"Kee" Points with Jim Kee, Ph.D.


  • What’s baked-in for the US Economy?
  • What’s baked-in for the world Economy?


What’s baked-in for the US Economy?

Is the Fed done raising rates, or at least done through 2019? The market seems to think so, as measured by the Chicago Mercantile Exchange’s “CME FedWatch Tool,” which calculates the probabilities of a rate high above the current 2.25%-2.50% target range using Fed Funds futures contract prices. A few research houses and Federal Reserve Branch Bank Presidents expect perhaps one hike this year, and a few others even expect rate cuts to begin, but I’d say consensus is for no rate hikes in 2019. In fact, there is some interesting (e.g. Stifel) research out there suggesting that, when one accounts for the 30-year downward trend in interest rates, the Fed is already at “neutral,” or the rate at which it is not distorting rates and markets. And I think the Fed is paying attention to this research. As I have mentioned previously, economic downturns typically don’t occur until after the Fed stops raising rates, and the maximum negative impact occurs over a year after the last hike. That relationship historically has been waning (i.e. getting weaker over time), but then again the current rate hike regime, which began at the end of 2015, is following an unprecedented seven years of zero percent rates. That could make the economy more sensitive to a given level of rate hikes. So the correct answer to the question, “What will be the impact on the economy this year of the rate hikes we’ve already had?” (i.e. “What’s already baked-in for 2019?”) is, “We don’t really know, we just have to watch the data.”


 

What’s baked-in for the global economy? 

This theme of ambiguity, for want of a better term, describes the outlook for the global economy as well. Global data has slowed since last summer, at least in the world’s largest economies like Germany, China, and Japan. A lot of this has been caused by ongoing uncertainty over global trade agreements (including tariffs), a headwind in 2018 that I think could turn into a tailwind in 2019. But there is something missing from the global trade discussion, and that is global capital flows. Free trade has both winners and losers, but generally the winners gain more than the losers lose. Obviously (?), a country is better off if its trading partner is large and wealthy than if it is small and poor (who in San Antonio drives past HEB to go grocery shopping in a small town with a single convenience store?). When an economy collapses or just enters into recession, some of the gains from trade are lost because that country imports and exports less. The volume of trade declines, just as would occur under a trade war. But there is an off-setting effect, which is that capital in the declining country(s) tends to flow towards the countries where opportunities are higher. And capital in those better-off countries that was slated to move abroad stays at home. This is a positive off-set for those stronger economies, and probably mitigates some of the negative impacts of the lost gains from trade. It might not fully offset them, but research does indicate that big downturns in one economy generally don’t result in downturns for all economies (HCWE Economics). That is, “contagion” effects are offset somewhat by capital flows. Now, measuring “capital” and “capital flows” is difficult (but fascinating), a topic for another day. The conclusion is that, as in the first paragraph, the answer to the question of how impacted the global economy will be from trade conflict that has already occurred is, “We don’t really know, we just have to watch the data.”