The U.S. expansion is into its ninth year and if it continues into May, it will be the second-longest run in history. The natural question is, how much life is left in the U.S. economy? James Marple, Senior Economist, TD Bank, talks to Sara D’Elia about potential risks to the U.S. economy and discusses the likelihood of a recession or further expansion from here. The TD Economics report is available here.
The US economic expansion is into the ninth year, and if it continues into May, it would mark the second longest run in history. But as the expansion grows longer, we have to wonder, how much life does it have left?
Joining us to explain is James Marple from TD Economics. Thanks for being here.
So I have to ask you, as the expansion continues to grow, people not only think a recession is inevitable, but they're also starting to think, it's overdue. Now when you look at the data, you don't think that's the case. How come?
Well there used to be this notion that the longer an expansion went, the more likelihood a recession would be. And if you look at the data further back, say in the 19th century and before that, that typically was the case. That the longer the expansion went, the greater the likelihood of a recession.
If you look at the data more recently, one, we've seen expansions getting longer over time, but we've also seen that probability of entering a recession diminish the longer it gets. So there isn't really a notion that's obvious in the data more recently, that expansion dies of old age or that it should end just because it's been going on for so long.
The second piece of it is, if we look at the economic data-- especially leading indicators of data right now, activity right now, and what it should be in a month from now-- it's all pointing to strengthen and even acceleration. So we don't typically get the economy plunging into recession, when businesses are expressing confidence. Consumers are confident. And all of the leading indicators are pointing to strength.
Now short-term, it doesn't sound like you're too worried, but longer term, in your framework, you also look at some factors like mortgages, and housing in the US, student loans, auto loans, and even inflation. Which of those factors are you most concerned about?
Sure. Well, we know we're not going to be able to predict a recession, if it comes from a shock that is idiosyncratic. So what we try to do is say, look, it's more likely if there are pockets of vulnerability building.
So if we see debt rising-- particularly, swift within a certain sector of the economy, especially-- as you mentioned-- the household sector. And there, I think it's worth noting, that overall household debt in the US is lower than it was, relative to income at the peak. There's actually been several years of de-leveraging. So households look to be pretty well-placed, to manage a change in the interest rate environment.
We do, though, see pockets of vulnerabilities building up in places like auto loans, student loans. Student loans have grown tremendously-- double digit pace over the last several years. Some of that-- I think-- as result of the recession itself. The 2008 recession, people went back to school because their job opportunities weren't as good. They took advantage of student borrowing to do that.
Auto loans-- we've seen the auto sector go from $9 million sales in the post-recession, up to doubling to $18 million sales. There has been expansion in some portions of the market, where there's some concern of so-called, subprime lending-- less quality lending, and that's led to concerns that that could be a catalyst of recession.
When we look at it, we've seen growth in the auto in the subprime space, hasn't really outpaced overall auto lending the way maybe it did in mortgage lending in the late days. But also, delinquency rates on autos have historically been much lower than mortgages. And I think that reflects the fact that people really need their cars. And really, it's an area that you don't think is going to be a catalyst of recession or we don't feel will be something that could worsen a downturn were it to happen,
I think the biggest area, though, to probably be concerned about is the rising corporate debt. We've seen, as interest rates have fallen, we've seen doubling in the level of corporate debt. We've also seen corporate bond yields fall to pretty close to historic lows-- as low as they've ever been-- and that suggests, maybe, some complacency in that market.
And the risk there, is that, obviously, if interest rates were to rise abruptly, servicing some of that debt becomes more difficult. So that's why we don't see that happening in the near term, but it's something that you have to pay attention to, as something that could be a catalysts for a downturn.
So it doesn't sound like there's a crystal ball, per se, but when you look at short-term pieces and even long-term factors in your framework, no alarm bells are ringing-- as I had mentioned. But what caused the really big sell-off and what I want to dig into a little bit, is the worries about inflation.
For the last couple of weeks, stocks declined on worries that rates will not only go up in the US, but faster than we thought. Why aren't you as concerned about that? And what could potentially throw things off?
Well, that's it. I think that's really the linchpin, is we would see recession risk increase, if we were to see suddenly, a spike in interest rates. And we have been in a remarkably low interest rate era for really, the last decade.
As a result, we've seen duration risk increase. The amount of losses that the fixed income will take if rates are even to go up 50-100 basis points is much higher than it was prior to the recession. I think financial participants are aware of that.
It's also shown up in equity valuations, just this notion that we're in a lower for longer interest rate environment. And if suddenly that paradigm shifts, if we're in a regime change, not surprising that we would see a bit of repositioning in financial markets to that.
I think you do have to take a few things in context. One, we do think that inflation will rise. It's been abnormally low over the last several years. In the US, the core inflation rate has run under the Fed's 2% target for five-six years. It's barely ever gone above 2% in the last decade. So we do expect to see some move higher in inflation. And when we've done the work to look at the relationship between inflation and economic slack or the unemployment rate, a lower unemployment rate should lead to a higher inflation rate.
But we're not overly concerned that we're going to see a sudden rise in inflation, one, because that relationship between slack and inflation has probably fallen in terms of magnitude. You need just a lot hotter labor market. You need a much lower unemployment rate to really generate significant inflationary pressures.
The second reason is there probably is more slack in the labor market, than just looking at the unemployment rate suggests. In the US, if you look at the core employment rate-- the employment rate of people who are 25 to 54-- it's well below where it was in 2008.
We could create jobs at the current pace for another two years before we got back to that peak. So that says that there's probably a little more room to run in the labor market, before you really worry about inflation.
I think the other thing that's important is the commodity environment. And you have seen in the past, spikes in commodity prices catalyze recessions, but if you look at, for example, the oil market, we've seen that whenever there's been an increase in oil prices, it's been responded by an increase in supply. And I think that keeps a lid on inflation from a commodity perspective.
Which also feeds into the global underlying backdrop, and there's some early signs that inflation is rising in the US, but globally, we've seen inflation really pretty soft. Very little signs of inflation rising in Europe or in Japan or in other advanced economies. Even in China, still some concerns about deflation.
So I think all of those factors suggest that we may see inflation rise, but probably not a sudden increase.
Now you suggested or asked what could go wrong, and I think one of the issues there is where we've just recently had the passing of a major tax bill in the US, and then, even more recently, a budget bill between a Bipartisan Budget Act, which add something like $400 billion in spending over the next two years.
So you're adding to an economy that's already running hot, that's getting ever closer to full employment, and you're putting on a whole bunch more stimulus on it. A whole much more treasury issuance into the market. And that's something where that could lead to change in expectations for inflation, and something that pushes inflation higher.
So I think the risks are there. I think there's on balance, good reason to think that inflation will move gradually higher, and that, therefore, the Fed can adjust policy relatively gradually. But things can change if governments do things unexpected, and continue to add fuel to the fire.
Bottom line-- we've had a number of people worried about the death of the economy or potential recession, it sounds like continued expansion is ahead.
I think so, at least for the next six to 12 months.
Lots to think about. Thanks very much for being here, James.
If you'd like to see James' full report, click the link below.