The United States economy will look about the same in 2020 as it did in 2019, but will improve in 2021. International trade presents the greatest uncertainty to the economic outlook, and if that clears up, 2020 will be even better.
The demand side of the economy will be a little subpar, giving a small break to the supply side. When spending improves, the supply limitations of low labor force growth and middling productivity growth will return to play. As the demand-supply imbalance grows in 2020, inflationary signs will increase, prompting the Federal Reserve to begin slow, gradual snugging of short-term interest rates.
Economic Forecast 2020-2021
Dr. Bill Conerly, with historical data from Bureau of Economic Analysis
With that summary in place, we turn to the largest component of spending, consumers. In the aggregate, households are growing their incomes a little more than they grow their spending. As a result, the savings rate is moving upward slowly. That’s ideal, as a higher savings rate puts the economy on a more sustainable path, but a sudden shift to higher savings could trigger a recession.
The growth of income and spending has not been as great this past year because job gains are lower. That, in turn, results from the tight labor market. Businesses would hire more if they could find additional qualified workers. Wages have not risen much, so the income growth rate is lower than back in 2018. However, the jobs picture is solid, leading to good incomes and a positive attitude among most consumers. Look for them to continue growing their spending moderately next year and into 2021.
Disposable income and consumer spending growth rates
Dr. Bill Conerly from Bureau of Economic Analysis data
Construction has been flat the last few years. On the residential side, low population growth translates into few new houses needed. Nonresidential construction is a mix of stronger (power production and healthcare) and weaker (retail). Public sector construction has gained a little thanks to state and local road-building, but no big stimulus is in the works. Overall construction will be flat in the next two years, though private nonresidential will start edging up in 2021.
Business capital spending declined in the third quarter of 2019 after two flat quarters. Companies are replacing what needs to be replaced, without thinking too much about future growth. The precursors of robust capital spending are in place: economic growth and low financing costs. Those low costs come from corporate cash, which is pretty strong, as well as low interest rates. The current decline in capital spending results from uncertainty related to international trade negotiations. Business supply chains are far more complex than most politicians understand, and monkeying around with trade rules throws significant uncertainty into sourcing products, leading many executives to wait and see what is going to happen. And this wait-and-see attitude dampens spending.
The weakest part of the economic outlook is inventories. Inventory-sales ratios are
Inventory/sales ratio for manufacturers, wholesalers and retail companies
Dr. Bill Conerly from Census Bureau data
elevated. When companies eventually trim excess inventories, they will sell products without fully replenishing their shelves. One dollar of spending will only generate 95 cents worth of replacement production. The inventory correction will put a damper on the economy early in 2020, but once done will have no lasting consequences.
International trade volumes will be low, which is a global trend, with more reduction in imports to the U.S. than exports. Worldwide trade is flat despite continued economic growth. Part of this is services growing more than merchandise sales. The other part is that during times of uncertainty about international trade rules, companies source more inputs in their home countries rather than from foreign suppliers. In addition, the dollar is ten percent higher on foreign exchange markets than it was a year ago, making our exports more expensive to overseas buyers. Our imports, of course, are cheaper in terms of greenbacks. The dollar is unlikely to reverse course unless other major economies show more economic strength, or the Fed eases significantly more. Neither of these possibilities seems very likely.
Federal government spending has been the fastest-growing part of the economy this year, as nobody in Washington seems concerned about the budget deficit. Until some fiscal discipline emerges, this forecast anticipates even more spending.
Rolling these parts of the economy together yields economic growth of 2.6 percent in 2020, about where 2019 is likely to end up when all the statistics are tallied. Then 2021 looks better, but comes up against the supply constraints. That limits growth to 2.9 percent, based on how much labor force expansion we can get and some productivity gains likely with more capital spending.
Inflation has been quite restrained so far in 2019, but will edge up slowly as the economy continues to expand.
Forecast of Federal Funds rate and 10-year Treasury bond
Dr. Bill Conerly with historical data from the Federal Reserve
The Fed will see more risk from inflation than recession and begin raising short-term interest rates. The Federal Funds rate, currently around 1.55 percent, will rise to about 2.30 percent by the end of 2021, not too much of an increase. Long term rates will move up faster thanks to global economic growth.
The risk of recession is worthy of a separate article, which will be published soon. On the upside, resolution of our international trade disputes would be a positive for business capital spending. If, at the same time, more people who have not been working nor looking for work choose to start job searches, increasing the labor supply, economic growth could approach four percent a year. That combination of events seems unlikely, but companies should ponder what obstacles to growth they would face if we get lucky. Being able to capitalize on good luck cannot be taken for granted. Does the company have adequate capital, staff and equipment to ramp up sales? Sometimes cheap and easy fixes can be made ahead of time to ensure the capability to seize growth opportunities.