Savannah Chamber

9 3 bonds relative to short-term bonds pushes long-term rates below short-term rates. In essence, an inverted yield curve indicates that bond market participants and others expect a recession – or at the very least a slowdown in GDP growth that approaches the economy's stall speed. It also suggests that monetary policy is too tight. The 2019 inversions warned the Federal Reserve that it made a policy mistake by raising policy interest rates too high given the escalation of the U.S.-China trade war. In 2019, the Federal Reserve reversed its policy stance by cutting policy interest rates and ending the reduction in the size of its balance sheet – quantitative tightening. The problem is not with monetary policy, it is with trade policy. In 2020, the Federal Reserve's monetary policy stance will support growth. The Federal Reserve will keep short-term policy interest rates below the rate of inflation. For example, we expect the federal funds rate target to fall to 1.5 percent by December 2020. Inflation will be 1.7 percent. Real interest rates will be negative. Cumulative easing over 2019-20 will be 100 basis points. There is also a good chance that the Federal Reserve will expand the size of its balance sheet in 2020 due to both recession fears and heavy Treasury issuance. In addition to signaling that a recession is coming, the yield curve inversion itself can contribute to recession because it discourages creditors from lending because they can no longer make money by borrowing short and lending long. Credit growth is vital to the growth of the modern economy. Any contraction in credit reduces the prospects for economic growth. On average, an inverted yield curve leads a recession by 15 months, but a reasonable range is between six and 18 months. An inverted yield curve is a good, but not a perfect predictor of recessions. There is speculation that the 2019 yield curve inversions are not as reliable a signal of recession as in the past because of international arbitrage in the bond market that is driving down U.S. yields without regard to economic conditions in the U.S. It is also argued that the Federal Reserve's policy of quantitative easing increased demand for long-term treasuries relative to short-term treasuries, which flattens the yield curve and therefore makes inversions more likely. Both arguments have some merit, but an inversion probably is still relevant today, at least with respect to signaling a substantial slowdown in growth if not an outright recession. In summation, the inverted yield curve is a red flag and it appears that the Federal Reserve took notice. Monetary policy has shifted to stave off or battle a 2020 recession. A monetary policy mistake is unlikely to trigger a recession in 2020. To the contrary, the Federal Reserve's shift from a slightly restrictive policy stance in 2018 to a stimulative policy stance in 2019-2020 will help offset some of the economic damage inflicted by the trade war. Due to the trade war, past appreciation of the dollar, and slower foreign economic growth, exports will grow slowly in 2020. Due to the trade war, lower confidence, and less business investment, imports also will grow slowly in 2020. Nonetheless, imports probably will grow faster than exports, causing net exports to subtract from U.S. GDP growth. The 2020 subtraction probably will be larger than in 2019. With the economy operating close to full employment – albeit not as close as in 2019, below-trend levels of foreign immigration over the last few years will limit the potential for U.S. GDP growth in 2020 and beyond. The stricter enforcement of U.S. immigration laws will be a headwind for GDP growth, especially in states such as Georgia that traditionally benefited economically from high levels of illegal immigration. Single-family housing starts will increase moderately due to very low mortgage rates, recent increases in the prices of existing homes, very low vacancy rates for apartments, rent increases that continue to outpace both inflation and income growth, population growth, and a slight uptick in the rate of household formation. It will help that there are not too many new single-family units in the development pipeline, especially with respect to low- and mid-priced homes. Indeed, low- and mid-price homes will be the sweet spots in the 2020 housing market. In contrast, the 2019 development pipeline is chock full of new apartments, which may cause new apartment construction to decline in 2020. Even so, apartment vacancy rates are quite low and given the turmoil in the equity markets investors may be seeking income-producing assets. Those favorable factors will limit any decline in new apartment construction. Sub-par productivity growth is another factor that will hold down GDP and personal income growth. Sub-par productivity growth reflects many short- and long-term developments; (1) tariffs and other restrictions on foreign trade, (2) low levels of business investment, (3) the aging of the U.S. population, (4) less foreign immigration – especially restrictions on the movement of highly trained people to the U.S., (5) the plethora of regulations at every level of government, (6) the inevitable repercussions of many years of mediocre gains in educational achievement, and (7) the lagged effects of underinvestment in the nation's major research universities.

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