If things can’t get better, does that mean they have to get worse?
The economy grew at annual rate of 3.5 percent in the third quarter, following an even more robust second-quarter rate of 4.2 percent, the best six-month performance in the past decade. There are more job openings, 7.1 million, than there are unemployed people, 6.1 million. The unemployment rate stands at a low 3.7 percent. Consumer confidence is at an 18-year high. The percentage of consumers expecting an improvement in their income prospects is up. No surprise, then, that consumption spending, almost 70 percent of GDP, rose in the third quarter at the fastest rate since 2014.
Why, then, did October see a plunge in share prices that vaporized $4.5 trillion of the world’s wealth, about half of that loss incurred in the United States? Most consumers don’t own shares, so their cheery job and income circumstances drive their confidence to high levels. Investors, on the other hand, look to the future from a present in which what were once modest jiggles in share prices have become deep dives and soaring ascents. Even though prices are settling about where they started at the beginning of the year-meaning traders are no worse off now than they were when the year began-they won’t be found humming Johnny Mercer’s tune, “When October goes. . . . I hate to see October go.” They hope for a better run between now and year-end.
Viewing the economy’s robust condition involves looking into the rear-view mirror. Investors have little interest in the road just traveled. They peer through their windshields in search of signs marking out clear directions to the course the economy will be taking. Nor can they see where U.S. trade policy is headed.
One set of such signs is posted by forecasters. Leading economists surveyed by the Wall Street Journalestimate that the economy’s growth rate will slow to 2.5 percent by the first quarter of next year, and to 2.3 percent by the third quarter. Economists at the Federal Reserve are putting the growth rate for 2021 at a mere 1.8 percent. They are assuming that the boost provided by the Trump tax cuts will peter out by then.
Investors need not rely solely on these forecasts, which are not famous for infallibility. They can also see that business investment, which grew at an annual rate of 11.5 percent in the first quarter of this year, slowed to 0.8 percent in the most recent (third) quarter. Unless that decline is reversed, hopes that businesses will respond to the tax cuts by investing in plant and equipment that will significantly increase worker productivity will be dashed. And with them hopes that an already-overstretched workforce will be able to produce more goods and services to keep the economy growing.
Then there is a tiny, much-ignored sign planted alongside the road by two of the biggest issuers of credit cards, Capital One Financial Corp. and Discover Financial Services. Discover specializes in customers of modest means and Capital One in subprime borrowers. To the aptly named Richard Fairbanks, CEO of Capital One, peering into his rear view mirror, the economy “almost feels too good to be true.” He assumes the road ahead will be rougher than the road already travelled. Both companies are tightening credit limits in what Discover CEO Roger Hochschild describes as a “nuanced” manner.
Other go-slower signs come from the industrial sector and from the housing market. Several important manufacturers warn that tariffs and labor shortages are raising their costs, a strong dollar is hurting sales, their Chinese markets are growing more slowly-all combining to crimp future profit performance. And sales of existing homes fell in September for the seventh straight month-the longest slump since 2014-and are now 4.1 percent below last-year’s level. The likelihood of a reversal of this downward trend is reduced by the fact that mortgage rates have risen and will rise even more as the Federal Reserve continues its policy of raising interest rates to a more “neutral level.”
Which brings us to a road sign that is fiendishly difficult to read-the one pointing to the future path of interest rates. If they continue to rise, sales of cars and homes will slow, some indebted companies will have to cut back even more on spending, and the economy will slow. Policymakers at the Federal Reserve are planning another quarter-point rise in its benchmark interest rate in December. Larry Lindsey, a former Fed governor, wonders why. He points out that the bank’s favourite measure of inflation has fallen steadily for three straight quarters, to 1.6 percent, well below the Bank’s target of 2 percent.
But Fed policymakers, rather like investors, care less about the past than about the future. They aim to nip inflation in its incipiency, rather than tackle it when it has taken hold, as it did in the days of Jimmy Carter, eventually forcing the Fed to push mortgage rates to about 17 percent. The Department of Labor reported yesterday that the economy created an unexpectedly large number of new jobs last month, 250,000, and that average hourly earnings have increased, year-over-year, by 3.1 percent, the largest jump in almost 10 years. Add reports from many companies that they are raising prices to pass on the higher costs of Trump’s tariffs, or simply because they can, and Fed chairman Jay Powell has what he considers reason enough to continue raising rates, even if the president thinks him “crazy,” and regrets appointing him. “He was supposed to be a low-interest rate guy. . . . Every time we do something great he raises interest rates,” says Trump. Those attacks by the president would make it difficult for Powell to postpone next month’s rate increase, even if he wanted to-which he doesn’t-because he would seem to be surrendering the Fed’s independence from political pressure. So you can, as they say, pencil it in-or even use ink, if you prefer, notwithstanding critics of the Fed (Lindsey among them) who believe that rising investment and increases in the labor force participation rate make it unlikely that wage increases will trigger inflation.
Many traders see the performance of share prices as typical of the “corrections” excessively exuberant markets experience from time to time. Or, as investment managers at Goldman Sachs put it: “the market [has a] tendency to overprice the prospect of slowing growth . . . to overstate the actual degree of macroeconomic deterioration.”
Perhaps. But Hudson Institute scholar Walter Russell Mead argues that the “crashing sound you heard in world markets last week wasn’t just a correction. It was the sound of the end of an age . . . of relatively stable international relations. . . . The world has entered a new, complicated and dangerous era of nationalist competition . . . reverberating through the world’s financial markets.”
Worse still, we are entering that “dangerous era” devoid of weapons with which to fight a slowdown or a recession. The Fed can’t cut interest rates below already-low levels, and the federal government can’t loosen monetary policy, already so loose that it is producing trillion-dollar deficits.
Americans will decide, on Tuesday, just how they will be governed for the next two years. The models on offer by the two parties couldn’t be more different in policy prescriptions for healthcare, immigration, tax policy, and almost anything else that matters. Markets hate uncertainty. Right now, they have a lot of hating to do.