-1980 1949-1953 1954-1957 1945-1948 1970-1973 1958-1960 1980-1981 0 20 40 60 80 100 120 140 Expansion Duration: Months …And expansions do not die of old age.

US growth looking handsome in comparison Synchronized growth of 2017 faded in 2018 Japan Eurozone US China (RHS) 4 7.1 7.0 3.5 6.9 3 6.8 2.5 (%, y/y) (%, y/y) 6.7 2 6.6 1.5 6.5 1 6.4 0.5 6.3 0 6.2 2015 Q1 2015 Q3 2016 Q1 2016 Q3 2017 Q1 2017 Q3 2018 Q1 2018 Q3

Pace of growth has been moderate but stable in the U.S. real GDP growth (annual average) …and growth likely will transition to estimated long -run trend rate of 1.8% beyond 2020.

5 Consumers continue to carry the load… Contribution to GDP Growth (percentage points) Percentage contribution of components to GDP growth 2016 2017 2018 (f) 2019 (f) 2020 (f) 2.0 1.5 1.0 percentage points 0.5 0.0 -0.5 -1.0 Pvt. Consumption Business Residential Government Exports Imports invesment investment Source: Oxford Economics, S&P Global forecasts …but swings in growth in 2018 & 2019 will largely come from business investment & govt. spending.

6 Unemployment rate has fallen below the Fed’s estimate of Natural Rate U3 rate (Standard) U6 rate (Broad) % 18 16 14 12 10 8 6 4 4. Feds NAIRU = 2 0 Data as of Jan 2019 Source: BLS …Unemployment rate (3.8% in Q4 ‘18) will likely fall as low as 3.5% by 2019 H2.

7 Labor crunch broadly…particularly for lower skilled jobs Skills mismatch cuts both ways as more and more share of the population gets educated and labor market gets tighter. High Skill Jobs Vs Low Skill Jobs No of Unemployed for Every Job Opening 7 1 High Skill Low Skill 2.0 1 6 1.5 5 1.0 4 0.5 0.0 3 (0.5) 2 (1.0) High-Skill Jobs: Dec'18 @1.3 Low - 1 Skill Jobs: Dec'18 @1.9 (1.5) 0 0 (2.0) 0 2001 2002 2003 2004 2005 2006 2008 2009 2010 2011 2012 2013 2015 2016 2017 2018 2001 2002 2003 2004 2005 2006 2008 2009 2010 2011 2012 2013 2015 2016 2017 2018 Source: BLS

8 Household deleveraging has stabilized… Household aggregate debt to income ratio home mortgage + consumer credit % of Disposable Personal Income 140% Q4 07, 124.2% 120% 100% Q3 18, 91.1% 80% 60% 40% 20% 0% Q4 54 Q4 57 Q4 60 Q4 63 Q4 66 Q4 69 Q4 72 Q4 75 Q4 78 Q4 81 Q4 84 Q4 87 Q4 90 Q4 93 Q4 96 Q4 99 Q4 02 Q4 05 Q4 08 Q4 11 Q4 14 Q4 17 Source: The Federal Reserve's U.S. Financial Accounts Z.1 Releases, September 2017 and S&P Calculations Note: Households represent "Households and Non-profit Organizations". This group's total liabilities (which includes other debt liabilities besides just home mortgage and consumer credit) as a % of disposable income was 102% in third quarter 2018.

% of GDP Estimated Output Gap Suggests Cyclical Recovery is Over… -10 -8 -6 -4 -2 0 2 Source: BEA, Oxford Economics, CBO, and S&P Global Economics Forecasts 1983 Q1 1983 Q4 1984 Q3 1985 Q2 1986 Q1 1986 Q4 1987 Q3 1988 Q2 1989 Q1 1989 Q4 1990 Q3 1991 Q2 1992 Q1 1992 Q4 1993 Q3 1994 Q2 1995 Q1 1995 Q4 1996 Q3 1997 Q2 1998 Q1 1998 Q4 1999 Q3 2000 Q2 2001 Q1 2001 Q4 2002 Q3 2003 Q2 2004 Q1 2004 Q4 2005 Q3 2006 Q2 2007 Q1 2007 Q4 2008 Q3 2009 Q2 2010 Q1 2010 Q4 2011 Q3 2012 Q2 2013 Q1 2013 Q4 2014 Q3 2015 Q2 2016 Q1 2016 Q4 2017 Q3 2018 Q2 2019 Q1 (f) 2019 Q4 (f) 2020 Q3 (f)

10 But Alternative measures of spare capacity suggest there could still be some ways to go to complete a normal cyclical recovery… • Industrial Capacity Utilization (%) Employment to Population Ratio: 25-54 yrs Employment Population Ratio: 25 - 54 years Capacity Utilization: Total Industry 87 84 82 82 80 77 78 (%) (%) 76 72 74 67 72 70 62 …Scope for demand led growth remains till at least this year.

Core Inflation is Near Where The Fed Wants It To Be… Personal Consumption Expenditure Price Index (PCE index) core-PCE index (PCE excluding food and energy) % The Fed's inflation target 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Source: Bureau of Labor Statistics Note: The Fed's inflation target is 2%. The Fed's preferred measureof inflation is the core-Personal Consumption Expenditure (PCE) inflation Data as of Nov 2018 Data is year over year percentage change …But the Asymmetry Around The Target Is Hard To Miss.

The Fed is On a Long Pause; The Bar to Change Policy Rates On Either Direction Is Very High

13 A Quick Look at where Non-Financial Corporates Stand in the current Business Cycle Non Financial Corporation Total Debt as % of GDP Non-financial corporate profit margins 48% 18% Percentage of Gross value added, 4-quarter average (Q318=46%) 46% 16% 44% 14% (Percentage of GDP) 42% 12% (Q3 18=12%) 40% 10% 38% 8% 36% 6% 34% 32% 4% Q3 85 Q3 88 Q3 91 Q3 94 Q3 97 Q3 00 Q3 03 Q3 06 Q3 09 Q3 12 Q3 15 Q3 18 Q3 83 Q3 86 Q3 89 Q3 93 Q3 96 Q3 99 Q3 02 Q3 05 Q3 08 Q3 12 Q3 15 Q3 18 Source: Board of Governors of the Federal Reserve System Source: Board of Governors of the Federal Reserve System Note:Dashed lines show standard deviation above and below the mean Note:Dashed lines show standard deviation above and below the mean Interest Coverage Ratio Short-term debt as a percentage of total debt 50 7.0 EBIT/ net interest and miscellaneous payment 45 6.0 40 5.0 (%) 35 4.0 (Q318=3.8) (Q3 18=30.56%) 30 3.0 25 2.0 20 1.0 Q3 85 Q3 88 Q3 91 Q3 94 Q3 97 Q3 00 Q3 03 Q3 06 Q3 09 Q3 12 Q3 15 Q3 18 Q3 83 Q3 86 Q3 89 Q3 93 Q3 96 Q3 99 Q3 02 Q3 05 Q3 08 Q3 12 Q3 15 Q3 18 Source: Board of Governors of the Federal Reserve System Source: Board of Governors of the Federal Reserve System, U.S. Bureau of Economic Analysis Note:Dashed lines show standard deviation above and below the mean Note:Dashed lines show standard deviation above and below the mean

Flat To Almost Inverted Yield Curve Recession T10Y3M mean+/- 1 stdev mean+/-2 stdev Percentage points 5 4 3 2 1 0 -1 Source: Federal Reserve Bank of St. Louis. Data through February 2019.

Recession Probability Climbing But Below Past Thresholds

Probability of growth slowdown six months ahead Suggested by leading indicators growth<1.5% growth >1.5% and <2.5% 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1Q 2007 2Q 2007 3Q 2007 4Q 2007 1Q 2008 2Q 2008 3Q 2008 4Q 2008 1Q 2009 2Q 2009 3Q 2009 4Q 2009 1Q 2010 2Q 2010 3Q 2010 4Q 2010 1Q 2011 2Q 2011 3Q 2011 4Q 2011 1Q 2012 2Q 2012 3Q 2012 4Q 2012 1Q 2013 2Q 2013 3Q 2013 4Q 2013 1Q 2014 2Q 2014 3Q 2014 4Q 2014 1Q 2015 2Q 2015 3Q 2015 4Q 2015 1Q 2016 2Q 2016 3Q 2016 4Q 2016 1Q 2017 2Q 2017 3Q 2017 4Q 2017 1Q 2018 2Q 2018 3Q 2018 4Q 2018 Note: In order to generate the estimates, we use an ordered-Probitmodel (data from 1967 to 2018) with Leading Economic Indicator Index (OECD) and Chicago Fed's National Activity Diffusion Index as predictors to estimate two-quarter out probabilities of growth categories: continuation of >2.5%, moderate slowdown to 1.5%-2.5%, or slumping to <1.5%. Probabilities sum up to 100%, thus probability of >2.5% growth rate is now below 50%. Source: OECD, Chicago Fed, St.Louis Fred and S&P Global Economics calculations

Policy-related economic uncertainty index is elevated 300 250 200 index 150 100 50 0 Jan-85 Jan-87 Jan-89 Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13 Jan-15 Jan-17 Jan-19 Note: Policy-related uncertainty index is a weighted combination of three underlying components: news coverage, temporary tax measures, and economic forecaster disagreement. Source: Baker, Bloom and Davic; www.policyuncertainty.com

18 Downside Risks to Baseline Growth Forecasts – Trade policy-- tensions risk turning to much severe trade war; stranded assets problem; China, EU (auto) – Fiscal policy – turns into sudden headwind: A divided Congress must • 1. Approve the USMCA • 2. Raise the debt ceiling, and • 3. Pass FY2020/21 budget – Export slowdown; policy risk abroad; Emerging markets rattle again – Will growth in investment stall? Regulatory costs increase in Tech? Interest sensitive sectors such as housing? – Oil Prices – cuts both ways; welfare shift from consumers to domestic producers, less to foreign producers than used to be because of shale revolution – Equity market correction (persistent)- business confidence down, consumer sentiments down – In our most likely downside scenario (based on ordinary risk – not extraordinary risk – surrounding our baseline forecasts), growth would slow to 1.4% this year and 0.9% in 2020 before bouncing back to 2% in 2021. • a broad loss in confidence and growing risk-aversion would lead to a drop in real investment, the equity markets, and consumer spending more than in our baseline.