In some way, the current global economic expansion resembles these unusual and complex animals…

Apr 2018

Found only on a remote chain of islands in the Pacific Ocean, the gigantic Galapagos Tortoise has thrived for centuries. Study by naturalist Charles Darwin in his breakthrough Theory of Evolution revealed several fascinating characteristics of these ancient reptiles. They lumber along rocky cliffs, feeding on cactus and grass, perfectly adapted to survive in their harsh environment. Though lacking in speed, they have few natural predators, and an impenetrable shell, leading to an enormously long life span. Centenarians are not uncommon among their ranks.

In some way, the current global economic expansion resembles these unusual and complex animals. By all measures, this has been a long and slow recovery. In the U.S., we see growth accelerating to a still modest 3% rate in the coming months, a slight improvement over last year. What the current expansion lacks in magnitude, however, it makes up for in duration. We are just shy of nine years into a period of continuous expansion. If growth persists through June (which we expect), it will become the second longest recovery on record (see the chart below). We see two primary factors contributing to this sustained improvement. First, the current expansion has been fueled by unconventional, unprecedented, and (nearly) unending support by global central banks. Normally charged with taming inflation and promoting full employment, today’s central bankers have ventured far into unchartered waters. They have kept short-term borrowing rates at or below zero, purchased trillions of dollars of bonds to suppress longer-term interest rates, and promised to do “whatever it takes” should further measures be required. So far, it has worked. Broad inflation measures remain below the elusive two percent target rate, and the labor market is particularly strong. We even see room for further improvement, especially in the labor market, where we expect the unemployment rate to dip below the current 4.1% rate toward 3.5%. Despite the tightening job market, wage inflation has remained low – an anomaly compared to prior recoveries. After the January wage data spiked to 2.9% yearly growth, contributing to a slide in stock prices, the February reading moderated to 2.6%. This is an important indicator for both the economy and for corporate profits, which we are watching closely as the year progresses. So far, wage pressures have been contained, and immediate concerns have faded.

We are also closely watching changes to the enormously accommodative measures orchestrated by central bankers. The U.S. is leading the world in a shift toward more “neutral” positioning. After the Fed raised the policy rate to 1.75% in March, we expect two more quarter percentage point increases this year. Policy rate increases will be accompanied by a gradual unwinding of the Fed’s gargantuan portfolio of government bonds, leading to tighter financial conditions over time. From a global perspective, the four largest central banks in the world still own between 20-40% of their countries’ respective government bonds. Even with the Fed winding down, global bond buying by central banks will not turn negative on a “net” basis until the end of this year. This will be an important fork in the road; how fast can the economy grow as central banks gradually remove their artificial support? Even with this less accommodative monetary policy, we see growth persisting into 2019, albeit at a slower pace. Importantly, a more neutral stance also gives the central bank additional flexibility should growth falter. Though the duration of the current recovery could end up being the longest on record, it is not likely to reach the hundred-year lifespan of the Galapagos Tortoise. While a recession is certain to reoccur at some point, it seems unlikely within the next eighteen months, in our view, though the new threat of an escalating trade war may put the global recovery at risk. When the current expansion does come to an end, we envision a relatively mild cyclical correction rather than a severe contraction similar to the Great Recession of 2008-09.

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