Global Reflation and the Trump Swerve
Commodity prices accelerated in the early 2000’s, encouraging the development of new supply and feeding capital investment globally. Very high commodity prices and the global financial market crisis led to significant demand destruction through the early years of this decade. With demand destruction came a downward reset in commodity prices, making high marginal cost production unprofitable. The stall in business investment fed back into demand destruction, pushing the U.S. economy to the brink of recession by the end of 2015. With commodity markets gradually rebalancing, in the presence of still highly accommodative monetary policy, the world is now reflating. U.S. demand upshifted in the third quarter of 2016, and looks set to continue in a higher gear for at least a few more quarters. China is catching a second wind. After revision, Japan GDP data looks better. European economies look stronger despite the ongoing political stress. The U.S. money supply, M2, is surging, up 7.8 percent in November on a year-ago basis.
Commodity prices are once again on the upswing. Wages are going up. Interest rates are still low as central banks respond to new conditions slowly. The global economy is reflating after a catastrophic loss of cabin pressure eight long years ago. The weak global economic recovery contributed to a rejection of the political status quo on both sides of the Atlantic. Now, as President-elect Trump prepares to take office under a mandate of change, the U.S. economy is already under the influence of the Trump Swerve. Equity markets jumped in November, and have not looked back. Measures of business and consumer confidence have surged. Anecdotal evidence suggests that businesses are set to accelerate capital spending in 2017.
The incoming administration has promised a lot. Healthcare reform, tax reform, fiscal stimulus and regulatory rollback are all expected, and soon. Major corporations have altered significant investment decisions under threat of tweet. Most policies expected of the Trump administration will support near-term growth and tend to increase inflation. With wages climbing, commodity prices up and very low inflation expectations threatening to unhinge, the Federal Reserve has ramped up the dot plot, showing upwardly revised expectations for interest rates. The dots now signal three rate hikes for 2017. If inflation warms up quickly, there may be more than three. So there is potential for a monetary offset to the Trump Swerve, in the form of higher interest rates. Fortunately, with interest rates still ultra low, the threat of interest rate drag on the U.S. economy is distant. Another key downside risk comes from rapidly inflating expectations for the stock market. The Trump Bump may morph into the Trump Slump if the administration fails to deliver this spring on the supercharged rhetoric of the 2016 political season. Trade is also a downside risk for 2017, both from the strong dollar and from the apparent potential for heavy-handed deconstruction of trade agreements.
Timing is everything. We believe that the Trump Swerve will position the U.S economy to catch a favorable tailwind from global reflation. As the threat of a near-term U.S. led recession recedes, businesses will recalibrate and extend the current expansion into the history books. At 90 months, the business cycle catches its second wind. Stronger growth, more inflation, higher interest rates and slower job creation are in store for 2017.
For a PDF version of the complete Comerica U.S. Monthly with additional commentary, tables, and charts, click here: USEconomicOutlook0117.