What to Expect Economically in the Near-Term for the US
Persistent political uncertainty in the United States, both domestic and cross-border, is impeding the execution of growth-friendly policies and restricting investment by businesses, prompting a downgrade in outlook by Dun & Bradstreet’s executive economists from ‘stable’ to deteriorating, according to our latest Global Risk Matrix. Yet, the fundamentals of the US economy remain robust, justifying consistency in our current overall rating of DB2a*; only three countries are ranked higher than the US in the 132-country Dun & Bradstreet universe. However, the Political Environment Outlook component of the overall rating remains firmly in red (downgraded from amber in March). The downgrade in the outlook points to a possibility that the overall rating is likely to be revised downward in the near term, unless the headwinds to the operating environment moderate.
Current Domestic Impediments to US Growth
The economy received short-term reprieve from the Congress on September 8, when the House overwhelmingly voted to approve a package to provide more than USD15B in disaster aid for victims of Hurricane Harvey, raise the debt ceiling and fund the government for three months. On the surface, this looks like progress in Washington and seems to curtail a potential government shutdown scheduled for October; however, this only postpones the debt ceiling debate (and the threat of a government shutdown) to December. Yet, the measure passed by a vote of 316-90 with every one of the 90 opposing members being Republicans. This exposes divisions within the President’s own party and highlights the difficulties with smooth passage of pro-growth reform despite a Republican majority in both houses of Congress. Republicans are particularly unhappy with this package as President Trump negotiated a deal with Democrats to compromise on the short-term debt limit; leaders of the Republican Study Committee, a collection of more than 150 conservative House members, openly opposed the deal as fiscally irresponsible.
Importantly, this political division significantly reduces the chances of a quick or smooth passage of tax reform measures that the White House is keen on implementing. Republicans are likely to argue that the tax rate should be cut (the President has proposed 15%) and address how to offset the fiscal cost of the consequent drop in revenues. Businesses in the US have been looking forward to tax reform since last November, as evidenced by the high business sentiment; they have been patient with the lack of details and actionable insights so far. But at the same time, this lingering uncertainty prevents them from undertaking additional investments- investments that the economy would otherwise encourage. Further, the longer the fiscal boost (in the form of tax cuts) is delayed, the less effective it becomes as the economy will be much closer to (or at) full-employment over the next few months.
Continued Global Geopolitical Uncertainty Raises Risk
Geopolitical uncertainty threatens to spill over into longer run trade policies of the US, especially in the Asia-Pacific. The US took one more step towards a diplomatic solution of the North Korea threat when the United Nations Security Council unanimously adopted new, more stringent economic sanctions on the regime, aimed at cutting off its sources of economic support. However, the actual sanctions passed fell short of the US’s original proposal of much stricter sanctions, including a complete ban on exports of oil to North Korea. A UN report has recently found that sanctions on North Korea have so far had limited impact due to non-compliance from other member countries.
Against this unsettled regional backdrop, President Trump has proposed pulling out of a major trade deal with South Korea, alleging that the US ally has benefited disproportionately from the deal with limited gains for US companies. It is likely that the administration will soften its stance and work toward a renegotiation of the trade pact, but a complete withdrawal could undermine US hegemony in the region, especially given the threat from North Korea. In fact, officials from the US, Canada and Mexico have just begun renegotiating NAFTA, which the President had initially threatened to quit, but later opted in favor of a rewrite of the rules. The NAFTA discussions will be closely watched by the rest of the world as they will offer signals on the eventual trade policy stance of the Trump administration.
The biggest regional dynamic, of course, is the evolving nature of US-China trade relations. Although President Trump has backed away from his pre-election proposal of 45% tariffs on imports from China, the current administration is taking a closer look at alleged violations of US trade laws by China. Earlier, in mid-July, the two governments failed to agree on new steps to reduce the US trade deficit with China; the US government has also been seeking greater access for US companies into key Chinese markets. More recently, in early August, the US Commerce Department imposed preliminary countervailing duties on imports of aluminum foil from four Chinese companies, alleging “injurious dumping and unfair subsidization”. In recent months, the US has also suggested imposing restrictions on import of steel from China (and other countries) to help revive the US steel industry facing a glut of cheap steel imports. Complicating future US-China ties, trade relations could depend on how much diplomatic cooperation the US receives from China on the North Korea sanctions.
The Murky Economic Outlook within the US
With measurable support from fiscal policy not expected to kick in until early 2018 at the earliest, the US Federal Reserve remains on track with its monetary policy normalizations plans. But recent data, and events, have reduced the chances that the Fed will be able to implement one more rate hike in the remainder of 2017 as previously intended. The Fed has a dual mandate of “maximum sustainable employment” and price stability in the form of 2% inflation. Based on solid hiring in the labor market, the first mandate of the Fed is being met currently. The unemployment rate is at its lowest in more than 16 years and is already at the Fed’s year-end projected value of 4.3%. Even if we assume other hidden sources of slack in the labor market and look at broader definitions of unemployment, we are still very close to full-employment and firmly on track to it with current rates of hiring. The labor market is not the source of any potential dilemma for the Fed. But even this very tight labor market is not doing enough for the inflation part of the mandate, as the strength in hiring has not resulted in faster wage growth; that points to the underlying weakness in productivity, a structural problem that has no immediate fix. Nevertheless, it contributes to already weak consumer price inflation, which has consistently fallen short of the Fed’s 2% target in the last few months. Central bank officials have argued that part of this weakness is due to transitory factors and increasing inflation, but time is running out for inflation data to improve for the Fed to justify a December hike.
Two other factors will dictate whether the Fed can raise rates in December. The first factor being the debt ceiling and government shutdown debate will renew in December, and has the potential to roil markets, pushing the Fed on to the backfoot. The second factor is the twin strikes by hurricanes Harvey and Irma will also contribute to an unsettled data environment that the monetary authorities will have to navigate carefully to optimize the timing of the rate hike. The humanitarian cost of the devastation aside, the storms will cause a temporary hit to GDP in Texas and Florida, which is likely to show up in national GDP data as well. How quickly the two states bounce back depends on the reconstruction process, but if growth is weakened significantly, it will give the Fed one more reason to pause, and wait for the rebound in activity. Inflation data will also be murkier in the near term; gas prices nationwide have already seen a spike due to Harvey’s impact on US refining capacity. Energy prices will settle down to a more modest longer run trend once refineries get back to normal operations. But prices of construction materials needed for rebuilding the disaster will also rise, reflecting increased demand.
When the dust settles, the growth path of the US economy will be very little changed, but increased data fluctuation in the near term could alter the timing of the Fed’s next move.
*Dun & Bradstreet’s Country Risk rating provides a comparative, cross-border assessment of the risk of doing business in a country. The risk indicator is divided into seven bands, ranging from DB1 to DB7. Each band is subdivided into quartiles (a-d), with ‘a’ representing slightly less risk than ‘b’ (and so on). Only the DB7 indicator is not divided into quartiles.