The economy is on a roll! Economic
growth picked up strongly in the second quarter, with a reading of +4.2%, as
momentum from the tax cuts and deregulation pushed spending and investment
higher. Third quarter growth is also expected
to be around +4.0%. Business and
consumer optimism have been high.
Indeed, equity investors have been optimistic, too, sending stock prices
higher this year, although these gains have not come without some extreme
volatility earlier in October. Bond
investors, on the other hand, are a miserable bunch. The Federal Reserve continues their
campaign, raising short-term interest rates another .25% in
September, to bring the Fed Funds rate to a range of 2.00% to 2.25%.
The Fed has now given us eight rate increases
totaling 2.00% since December, 2015.
the way, I want to run down the street screaming, “Stop!”
At the same time, longer-term rates have
risen about .20% to .25% in the past month, while inflation has been
The ten-year Treasury has topped 3.00% and
many economists call for its continued rise.
Only a few call for stable or falling rates.
Just remember this:
Rising rates are always the culprit that
derails economic growth, ultimately resulting in a reversal for the Fed and
We now have four quarters to go before we set a new record length of
economic expansion. I believe that we
will. GDP has increased an average of
2.2% since the current recovery began in June, 2009. The longest expansion on record was from
March, 1991 to March, 2001, with growth of 3.6%, engineered by Maestro
Greenspan. That time period was not
without its challenges, especially when the Fed raised rates unexpectedly in
1994. They may have raised rates too
much but quickly realized their error and eased to keep the recovery intact. We face challenges, too, but we have a good
chance of setting the new record in 2019; even if growth slows, I believe it
will be back to the 2% trend line through the middle of next year. The
Fed thinks we will make it, too.
Standing in the Way of Growth
I read Dr. Lacy Hunt’s latest newsletter and was surprised when he wrote
that the economy appears to be on a downward trend and that long-term rates
will fall. Of course, he does not say
when…The Federal Reserve’s raising of interest rates has been a drag on the
economy. Fiscal stimulus in the form of
tax cuts, especially for corporations, led to spikes in investment and
spending. But how long can that be
sustained as rates rise? Interest
sensitive sectors like automobiles and housing are already slowing. The yield curve is much flatter this year
than last. The spread between ten year
and two year Treasuries is .24% at September 30, 2018 compared to .84% at
September 30, 2017. The curve is not
close to inverted yet, but if it does, it will be a precursor of tough economic
Government debt poses a threat to growth, but more on that later. Trade wars and tariffs dominated the market
discussion in the third quarter with talk quieting down for now. Politics is causing concern both here
domestically with our upcoming mid-term elections in November and around the
world with places like China and the Middle East. Finally, the dreaded rising oil prices, now
at $70 per barrel, always have the potential to derail growth.
Too Much Debt
Here I go, sounding like a broken record again. I harp on debt too much, but I strongly
believe that it is the primary reason that GDP has only been able to average
+2.2% since 2009, compared to 3% to 4% growth in other recoveries. Debt creates a drag on GDP, especially if it
is not productive in generating income.
US Government debt is at 104% of GDP at the end of the second quarter of
2018 and the ratio is likely higher in the third quarter. Treasury debt exceeds $21 trillion and the
growth is on an unsustainable path.
Studies show that GDP growth is sub-par in scenarios where debt is above
90% of GDP for over five years. Just
look at Japan and Europe and see how sluggish their economies have been. China has slowed from its potential growth
rate as debt mounts. Even US growth is
weaker than average. As rates move
higher here at home, do not forget all of the countries that tie their currency
to the US dollar. It is stronger and
rates are higher, making it tougher for them to repay debt.
It is not just government debt that is of concern. Here are some staggering numbers: Since the financial crisis of 2008, worldwide
debt has increased by $70 trillion to $247 trillion, or 236% of world GDP
versus 207% in 2008. US household debt
is at $13.3 trillion, up from $9 trillion.
Student debt has more than doubled from 2008 to $1.5 trillion and auto
loans are higher at $1.25 trillion. Just
when you think I don’t have any positives, here is the good news on employment
Record Low Unemployment
Wow! The unemployment rate fell
in September to 3.7%, matching a low rate first attained in September, 1966 and
one that is only slightly above the rate of 3.4% in September, 1968. This has been great for the economy and is
quite an achievement by the Fed, but it is also a source of their constant
worry about a low rate of unemployment that could lead to high inflation. Those who advocate the Phillips Curve
relationship would worry. Those of us
who don’t believe in it aren’t too concerned.
It has been great for the economy to see millions of workers obtain jobs
and spending ability to push our economy further. There are over 7 million job openings
nationwide. We still have a large pool
of available workers, at over 11 million people, who could jump in to fill
jobs. This “excess capacity” keeps
inflation in check.
Speaking of inflation… Admittedly, inflation was trending higher early
in 2018. Wage growth on a year-over-year
basis scared everyone with a reading of +2.9% and subsequently settled back in
a range of +2.6% to +2.8%. The consumer
and producer price indices were rising vigorously, at +2.8% and +3.1%,
respectively, but now the year-over-year changes are falling back to +2.7% and
+2.8% for August. The inflation picture
in China was very scary in early 2018, with the “world’s manufacturer”
reporting producer prices rising at 7.8% in February; in September, price
pressures there have eased to 3.5%. A
leading inflation index published by ECRI was also rising annually earlier in
2018, but is now falling. Still of
concern are oil prices that are up 21% and gasoline prices that are up 11% to
13% year-to-date. Housing price
increases continue, but at a decelerating pace.
Should inflation worry us? Of
course. But is there a risk of huge inflation? Not right now. This will also help us get to the expansion
The brightest spot in the economy right now is the movie industry,
bringing us films featuring Lady Gaga and Queen, two of my favorites! I also have two great nephews, ages 2 and 4,
who want their Aunt Dorothy to take them to see The Grinch.
Thanks for reading! DJ 10/17/18
Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy has been with Penn Community Bank and its predecessor since November, 2004. She is the author of Just Another Good Soldier, and Honoring Stephen Jaworski, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.