We disagree. Certainly, a slowdown in US growth is inevitable given the hectic pace at which the economy has expanded this year. Unemployment cannot keep falling by 1 per cent a year, while the boost from President Trump’s hefty tax cuts and fiscal stimulus is likely to fade. It should also be noted that the Fed is probably only part of the way through its cycle of increasing interest rates.
Chart 5: Yield Curve and Bank Interest Margin
Source: Bloomberg, as at September 2018
Consensus suggests a US recession is likely in 2020. Is this likely?
The Phillips curve shows the relationship between wage inflation and unemployment. There is much debate about the strength of this relationship or, indeed, whether it has broken down completely. It is usually plotted as a scattergram but a clear picture emerges if the dots are joined up, as in AW Phillips’ original 1958 article. In chart 6, the dark blue segment relates to economic downturns and recessions when unemployment is rising. The upswing part of the cycle, when unemployment is falling, is plotted in light blue. The dark segment is clearly steeper than the lighter segment. This suggests that inflationary pressures emerge relatively slowly in economic upswings but diminish rapidly in downturns.
Offsetting these concerns, however, is a benign inflationary picture, which is, in part, a consequence of the way in which intangibles have alleviated capacity constraints. This suggests that, rather than suffering an outright contraction, the US will only experience a modest slowdown in its next downturn.
The charts indicate that if the downturn is sufficient to raise unemployment – not our core view over the next year or so – wage inflation would decline, allowing the Fed to respond quickly. This would reduce the risk of a severe recession.
Chart 6: Joining the dots for the US Phillips curve.
Forecasters can probably discount one of the main catalysts of the last downturn – the US housing market – from being a cause of the next. Household debt has fallen, serious mortgage delinquencies are on the wane, as is the proportion of subprime loans in overall housing debt. Yet, housing has been a source of weakness this year. This is partly in response to rising mortgage rates but is also a result of the Trump tax reform, which restricted mortgage tax relief, and capped at $10,000 the amount of state and local tax (SALT), much of which is property-related, that can be deducted from federal income tax. This is a useful, if accidental, offset to reflationary pressures stemming from the Trump tax reform.