An Economic Update, 1/24/19

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As January nears a close, the beginning of 2019 has proven to be a rocky start. From predictions of a global economic slowdown, to a government shutdown now over a month old, to more Brexit drama, it has been an eventful month so far.

Although there is plenty of news that can be discussed, I would like to share some highlights of the past few weeks that I found particularly interesting. Let’s dive in.

Drama in Davos 

With the annual economic forum underway this week in the Swiss Alps, the global economy appears to be heading for a slowdown. This is not a one factor dilemma either, with worries coming in from many areas of the world.

First, there is Europe and the EU. Politics are weighing heavily on the region, with drama unfolding in multiple countries.

In France, there are the on-going “yellow vest” protests against President Emanuel Macron. These began in response to a proposed gas tax that Macron wanted to use to help combat climate change. These protests highlight the former investment banker’s dwindling approval rating, now at 27%. Such low popularity makes it even harder for him to pass pro-business legislation aimed at loosing labor regulations. With Chronically high unemployment at around 9.4%, the proposed deregulations from a confident new leader were seen by many as a possible fix to France’s struggling labor market.

Italy has helped to fuel the slowdown as its populist coalition government has contended with the rest of the EU over a deficit-increasing budget. Italy is already highly indebted and the new budget, which proposes steep increases to welfare and public spending, would continue to add to it. The risk of high deficits helped push up borrowing costs in Italy over the past year. Even with recent compromises between Brussels and Rome , the financial woes have led to a 2019 growth forecast of only 0.6% for the country.

Adding to downward pressure from Europe is China, the world’s second largest economy. China’s growth fell to a 28-year low of 6.6% last year, highlighting a drop off in consumer spending across the board. Automobile, property, and retail sales all fell last year as Chinese consumers contended with higher prices and increasing debt. Although not the main cause of problems, tariffs from an on-going trade war with the U.S. have helped push up prices and subdue confidence as well.

China’s Communist Party leadership sits at crossroads now. On one hand, they can increase spending and reverse the past year’s trend of slowing debt growth. This would help stimulate the economy but would further balloon debt that was at 266% of GDP in 2017. On the other hand, they could cut taxes to help put money back into consumers’ pockets. This would help fuel the public deficit though, and also put upward pressure on debt.

Coupling the EU and China’s woes with the continued drama of Brexit and a prolonged government shutdown in the U.S., the IMF recently lowed their global growth forecast to 3.5% for 2019, the second decrease in the pat six months.

Housing

After many years of expansion, the housing market appears to have reached its peak. Home sales for December 2018 dropped 6.4% from the previous month and 10.3% from a year earlier. This comes on top of slowing prices as well.

A combination of a few factors have likely caused the sales drop off. First, there is the simple fact that home prices have reached a fairly high point. The median property value was at $223,000 in December 2018 according to Zillow.com, up 7.2% from the previous year. This price growth has far outpaced the 3.2% wage growth in the same time period. Many people are likely being priced out of new homes.

Second, rising interest rates have further burdened potential buyers. After four quarter-percentage point increases in 2018, the Fed funds rate is now at a range of 2.25-2.5%. At a median $223,000 price, an increase of 1% to interest would increase the monthly payment for a 30-year mortgage by about $186. Combined with the fast pace of price increases, this has led to an unfriendly environment for potential buyers.

We will likely see some cooling off in prices over the next few months, or at least the flattening of price growth.

PG&E: A Victim of Climate Change

After announcing plans to enter chapter 11 bankruptcy, PG&E, owner of California’s largest electric utility, secured $5.5 billion in financing to help get through its financial woes. The bankruptcy comes on the heels of the utility company being found responsible for many of the nasty wildfires that occurred throughout the Golden State this year. The need to pay settlements to victims as well update equipment has put the company into its tight squeeze.

Although no fires were intentionally started, the utility company’s equipment have been found at fault for creating the sparks that started many of the fires. California has become exceptionally prone to fires in recent years as dry, drought-like conditions have met shaky forest management of brush and low lying trees.

The bankruptcy is seen by many as the first major impact of climate change on a business. Although PG&E is not going under or anything, their financial woes can be tied directly to natural disasters that have been fueled by climate change. Fire investigators have tied 17 of 21 major Northern California fires to their equipment and estimates point to them being responsible for possibly $30 billion in liabilities, a sum larger than all of their assets.

If this is an early glimpse at the headwinds businesses may be facing in the coming years from climate change, many should take note on how quickly costs can mount.

A Brighter End

To end on a more positive note, the U.S. job market once again continues to send positive signals. Jobless claims reached a 49-year low in mid-January as the number fell to 199,000 in the week ending on January 19th, according to the labor department. Jobless claims are seen as a proxy of layoffs.

This follows on the heels of the strong December jobs report, where 312,000 people were hired and unemployment was at 3.9%

With such a strong labor market, the U.S. appears to be on strong footing to contend with numerous other economic headwinds. With consumer spending remaining high (outside of housing), the U.S. economy will likely not feel as hard of a slowdown as the rest of the world. The on-going shutdown and missed paychecks by 800,000 federal works is likely to weigh down on growth in the short run (see Mr. Hassett’s remarks), but so long as people remain working and wages continue to grow, 2019 as a whole should see the U.S. growing at a stronger pace as compared to many other advanced economies.

 

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