Mark Zandi: Economy Is Booming, But Trade, Interest Rates Pose Risk

Federal tax cuts and spending hikes will fuel an already-blazing economy, but higher interest rates and a trade war with China could hasten a recession, said economist Mark Zandi.

The United States has been creating 2.5 million jobs annually for each of the past few years, or roughly double the rate of new entrants into the labor, according to Zandi, chief economist at Moody's Analytics. This has resulted in more open job positions than unemployed workers for the first time since both metrics began being tracked in 2001, Zandi said.

The present unemployment rate of 3.7 percent is expected to go into the low 3s and maybe even 3 percent in late 2019 or early 2020, Zandi said, which would be the lowest jobless rate since the early 1950s. The macroeconomic boom has been accompanied by increased business spending on IT, Zandi said, with nominal year-over-year growth of 8 percent encompassing both IT hardware and software.

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And beginning in early 2018, businesses are spending more on IT software than IT hardware for the first time in history, Zandi told attendees at the 2018 Best of Breed Conference, hosted by CRN parent The Channel Company.

Customers have been spending more with Chicago-based solution provider PSC Group due to having a surplus of cash, according to John Head, the company’s vice president and chief evangelist. In addition, Head said companies have increasingly bought into the idea that spending more money on technology will help drive innovation across their business.

"The economy is doing really well," Head said. "Unemployment is going well."

Wages have also picked up, Zandi said, improving from growth rates of just 1.5 percent to 2 percent between 2013 and 2015 – which is below the annual inflation rate of 2 percent – to yearly wage increases of 3 percent today. And if employment dips below 3.5 percent, Zandi said wage growth could climb to between 3.5 percent and 4 percent by the end of next year.

"The American consumer drives the train," Zandi said.

In addition, Zandi said the major tax cut approved in late 2017 and a huge increase in military and non-defense spending by the Trump administration in early 2018 have served as a fiscal stimulus. This is expected to make the economy even stronger over the next 12 to 18 months as the money that was borrowed via deficit finance makes its way through the economy, according to Zandi.

Zandi said his optimism about the economy assumes that President Trump would end the trade war if the stock market suffered two-to-four sustained weeks of decline or employment in the manufacturing or housing industries suffered significant damage.

But if Trump were to follow through with the $800 billion of tariffs he has proposed on imported goods, America's effective tariff rate would jump to the highest it's been since the World War II era and consumers would feel it by way of higher prices.

"You can feel it. You can see it. It's starting to have an impact," Zandi said.

But Zandi said the real damage would come if the Chinese decided to retaliate, which they have been willing to do thus far. The Chinese would eventually run out of things to put tariffs on due to their trade surplus with the United States, but Zandi said they could instead make life difficult for American companies doing business in China.

For instance, Zandi said the stock market will likely fall for two or three months if the Chinese government discouraged its citizens from buying iPhones as a way to punish the United States.

PSC Group’s Head believes a hike in tariffs could result in a recession sooner than Zandi is projecting since that would lead to higher prices on smartphones, video games and appliances. Head believes this would have a bigger and faster impact on the economy than other risk factors Zandi identified.

"Economies have peaks and valleys, regardless of what we do or what we want," Head said.

In addition, Zandi said a pretty big gap exists between the modest extent to which investors expect the Federal Reserve to raise short-term interest rates and the more substantial hikes the Federal Reserve itself projects making over the next two years. There could be volatility in the market as the gap between the competing set of expectations closes over the next year or so, according to Zandi.

All told, America's economic expansion is closing on 10 years as of June 2019, which Zandi said would make it the longest sustained period of growth in the country's history. The best leading indicator of a recession, Zandi said, is when unemployment goes below 4.5 percent, which economist believe represents full employment.

Unemployment dropped below that figure last summer, is now at 3.7 percent, and is expected to fall to 3 percent by late next year, Zandi said. If unemployment remains below 4.5 percent wages, Zandi said wages will accelerate, corporate profit margin will decline, inflation will escalate, the Federal Reserve will hike interest rates, and the economy will weaken.

And the further away from full employment America's economy goes, Zandi said, the harder it will be to get it back there gracefully. The average length of time between when the economy goes under 4.5 percent unemployment and the start of a recession is three years, which would indicate that a recession will hit in summer 2020.

Another indicator of an impending recession is an inversion of the yield curve, Zandi said, which happens when short-term interest rates push above long-term interest rate due to substantial Federal Reserve hikes in the short-term rate. There has been a recession every time the curve has inverted since 1975, and Zandi said this indicator has never falsely predicted a recession.

The gap between these rates has been narrowing significantly, and Zandi expects the curve will be inverted by this time next year. The average length of time between when the curve inverts and when a recession hits has been 12 months, Zandi said.

As a result, Zandi predicted that the next recession will arrive on June 20, 2020, or the day of the summer solstice.