Economic Perspectives - Risks to the 2020 Outlook

by Robert F. DeLucia,
CFA Consulting

Economist Summary and Major Conclusions:

• The US economy should perform better in 2020 than it did in 2019, but there are risks to the outlook. Most of the risks are associated with the age of the business expansion cycle, but others pertain to political and geopolitical factors.
• The current pace of job creation is well above the natural growth in the labor force and implies a steadily tightening labor market and accelerating growth in wages over the next year. Business surveys reveal that a shortage of qualified workers is the biggest problem for firms.
• The primary risk associated with rapid wage growth is a sooner-than-expected and more aggressive tightening of monetary policy by the Federal Reserve, increasing the odds of recession.
• Historically, the onset of recession has always been preceded by a marked deterioration in credit quality. Excessive optimism on the part of both lenders and borrowers results in risky lending, ultimately triggering a rise in delinquencies and defaults. Corporate sector finances are the greatest source of concern.
• The financial risk to the economy is clear: A perceived rise in credit risk will prompt lenders to curtail credit creation. Higher borrowing rates — resulting from a spike in credit spreads — will increase the difficulty for business firms to borrow.
• Continued strength in the US dollar would be a contractionary force for both the US and global economies, while dollar weakness would be a form of economic stimulus. Persistent dollar strength over the past two years has been a severe headwind for the world economy and for dollar profits.
• My forecast assumes that the value of the US dollar will gradually weaken over the next two years, thereby easing financial conditions worldwide. However, this outcome is far from assured. A further strengthening in the dollar would be a serious threat to growth, raising the odds of a global recession.
• The world economy has become more dependent upon China at a time when China is less reliant upon the rest of the world. A healthy recovery in global GDP in 2020 is predicated upon a sustained recovery in domestic demand within China.
• In turn, a sustained economic recovery in China is dependent upon the willingness of policymakers to deliver sufficient monetary and fiscal stimulus to revive domestic demand. Policymakers are constrained by excess debt levels and have been cautious in adopting an expansionary credit policy.

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