David Rosenberg, the head economist and strategist at Gluskin Sheff, said the chances of a recession are growing as the Trump administration’s tax cuts don’t help productivity and the Federal Reserve raises interest rates.
The S&P 500’s profit growth will slow to 10 percent in 2019 from 19.4 percent this year, according to the consensus estimate compiled by Thomson Reuters. The Fed Funds rate is forecast to reach 2.7 percent by the end of 2019, according to the median estimate by the Federal Open Market Committee, compared with a target range of 1.25 percent to 1.5 percent now.
“We will be seeing the lagged effects of the Fed tightening kicking in, with higher rates coinciding with an epic corporate debt refinancing calendar,” Rosenberg said in a March 13 report obtained by Newsmax. “Recession is a high likelihood for next year.”
The Fed and the market aren’t prepared for such a possibility, Rosenberg said, pointing to research from the Federal Reserve Bank of San Francisco.
“As of February 2018, the estimated recession probability is 11 percent, which is elevated but comfortably below the critical threshold given that the term spread is not yet close to zero,” the San Francisco Fed said last week in its economic letter.
President Donald Trump last year approved tax cuts intended to boost the economy by giving workers more take-home pay, and making the corporate tax system more competitive with other countries as a way of encouraging investment. But because the government isn't cutting spending by a commensurate amount, the budget deficit is likely to exceed $1 trillion in the next fiscal year.
“The ongoing bullish talk about deficit-financed tax cuts is really unnerving,” Rosenberg said. “When spending growth is spiraling upwards as it is in the USA, a tax cut package that boosts the public debt is akin to an individual tapping his/her credit card and accounting for that as income. Rising government deficits and inflated P/E multiples generally do not go hand-in-hand for very long.”
Rosenberg sees the U.S. Treasury under greater pressure to finance deficits with bond sales, whose rates are rising to attract buyers. A $29 billion auction of three-year Treasury notes had the highest yield since 2007, before the last recession.
The Trump administration is also more protectionist, which may dissuade foreign countries from purchasing U.S. debt and support the dollar so that American consumers can keep buying imported goods. Last week, President Trump approved tariffs of tariffs of 25 percent on steel imports and 10 percent on aluminum, leading to threats of retaliation from trade partners.
“We have an administration dedicated to eliminating the capital account surplus as it chases fiscal deficits to levels unprecedented in the context of a non-war, non-recessionary environment,” Rosenberg said. “And sorry, there is no construct either in theory or in practice that leads to anything here except higher interest rates.”
Rosenberg said productivity growth is not getting enough attention as a driver of long-term prosperity, and it’s not clear that tax cuts will drive greater investment.
“Maybe it goes into bonuses, dividend payouts or stock buybacks,” Rosenberg said. “None of these boost productivity….The difference between borrowing for a tax cut and actually generating improved productivity growth – meaning a greater focus on education, skills and human capital which would bring greater and more durable income growth – is rather considerable.”
Ultimately, the government needs to consider spending cuts, especially if the Fed can’t be counted on to buy up federal debt as it did with its trillion-dollar quantitative easing programs aimed at keeping interest rates low to stimulate borrowing and spending.
“Today’s tax cut will inevitably morph into a future tax hike by some future government,” Rosenberg said. “Without some fundamental reforms to ‘entitlement spending,’ which the president has already said is off the table, the current fiscal stance is simply on an unsustainable path – and one that does pose risk to the interest rate landscape.”
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