Slowdown ahead

Economic Trends 2019

American workers and businesses benefited from a strong U.S. economy in 2018.

The U.S. gross domestic product grew 4.2 percent during the second quarter, the highest quarterly growth for U.S. GDP since the third quarter of 2014. U.S. economic growth remained healthy during the third quarter at 3.4 percent.

The U.S. unemployment rate was at 3.4 percent in December, after reaching a 49-year low of 3.7 percent in November. The U.S. economy added about 2.6 million jobs in 2018, an increase of 17.9 percent from 2017. The U.S. added 312,000 of those jobs in December, exceeding expectations. Wages rose 3.2 percent in 2018.

The economy clearly seems to have benefitted from the $1.5 trillion tax cut approved by the Republican-led Congress and President Donald Trump in late 2017. Trump has also reduced numerous regulations in an attempt to boost the economy.

However, some economists are predicting that U.S. economic growth will slow in 2019. The Federal Reserve Bank of Atlanta estimates that GDP growth slowed to 2.8 percent during the fourth quarter.

Despite the strong U.S. economy in 2018, the stock market had its worst year since 2008. The Dow Jones Industrial Average fell 5.6 percent, the S&P 500 dipped 6.2 percent and the Nasdaq was down 4 percent.

Tariffs set by the Trump administration created challenges for some businesses in 2018. Trump remains in a significant trade confrontation with China. He has said the short-term pain from tariffs will pay off in the long run with more favorable trade deals, such as the United States-Mexico-Canada Agreement that would replace the North American Free Trade Agreement.

Meanwhile, Trump complained that the U.S. Federal Reserve’s interest rate hikes in 2018 were hurting economic growth. More rate hikes could be in store for 2019.

For more insight on what lies ahead for the U.S. economy in 2019, BizTimes Milwaukee editor Andrew Weiland conducted his annual macroeconomic interview with Michael Knetter, the president and chief executive officer of the University of Wisconsin Foundation. Knetter, a former staff economist for presidents George H.W. Bush and Bill Clinton, will once again be a speaker at BizTimes Media’s annual Economic Trends event on Jan. 25 at the Italian Community Center in Milwaukee.

BizTimes: There seem to be several signs pointing to a possible economic slowdown this year and several economists are predicting that, as well. How do you think the U.S. economy will perform overall in 2019? Do you also anticipate a slowdown? Why or why not?

Knetter

Knetter: “There is little doubt in my mind that real economic growth (production and employment growth) will slow down in 2019. The more uncertain issue is whether they will actually contract (i.e., whether the U.S. economy enters a recession). The growth we have enjoyed in 2017 and 2018 was due to a continuation of the slow recovery from the Great Recession as companies and households rebuilt their balance sheets and their confidence, augmented more recently by lighter regulation, corporate tax reductions and fiscal expansion. The slowdown in growth that I expect will result from a combination of factors, including the limited amount of spare capacity in the economy (the labor force cannot keep growing as fast now that nearly everyone is employed), higher interest rates (as the Fed seeks to get back to a more normal policy regime and reduce the possibility of a surge in inflation), slower growth in other economies, and greater uncertainty about international markets (which can reduce the incentive to sink capital expenditures because of confusion about where to locate).”  

BizTimes: There has been tremendous volatility in the stock market in recent months. Why? Do you expect that to continue in 2019? What is the stock market telling us about how the U.S. economy will perform in 2019?

Knetter: “As I write this, the markets have been chaotic and mostly downcast, while the production and employment side of the economy remains quite healthy, with real GDP growing at a 2 percent annual rate or more and the unemployment rate at an incredibly low 3.9 percent. This dichotomy will not last throughout 2019. Either the stock market will bounce back to some degree, or it will eventually pull the real economy into recession. Which will it be?

“In my opinion, 2019 is a year when sentiment will tell the tale. Dating back to (John Maynard) Keynes, economists have acknowledged that expectations about the future are important in determining actual behavior of economic decision-making units. In the current environment, the Trump administration, and President Trump himself, will have a disproportionate influence on what happens next. The administration made a number of regulatory and tax choices and judicial appointments that have given the economy a short-term boost. These decisions made people confident about the economic future and confident in decisions to spend and invest. That confidence can be self-fulfilling to some degree. 

“More recently, the balance seems to be shifting to decisions that are eroding confidence in the administration and the economic future. Among the particular decisions I would note include: departures of some highly regarded team members, such as (former chief of staff John) Kelly and (former defense secretary Jim) Mattis, who were believed to be top performers with good experience and judgment in key roles; the ongoing trade and geopolitical stress with China and other trading partners; the public harassment of Fed chairman (Jerome) Powell and the reversal of the harassment of Powell; and the Treasury outreach to bank CEOs when markets tanked. 

“It is easy to imagine people losing confidence in the administration and the economic future given the erratic behavior.  In many ways, it is surprising the market was performing so well given the greater degree of uncertainty most people have in the future of fiscal, trade and monetary policy resulting from the administration’s various pronouncements. 

“All that said, my guess today is that the markets have overreacted to noise and that we will see a partial recovery in equities early in 2019, and that recovery will be enough to keep the entire economy from slipping into recession. I think the administration cares deeply about preserving economic growth and that the instinct to do that will eventually guide them to better decisions in the conduct of fiscal, trade and monetary policy. And as market participants see those better decisions, equities will recover a bit and the momentum the economy has will carry through the balance of 2019, albeit with growth slowing over the course of the year.” 

BizTimes: Trade and tariffs were a big topic in 2018. President Trump announced trade deals with the European Union, Canada and Mexico and expressed confidence a new deal will be worked out with China. What impact have the tariffs instituted by Trump had on the economy? What impact will the new deals have on U.S. trade?

Knetter: “My view on trade in a nutshell is that free and open trade is good for both parties for the age old reason of the efficiency that results from specialization and division of labor. Of course, trade was not completely free. So there is an opportunity to improve the trade regime. I think we have made some improvements over the past year and we also have some setbacks remaining with China as we attempt to get to a better place. 

“Tariffs and other barriers to trade, and especially changes to the trade regime, are very disruptive in the short term. There is little ability to quickly adjust supply chains, and so we mostly get higher prices on everything affected. Nobody immediately adjusts production to a ‘trade war’ because they cannot know how long the war will last. This hurts investment spending. Firms don’t know where to locate until the dust settles on the trade war. The short-term effect is negative, but has been overshadowed by other things that have been pro-growth (e.g., other regulatory relief and tax cuts).” 

BizTimes: Trump has been critical of the Fed for raising interest rates. What moves do you expect the Fed to make in 2019 and how will it impact the economy? Will rising interest rates hurt home and car sales?

Knetter: “The Fed will follow the data, which has gotten much more interesting with the market decline. If the decline accelerates or persists, the Fed may be done raising rates already. I suspect the market will bounce back a bit and I look for another 25 basis point increase in rates during 2019. I do not think the Fed will get very far in reducing its balance sheet, either. The market does not seem able to absorb that reduction in Fed participation very easily and I expect the Fed to back off on that plan in the weaker economic environment I believe we will see in 2019.” 

BizTimes: General Motors recently announced plans to cut up to 14,000 jobs. Is that a bad sign for the broader economy, or just an indication of problems with GM itself?

Knetter: “I think that is a sign of problems with GM and labor costs in the U.S.” 

BizTimes: Wisconsin has a new governor in 2019. Gov. Scott Walker and his agenda were popular with much of the state’s business community. With Democrat Tony Evers coming in to replace him, and the Legislature still in Republican control, how will the changing political dynamics in Madison affect the state’s economy? 

Knetter: “I do not expect the change in the governor’s office to have a huge effect on the state economy as I believe Gov. Evers is getting good counsel and will have a healthy balance in his policy agenda (and as you note, will in any case face a Republican-controlled Legislature).” 

BizTimes: Meanwhile, in Washington the Democrats have taken control of the House. Divided government in Washington resulted in a partial shutdown. Is gridlock a good thing or a bad thing for the economy?

Knetter: “Gridlock at present is probably a good thing. As noted earlier, some pro-growth decisions have been made and implemented. A period of time without change might be good for the investment climate.”

BizTimes: This has been a long-running, if sometimes slow, expansion for the U.S. economy. Is that expansion finally nearing an end? Is a recession around the corner?

Knetter: “This recovery is indeed long in the tooth, but that doesn’t necessarily mean it has to end. Expect 2019 to be a year of slower growth, but not a recession, as the administration tries to stabilize itself and convert a few more modest wins to calm economic actors. As growth slows and people begin to shift attention to the fiscal imbalance we have created, which will become even more apparent as we roll over debt with higher interest rates, look for the sentiment on the U.S. economy to begin to sour and our vulnerability to recession to rise accordingly. My guess is we get through this year without a recession, but the likelihood of getting through 2020 without one is much lower.”

American workers and businesses benefited from a strong U.S. economy in 2018.

The U.S. gross domestic product grew 4.2 percent during the second quarter, the highest quarterly growth for U.S. GDP since the third quarter of 2014. U.S. economic growth remained healthy during the third quarter at 3.4 percent.

The U.S. unemployment rate was at 3.4 percent in December, after reaching a 49-year low of 3.7 percent in November. The U.S. economy added about 2.6 million jobs in 2018, an increase of 17.9 percent from 2017. The U.S. added 312,000 of those jobs in December, exceeding expectations. Wages rose 3.2 percent in 2018.

The economy clearly seems to have benefitted from the $1.5 trillion tax cut approved by the Republican-led Congress and President Donald Trump in late 2017. Trump has also reduced numerous regulations in an attempt to boost the economy.

However, some economists are predicting that U.S. economic growth will slow in 2019. The Federal Reserve Bank of Atlanta estimates that GDP growth slowed to 2.8 percent during the fourth quarter.

Despite the strong U.S. economy in 2018, the stock market had its worst year since 2008. The Dow Jones Industrial Average fell 5.6 percent, the S&P 500 dipped 6.2 percent and the Nasdaq was down 4 percent.

Tariffs set by the Trump administration created challenges for some businesses in 2018. Trump remains in a significant trade confrontation with China. He has said the short-term pain from tariffs will pay off in the long run with more favorable trade deals, such as the United States-Mexico-Canada Agreement that would replace the North American Free Trade Agreement.

Meanwhile, Trump complained that the U.S. Federal Reserve’s interest rate hikes in 2018 were hurting economic growth. More rate hikes could be in store for 2019.

For more insight on what lies ahead for the U.S. economy in 2019, BizTimes Milwaukee editor Andrew Weiland conducted his annual macroeconomic interview with Michael Knetter, the president and chief executive officer of the University of Wisconsin Foundation. Knetter, a former staff economist for presidents George H.W. Bush and Bill Clinton, will once again be a speaker at BizTimes Media’s annual Economic Trends event on Jan. 25 at the Italian Community Center in Milwaukee.

BizTimes: There seem to be several signs pointing to a possible economic slowdown this year and several economists are predicting that, as well. How do you think the U.S. economy will perform overall in 2019? Do you also anticipate a slowdown? Why or why not?

Knetter

Knetter: “There is little doubt in my mind that real economic growth (production and employment growth) will slow down in 2019. The more uncertain issue is whether they will actually contract (i.e., whether the U.S. economy enters a recession). The growth we have enjoyed in 2017 and 2018 was due to a continuation of the slow recovery from the Great Recession as companies and households rebuilt their balance sheets and their confidence, augmented more recently by lighter regulation, corporate tax reductions and fiscal expansion. The slowdown in growth that I expect will result from a combination of factors, including the limited amount of spare capacity in the economy (the labor force cannot keep growing as fast now that nearly everyone is employed), higher interest rates (as the Fed seeks to get back to a more normal policy regime and reduce the possibility of a surge in inflation), slower growth in other economies, and greater uncertainty about international markets (which can reduce the incentive to sink capital expenditures because of confusion about where to locate).”  

BizTimes: There has been tremendous volatility in the stock market in recent months. Why? Do you expect that to continue in 2019? What is the stock market telling us about how the U.S. economy will perform in 2019?

Knetter: “As I write this, the markets have been chaotic and mostly downcast, while the production and employment side of the economy remains quite healthy, with real GDP growing at a 2 percent annual rate or more and the unemployment rate at an incredibly low 3.9 percent. This dichotomy will not last throughout 2019. Either the stock market will bounce back to some degree, or it will eventually pull the real economy into recession. Which will it be?

“In my opinion, 2019 is a year when sentiment will tell the tale. Dating back to (John Maynard) Keynes, economists have acknowledged that expectations about the future are important in determining actual behavior of economic decision-making units. In the current environment, the Trump administration, and President Trump himself, will have a disproportionate influence on what happens next. The administration made a number of regulatory and tax choices and judicial appointments that have given the economy a short-term boost. These decisions made people confident about the economic future and confident in decisions to spend and invest. That confidence can be self-fulfilling to some degree. 

“More recently, the balance seems to be shifting to decisions that are eroding confidence in the administration and the economic future. Among the particular decisions I would note include: departures of some highly regarded team members, such as (former chief of staff John) Kelly and (former defense secretary Jim) Mattis, who were believed to be top performers with good experience and judgment in key roles; the ongoing trade and geopolitical stress with China and other trading partners; the public harassment of Fed chairman (Jerome) Powell and the reversal of the harassment of Powell; and the Treasury outreach to bank CEOs when markets tanked. 

“It is easy to imagine people losing confidence in the administration and the economic future given the erratic behavior.  In many ways, it is surprising the market was performing so well given the greater degree of uncertainty most people have in the future of fiscal, trade and monetary policy resulting from the administration’s various pronouncements. 

“All that said, my guess today is that the markets have overreacted to noise and that we will see a partial recovery in equities early in 2019, and that recovery will be enough to keep the entire economy from slipping into recession. I think the administration cares deeply about preserving economic growth and that the instinct to do that will eventually guide them to better decisions in the conduct of fiscal, trade and monetary policy. And as market participants see those better decisions, equities will recover a bit and the momentum the economy has will carry through the balance of 2019, albeit with growth slowing over the course of the year.” 

BizTimes: Trade and tariffs were a big topic in 2018. President Trump announced trade deals with the European Union, Canada and Mexico and expressed confidence a new deal will be worked out with China. What impact have the tariffs instituted by Trump had on the economy? What impact will the new deals have on U.S. trade?

Knetter: “My view on trade in a nutshell is that free and open trade is good for both parties for the age old reason of the efficiency that results from specialization and division of labor. Of course, trade was not completely free. So there is an opportunity to improve the trade regime. I think we have made some improvements over the past year and we also have some setbacks remaining with China as we attempt to get to a better place. 

“Tariffs and other barriers to trade, and especially changes to the trade regime, are very disruptive in the short term. There is little ability to quickly adjust supply chains, and so we mostly get higher prices on everything affected. Nobody immediately adjusts production to a ‘trade war’ because they cannot know how long the war will last. This hurts investment spending. Firms don’t know where to locate until the dust settles on the trade war. The short-term effect is negative, but has been overshadowed by other things that have been pro-growth (e.g., other regulatory relief and tax cuts).” 

BizTimes: Trump has been critical of the Fed for raising interest rates. What moves do you expect the Fed to make in 2019 and how will it impact the economy? Will rising interest rates hurt home and car sales?

Knetter: “The Fed will follow the data, which has gotten much more interesting with the market decline. If the decline accelerates or persists, the Fed may be done raising rates already. I suspect the market will bounce back a bit and I look for another 25 basis point increase in rates during 2019. I do not think the Fed will get very far in reducing its balance sheet, either. The market does not seem able to absorb that reduction in Fed participation very easily and I expect the Fed to back off on that plan in the weaker economic environment I believe we will see in 2019.” 

BizTimes: General Motors recently announced plans to cut up to 14,000 jobs. Is that a bad sign for the broader economy, or just an indication of problems with GM itself?

Knetter: “I think that is a sign of problems with GM and labor costs in the U.S.” 

BizTimes: Wisconsin has a new governor in 2019. Gov. Scott Walker and his agenda were popular with much of the state’s business community. With Democrat Tony Evers coming in to replace him, and the Legislature still in Republican control, how will the changing political dynamics in Madison affect the state’s economy? 

Knetter: “I do not expect the change in the governor’s office to have a huge effect on the state economy as I believe Gov. Evers is getting good counsel and will have a healthy balance in his policy agenda (and as you note, will in any case face a Republican-controlled Legislature).” 

BizTimes: Meanwhile, in Washington the Democrats have taken control of the House. Divided government in Washington resulted in a partial shutdown. Is gridlock a good thing or a bad thing for the economy?

Knetter: “Gridlock at present is probably a good thing. As noted earlier, some pro-growth decisions have been made and implemented. A period of time without change might be good for the investment climate.”

BizTimes: This has been a long-running, if sometimes slow, expansion for the U.S. economy. Is that expansion finally nearing an end? Is a recession around the corner?

Knetter: “This recovery is indeed long in the tooth, but that doesn’t necessarily mean it has to end. Expect 2019 to be a year of slower growth, but not a recession, as the administration tries to stabilize itself and convert a few more modest wins to calm economic actors. As growth slows and people begin to shift attention to the fiscal imbalance we have created, which will become even more apparent as we roll over debt with higher interest rates, look for the sentiment on the U.S. economy to begin to sour and our vulnerability to recession to rise accordingly. My guess is we get through this year without a recession, but the likelihood of getting through 2020 without one is much lower.”

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