US Macro Economic LandscapeGrowth, Interest Rates and Recession Risk

Satyam Panday, Ph.D.

Senior Economist, S&P Global RatingsMarch 2019

Current U.S. expansion is now 117 months old…

2

…And expansions do not die of old age.

Duration of U.S. Expansions since World War II (months)

63

117

0 20 40 60 80 100 120 140

1980-1981

1958-1960

1970-1973

1945-1948

1954-1957

1949-1953

1975-1980

Average

2001-2007

1982-1990

1961-1969

2009-Present

1991-2001

Expansion Duration: Months

Duration of Expansions Since World War II

US growth looking handsome in comparison

6.2

6.3

6.4

6.5

6.6

6.7

6.8

6.9

7.0

7.1

0

0.5

1

1.5

2

2.5

3

3.5

4

2015 Q1 2015 Q3 2016 Q1 2016 Q3 2017 Q1 2017 Q3 2018 Q1 2018 Q3

(%, y

/y)

(%, y

/y)

Japan Eurozone US China (RHS)

Synchronized growth of 2017 faded in 2018

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.

Contribution to GDP Growth (percentage points)

5

Consumers continue to carry the load…

…but swings in growth in 2018 & 2019 will largely come from business investment & govt. spending.

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

Pvt. Consumption Businessinvesment

Residentialinvestment

Government Exports Imports

perc

enta

ge p

oint

s

Percentage contribution of components to GDP growth

2016 2017 2018 (f) 2019 (f) 2020 (f)

Source: Oxford Economics, S&P Global forecasts

Unemployment rate has fallen below the Fed’s estimate of Natural Rate

6

Feds NAIRU =

4.

…Unemployment rate (3.8% in Q4 ‘18) will likely fall as low as 3.5% by 2019 H2.

0

2

4

6

8

10

12

14

16

18

Data as of Jan 2019

U3 rate (Standard) U6 rate (Broad)

Source: BLS

%

Labor crunch broadly…particularly for lower skilled jobsSkills mismatch cuts both ways as more and more share of the population gets educated and labor market gets tighter.

7

0

1

0

1

2

3

4

5

6

7

2001 2002 2003 2004 2005 2006 2008 2009 2010 2011 2012 2013 2015 2016 2017 2018

No of Unemployed for Every Job Opening

0

1

(2. 0)

(1. 5)

(1. 0)

(0. 5)

0.0

0.5

1.0

1.5

2.0

2001 2002 2003 2004 2005 2006 2008 2009 2010 2011 2012 2013 2015 2016 2017 2018

High Skill Jobs Vs Low Skill Jobs

High Skill Low Skill

High-Skill Jobs: Dec'18 @1.3 Low -Skill Jobs: Dec'18 @1.9

Source: BLS

8

Household deleveraging has stabilized… Household aggregate debt to income ratio

Q4 07, 124.2%

Q3 18, 91.1%

0%

20%

40%

60%

80%

100%

120%

140%

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

home mortgage + consumer credit % of Disposable Personal Income

Source: The Federal Reserve's U.S. Financial Accounts Z.1 Releases, September 2017 and S&P CalculationsNote: 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.

Estimated Output Gap Suggests Cyclical Recovery is Over…

-10

-8

-6

-4

-2

0

2

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)

% o

f G

DP

Source: BEA, Oxford Economics, CBO, and S&P Global Economics Forecasts

But Alternative measures of spare capacity suggest there could still be some ways to go to complete a normal cyclical recovery…

10

• Industrial Capacity Utilization (%) Employment to Population Ratio: 25-54 yrs

…Scope for demand led growth remains till at least this year.

62

67

72

77

82

87

(%

)

Capacity Utilization: Total Industry

70

72

74

76

78

80

82

84

(%)

Employment Population Ratio: 25 - 54 years

Core Inflation is Near Where The Fed Wants It To Be…

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Data as of Nov 2018

Personal Consumption Expenditure Price Index (PCE index)core-PCE index (PCE excluding food and energy)The Fed's inflation target

Source: Bureau of Labor StatisticsNote: The Fed's inf lation target is 2%. The Fed's preferred measureof inf lation is the

core-Personal Consumption Expenditure (PCE) inflationData 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

32%

34%

36%

38%

40%

42%

44%

46%

48%

Q3 83 Q3 86 Q3 89 Q3 93 Q3 96 Q3 99 Q3 02 Q3 05 Q3 08 Q3 12 Q3 15 Q3 18

Note:Dashed lines show standard deviation above and below the mean

(Q318=46%)

(Per

cen

tage

of

GD

P)

Source: Board of Governors of the Federal Reserve System

Non Financial Corporation Total Debt as % of GDP

1.0

2.0

3.0

4.0

5.0

6.0

7.0

Q3 83 Q3 86 Q3 89 Q3 93 Q3 96 Q3 99 Q3 02 Q3 05 Q3 08 Q3 12 Q3 15 Q3 18

Note:Dashed lines show standard deviation above and below the mean

(Q318=3.8)

EBIT

/ n

et i

nte

rest

an

d m

isce

lla

neo

us

pa

ymen

t

Source: Board of Governors of the Federal Reserve System, U.S. Bureau of Economic Analysis

Interest Coverage Ratio

4%

6%

8%

10%

12%

14%

16%

18%

Q3 85 Q3 88 Q3 91 Q3 94 Q3 97 Q3 00 Q3 03 Q3 06 Q3 09 Q3 12 Q3 15 Q3 18

Source: Board of Governors of the Federal Reserve System

(Q3 18=12%)

Per

cen

tage

of

Gro

ss v

alu

e a

dd

ed, 4

-qu

art

er a

vera

ge

Note:Dashed lines show standard deviation above and below the mean

Non-financial corporate profit margins

20

25

30

35

40

45

50

Q3 85 Q3 88 Q3 91 Q3 94 Q3 97 Q3 00 Q3 03 Q3 06 Q3 09 Q3 12 Q3 15 Q3 18

Source: Board of Governors of the Federal Reserve System

(Q3 18=30.56%)

(%)

Note:Dashed lines show standard deviation above and below the mean

Short-term debt as a percentage of total debt

A Quick Look at where Non-Financial Corporates Stand in the current Business Cycle

Flat To Almost Inverted Yield Curve

-1

0

1

2

3

4

5

Recession T10Y3M mean+/- 1 stdev mean+/-2 stdev

Source: Federal Reserve Bank of St. Louis. Data through February 2019.

Percentage points

Recession Probability Climbing But Below Past Thresholds

Probability of growth slowdown six months ahead Suggested by leading indicators

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1Q 2

007

2Q 2

007

3Q 2

007

4Q 2

007

1Q 2

008

2Q 2

008

3Q 2

008

4Q 2

008

1Q 2

009

2Q 2

009

3Q 2

009

4Q 2

009

1Q 2

010

2Q 2

010

3Q 2

010

4Q 2

010

1Q 2

011

2Q 2

011

3Q 2

011

4Q 2

011

1Q 2

012

2Q 2

012

3Q 2

012

4Q 2

012

1Q 2

013

2Q 2

013

3Q 2

013

4Q 2

013

1Q 2

014

2Q 2

014

3Q 2

014

4Q 2

014

1Q 2

015

2Q 2

015

3Q 2

015

4Q 2

015

1Q 2

016

2Q 2

016

3Q 2

016

4Q 2

016

1Q 2

017

2Q 2

017

3Q 2

017

4Q 2

017

1Q 2

018

2Q 2

018

3Q 2

018

4Q 2

018

growth<1.5% growth >1.5% and <2.5%

Note: In order to generate the estimates, we use an ordered-Probit model (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

0

50

100

150

200

250

300

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

ind

ex

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

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.

18

Deteriorating fiscal space amidst pro-cyclical stimulusWill there be political will for fiscal stimulus in the next recession?

0

2

4

6

8

10

12(12)

(10)

(8)

(6)

(4)

(2)

0

2

4

6

8

1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

(%)

(% o

f G

DP

)

Budget balance (LHS) Unemployment rate (RHS, inverted)

Productivity Growth is the key in determining 2% vs. 3% economic growth, given demographic dynamics (Aging)

0

0.5

1

1.5

2

2.5

3

3.5

1956-1965 1966-1975 1976-1985 1986-1995 1996-2005 2006-2015 2011-2017

aver

age

ann

ual

gro

wth

%

Labor Productivity Growth

Nonfarm Business Sector Average 1956-2017

Source: BLS and S&P calculations