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Economic Insights

Could the current U.S. economic expansion last longer than many forecasters expect?

Like the two characters in Samuel Beckett’s play Waiting for Godot, U.S. markets are waiting for the arrival of a recession that, in the opinion of some observers, seems to be long overdue. Hence, the market jitters with every blip in the yield curve and the volatility around trade negotiations.  

In Beckett’s play, Godot never shows up.  In the real world, recessions do eventually, but not with any regularity or dependability.  In fact, according to our own international economist, Lord Abbett Partner Giulio Martini, director of strategic asset allocation, the decade-long expansion that the United States is currently enjoying could last longer than many forecasters expect, although its precise duration cannot be forecasted or guaranteed. We recently asked him to opine on the extraordinary length and breadth of the current U.S. economic expansion.

According to the National Bureau of Economic Research, the current U.S. economic expansion began in June 2009 following the Great Recession. At 121 months long (as of June, 2019), the current growth phase has exceeded the reigning champion of U.S. economic recoveries – the 1990s expansion, which lasted 120 months exactly.

 

Chart 1. The Current U.S. Economic Expansion Now Exceeds That of the 1990s
U.S. post-WWII economic expansion in months. (Data as of June 3, 2019)

Source: National Bureau of Economic Research.

 

What is the prospect for the recovery’s continuation? How sustainable is an expansion that is already a decade long?  Isn’t it just getting a bit old?  We posed those questions to Martini.

Well, “business expansions don’t die of old age,” Martini said.  “They are either murdered or they commit suicide.  When they’re murdered, the Fed [U.S. Federal Reserve Board] is tightening monetary policy to combat the threat of inflation, and that forces the economy into a downturn to correct the excesses that led to inflation.”

“When business expansions commit suicide,” Martini continued, “it’s usually been because a financial bubble has burst, and that spills over to the economy by reducing household and business spending, causing a recession.”

 

“Business expansions don’t die of old age. They are either murdered [when the Fed raises rates] or they commit suicide [when a financial bubble bursts].”
-Giulio Martini

 

With neither a Fed-induced nor a bubble-led recession in view, according to Martini, “we need to ponder the possibility that the current expansion may exceed investors’ expectations in terms of its duration.”

Martini points to the late-in-the-cycle appearance of productivity growth, which he says “has been missing in action up to now,” as one indicator of the sustainability of this recovery.  Labor productivity growth in the nonfarm business sector accelerated at an unexpectedly strong 3.6% in the first quarter of 2019.  This took the year-over-year gain to 2.4%, by far the swiftest advance in the current expansion, according to Martini.

 “Since the recovery began in 2009, we’ve had very weak productivity growth, and that's resulted in slow wage increases and, frankly, a lot of dissatisfaction as people just didn't really feel the benefits of the economic expansion,” Martini said.  “Then a couple of years ago, we started to see wage increases accelerate.”

“Normally, wage increases could pose an inflationary threat,” Martini continued.  “But it's not doing so, because simultaneously productivity is picking up.  That means production costs aren't going up, even though wages are. And in many ways, that kind of acceleration in productivity creates the potential to have the best of all possible worlds, because it means that households can have an improving standard of living, we can continue to have low inflation, businesses can maintain profit margins to the benefit of shareholders, and all of that coming together is something that we saw for extended periods of time in the 1960s, in the 1980s, in the mid-1990s, but we haven't seen for a while”

“And if in fact the economy is entering a period of higher productivity growth, it's a signal that we can continue to have low inflation and maintain this economic expansion for longer than investors might have been counting on,” Martini said.

What’s Different This Time?
Martini points out that it is unusual for this kind of productivity growth to occur so late in a business cycle.  “Generally, the pattern is for productivity growth to be very strong in the early phases of an economic recovery, when you're coming out of recession, and then for it to slowdown in the latter phases of business expansion.”

“The mere fact that productivity is not decelerating, as it normally would so deep into a period of economic growth, allows growth to be sustained,” Martini says. “We saw this happen in the long expansion period in the 1990s, when [former U.S. Federal Reserve chairman] Alan Greenspan famously perceived that technological change was allowing an acceleration in productivity growth that hadn't shown up in the data yet, but that he thought would allow the Fed to maintain low interest rates for longer.”

“In terms of the performance of the U.S. economy, that late-cycle acceleration and productivity growth was one of the things that really led to the longest period of uninterrupted economic growth (the 1990s) that we've ever had in history—until this one,” Martini says.

“In hindsight,” Martini concluded, “the last year has been even more surprising than I thought it would be.  China’s economy slowed, Europe’s economy slowed, yet U.S. GDP growth year-over-year in the first quarter turned out to be 3.0%.”

“Most people think that potential output growth is something like 1.8%” Martini said. “So the U.S. did almost double its potential output in a year when the rest of the world was slowing down. That's pretty impressive. What's more impressive is that inflation decelerated as the economy was growing at 3.0%.”

“What that really suggests, to me at least, is that those estimates of potential output are probably too low, that the economy's real potential in the medium term is growing more rapidly than we thought it was. And that's exactly what accelerating productivity would suggest.”

About That Yield Curve
Investors watch the yield curve carefully as an indicator of an impending recession.  When the yield curve inverts, i.e., when short-term interest rates exceed long-term rates because investors expect short-term rates to fall as the Fed eases, the yield curve is said to be predicting a downturn.  Such an event occurred on March 22, 2019, when three-month Treasury rates exceeded 10-year Treasury rates.  The yield curve has inverted before every recession going back to the 1960s, with a time lag of about six to 24 months before a recession begins.

Since 1980, however, the three-month/one-month yield curve has given nine false recession signals, according to Bloomberg, confounding the expectations of investors.   

In fact, according to Martini, the shape of the yield curve today may be a less reliable guide to the timing of the next recession than it has been in the past.  “It helps,” he says “if you consider the fact that the yield curve is really made up of two components.  One is investors’ projections of future short-term interest rates and the other is a risk or term premium.”

 

Since 1980, the three-month/one-month yield curve has given nine false recession signals.

The current curve (June 6, 2019) reflects market expectations that the Fed will incrementally (perhaps in four cuts) reduce rates by 75-100 basis points from the current 2.375% mid-point of the fed funds target range over the next 12 months.

The second component, the term premium, is the excess yield that investors require to commit to holding a long-term bond instead of a short-term bond. Low inflation and low inflation volatility have narrowed the term premium or even turned it negative.  This makes is much easier for the yield curve to invert without necessarily signaling rate-cut expectations consistent with a forthcoming recession.

“Both factors make it more likely that the current yield curve inversion is an even noisier signal than it has been in the past, lengthening the lead time between inversion and a potential recession,” Martini said.

 

Leading economic indicators and measures of broad financial conditions suggest the end of the current economic expansion is not on the horizon yet.

In the present circumstance, with a different monetary policy regime in place and different macroeconomic fundamentals prevailing, it is wise to consult other indicators that have been more reliable guides to cyclical peaks such as leading economic indicators (as represented by the Composite Index of Leading Indicators) and broad financial conditions (as measured by the Chicago Fed National Financial Conditions Index).  “Both currently negate the recession warning given by the inverted yield curve and suggest the end of the current economic expansion is not on the horizon yet,” Martini said.

Given the volume of the media coverage of the recent yield curve inversion, we thought you should know where we stand on the issue.

 

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future. Past performance is not a guarantee or a reliable indicator of future results.

Glossary of Terms

U.S. Treasuries are debt securities issued by the U.S. government and secured by its full faith and credit.

Fed funds are overnight borrowings between banks and other entities to maintain their bank reserves at the U.S. Federal Reserve (Fed). Banks keep reserves at Fed banks to meet their reserve requirements and to clear financial transactions.

Yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates. One such comparison involves the two-year and 10-year U.S. Treasury debt. This yield curve is used as a benchmark for other debt in the market, such as mortgage rates or bank lending rates. The curve is also used to predict changes in economic output and growth.

The Chicago Fed National Financial Conditions Index is a gauge of U.S. financial conditions compiled by the U.S. Federal Reserve Bank of Chicago. The index tracks measures of financial stress and tightness of credit markets

The Composite Index of Leading Indicators is an index published monthly by The Conference Board. It is used to predict the direction of global economic movements in future months. The index is composed of 10 economic components whose changes tend to precede changes in the overall economy. 

Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein. If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in this commentary are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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