UNITED STATES
The market turmoil was the event last week. Financial conditions tightened considerably, expectations worsened, and risk aversion increased. The pain to investors was real. It is not clear, however, that the ripple effects reached the real economy. It is, anyway, too soon to tell; and, unless the shock persists, the impact will likely be small. Far more significant for its impact on growth and macroeconomic stability was the other big event last week, namely, the budget deal.
In search of short-term political gains, absent a stabilizing executive, Congressional leaders threw away decades of fiscal caution, and ushered-in a return to large deficits and mounting debt burdens. The increase in spending comes on top, of course, of the fiscally irresponsible tax cuts enacted at the close of 2017. Together, they could produce deficits in the range of 5-5.5% of GDP by 2019-20. Estimates now show the deficit approaching $1.1trillion in FY2019 and continuing to grow unabated thereafter.
Consider the maturing debt from the existing stock, and new debt issued to finance the new fiscal gaps. Together, these flows, plus the deficit, would produce gross funding requirements of $3.1trillion in FY2019 —14.2% of forecasted GDP. Consider further the saving capacity of the private sector. In 2014, when the deficit was 2.5% of GDP, private saving was 20.8% of GDP; investment, 16.8% of GDP. The 4% of GDP surplus in private saving helped finance the public deficit. If private investment increases (as the proponents of the tax cut suggest it will) the surplus will diminish and may even dwindle and turn into a deficit, if private consumption also increases, as it is expected to, reducing the private saving rate. The upshot would be an increased reliance on foreign saving (aka, an increase in the external current account deficit) to cover the fiscal gap. In other words, a return to the large “twin deficits” of the 1980s.
Only, in contrast to the 1980s, the macroeconomic imbalances would be larger. Presently, the economy is already at full employment, and the estimated 0.7pp of GDP fiscal stimulus in 2018-2019 will lead to faster growth. The fiscal multiplier may be smaller than when the economy was in recession, but it is likely still close to one, meaning that GDP growth in 2018-2019 could average 2.4-2.5%pa, significantly faster than the estimated 1.7-1.8%pa rate of potential growth.
It is the classic tale of doing the wrong thing at the wrong time. In 2011-2013 the fiscal contraction stifled growth when it still had a long way to go to approach cruising speed. Now it is adding to an economy that is already at or beyond the cruising speed. Short-term this will give an additional boost to the labor market and real incomes, but already by 2020 the imbalances could be such that the trend would reserve. Even if inflation is slow to pick up, the widening deficits and worsening financial conditions would support a vigilant Fed delivering not only the 4 hikes expected this year, but another 4 in 2019. The higher interest burden will add to the growing sense that the overall fiscal situation is running out-of-control, that the debt is expanding at an unsustainable pace; this notwithstanding the global greed for US Treasury securities.
The week is full of data to help gauge the state of the economy at the start of 2018.
- Wednesday, February 14: CPI—Jan/18. (Consensus 0.3%, 1.9%yoy; Core 0.2%, 1.7%yoy). In 2017, the market at first expected accelerating inflation, then spent much of the rest of the year disappointed when it didn’t come. This year begins with more modest and realistic expectations. The January results are likely to show payback for unusual increases in both vehicles and medical goods in Dec/17, which should constrain the month-on-month change in the core to just 0.2%. In part because employers are using one-time bonus payments in lieu of more permanent wage increases, wage inflation remains subdued—and this may be exerting a signaling effect on overall prices.
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Retail sales—Jan/18. (Consensus 0.2%; Ex-auto 0.5%; Core 0.4%). Inclement weather will likely impact headline sales, given drops in auto sales and building materials. Other measures should do well. Core retail sales (ex-autos, gasoline, and building materials), which enters GDP accounting, likely remained solid—reflecting a boost from strong service sector data and the January stock market rally.
- Thursday, February 15: PPI (Producer Price Index) final demand—Jan/18. (Consensus 0.4%; Ex-food and energy 0.2%; Ex-food, energy, and trade 0.2%). In January, WTI oil prices gained 9.9%, while the Bloomberg Commodity Index rose 4.5%. Likely, the price gains ex-food, energy, and trade services category will be smaller. On balance, however, PPI accelerates at a healthy speed, no longer weighed-down by deflation in import prices.
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Philadelphia Fed manufacturing index—Feb/18. (Consensus +20.6).
The market expects a mark down in the index but, as in Jan/18, the New Orders component is likely to remain strong—and this bodes well for the continued recovery in manufacturing (see below).
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Industrial production—Jan/18. (Consensus 0.2%; Manufacturing 0.1%).
Colder-than-usual temperatures likely boosted electric production, which should lift utilities output. Aggregate hours worked in manufacturing fell in Jan/18, but overtime hours increased. Likewise, the regional manufacturing surveys were mixed. On balance, some retrenchment is expected from the torrid pace in Dec/17 but, overall, the numbers continue to show a solid evolution.
- Friday, February 16 University of Michigan consumer sentiment—Feb/18 – preliminary. (Consensus 95.5, unchanged). The big question is whether the recent stock market selloff is already in the surveys conducted last week.
BRAZIL
For all practical purposes the market is closed this week (Carnival), although the release of the COPOM minutes should be of interest.
IMPORTANT NOTICES:
This report is a general discussion of certain economic and geopolitical trends and forecasts. It does not constitute investment advice of any kind or constitute a recommendation to buy or sell any security or other financial instrument. Investors may not rely upon any of the conclusions or other statements contained herein.
Certain of the factual information contained herein was obtained from third party sources which the author considers reliable, but the accuracy of such information cannot be guaranteed.
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