Q4 Economic and Credit Trends: Risks to the Economy
In November, Equifax and Moody’s joined forces to recap the economic and credit trends of 2018 — and look ahead to 2019. This is the first of three blog posts where I’ll highlight key takeaways.
Takeaway 1: Trade Policy and Interest Rate Uncertainty Are Risks to the Economy
Overall, the economy continues to perform well. However, trade policy and interest rate hikes are a source of great doubt. Such unknowns may be holding back some business investment and may also impact consumer confidence and spending.
Unknowns in Trade Policy Continue to Shake Things Up
We used the Moody’s Global Macroeconomic model to take a look at the impact that different trade policies could have on the US economy. The first round of tariffs (red) that went into effect back in July 2018 had a relatively modest effect in the simulated results. This was a 25% tariff on about $50 billion worth of goods. It had a large impact on certain industries such as soybean farmers. However, the effect on the overall economy was relatively small given other sources of strength in the economy.
The second round of tariffs (gray) which went into effect back in September, was a 10% tariff on an additional $200 billion worth of Chinese goods. We project that this round of tariffs could shave off a half a percent of GDP growth over the next 12 to 18 months. But with the economy growing at an annual 3.0% rate, it won’t plunge the economy into a recession.
Wider Tariff Increases Could Indirectly Impact Businesses
The real risk is apparent when we accelerate the model to show a 25% tariff on all Chinese imports. We assume the Chinese will impose a similar tariff on all US exports in addition to devaluing the yuan. This will have a direct impact on businesses and consumers, but the indirect effects of this hike on the economy could be even larger. Many Chinese products that are imported into the US are either capital goods or intermediate goods that are used by US companies to produce final goods and services. As a result, a wide-ranging number of businesses will feel the impact of a broader tariff hike.
Although no region will be completely immune, we find that the weight of the tariff won’t be universal across all geographies. The impact would be more concentrated in the northwest and southern parts of the country affecting industries like aircraft production, agriculture and energy.
Interest Rate Hikes May Have Long Term Effects
The second major risk to consider is interest rates. With the Federal Reserve policy of tightening, we expect another increase in the federal funds rate in December. This is reflective of some signs of inflation that may be creeping in. Higher interest rates will dampen economic growth.
If we consider only the near-term prospects, things continue to look favorable. There are many positives to offset some of the risks. For example:
- Overall economic growth
- A strong labor market with increasing wage growth
- Fiscal stimulus, including deficit-financed tax cuts and spending, that continues to push the economy forward
If these indicators continue to perform through the middle of 2019, this will become the longest economic expansion in US history. At the moment, all indicators suggest there is enough momentum to carry us forward. However, we should be mindful of the risks.
Keeping an Eye on the Unemployment Rate
We continue to add hundreds of thousands of jobs to the economy every month. The unemployment rate is 3.7%, which is the lowest rate in 50 years. By our projections, we expect the unemployment rate to fall even further getting closer to 3.4% over the next year. As we move into 2020, recession risks will build as some of the fiscal stimulus fades away. Additionally, we expect job growth to slow down along with investment and consumer spending in 2020 as interest rates rise. The unemployment rate may actually start to rise to its long-run, equilibrium level.
Next in our series, we’ll review the risk factors associated with a recession, and review the key indicators to keep an eye on.
To learn more, watch one of our U.S. Economic and Credit Trends webinars.
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