About this episode:
After a strong 2017, 2018 seems poised to follow suit. But there are a few areas to watch as the new year gets going. Zions Bank Senior Vice President and Economic and Public Policy Officer Robert Spendlove talks about where the economy is now, and what to expect from the year ahead. Read more about this topic in our article, “Economic Outlook 2018.”
[The following has been edited for grammar and clarity.]
Lisa Christensen: Hello and welcome to UB Insider. I’m Lisa Christensen, online editor at Utah Business magazine. 2017 was filled with news, to put it lightly, a lot of which was about the economy. From rising stock prices and a burgeoning economy to fears about trade deals and things in the future, it was a fairly wild ride. 2018 looks to follow suit. Here with us to talk about that is Robert Spendlove, senior vice president and economics and public policy officer with Zions Bank. Welcome.
Robert Spendlove: Thanks for having me.
Lisa Christensen: Briefly tell me about some of the highlights of what happened to the economy last year and where we are now.
Robert Spendlove: 2017 was a really interesting year. You almost have to go back to 2016 to really set the stage for 2017. It was really defined by the election of Donald Trump. Leading into the election there was an expectation that we were going to see a Hillary Clinton presidency. Everyone expected that to happen. Everyone kind of priced in a Clinton presidency which would have been very similar to an Obama presidency.
On Election Day everyone was surprised by the election of Donald Trump. That changed people’s expectations pretty fundamentally. With a Clinton presidency we would have had a focus on social issues, on bringing people out of the shadows, of redistribution of wealth, very similar to an Obama presidency. But with a Trump presidency, that focus shifted to essentially growing the economy. Trump made his top economic policies: trade, renegotiating our trade deals, changing the Affordable Care Act, redoing the tax system in America and regulatory reform. His aim was to do all of those with the goal of growing GDP and growing the economy.
The day before Election Day the DOW was right around 16,000. During 2017 the DOW broke through that level and has continued to break through higher and higher levels. Just recently the DOW broke through 26,000. So we’ve gone from 18,000 before Election Day to around 26,000 today which is a 44% increase in equity markets. That’s been driven by a big increase in consumer confidence, a big increase in business optimism and expectations of higher economic growth going forward that are all tied to this new agenda.
Lisa Christensen: Right, so as we’re coming into 2018 we’re seeing some of the things that were started in 2017 come to light. Some of the trends that started last year or in late 2016 have started to affect things. I know one thing that is on a lot of people’s minds is what the Fed is doing and is planning to do in regards to interest rates, correct?
Robert Spendlove: It’s really tied to this overall economic picture. The Trump administration was not successful in repealing the Affordable Care Act, but they were successful in passing a huge tax reform bill. There is a $1.5 trillion cost on that, but their theory is that the dynamic impact will cause the economy to grow much more quickly. They also built in a repeal of the individual mandate that forced everyone to buy health insurance or essentially be fined by the government. So we’re already starting to see some of those dynamic impacts from the tax reform plan.
We’ve seen Walmart raise their minimum wage to $11 an hour. Citigroup and J.P. Morgan both raised their minimum wage to $15 an hour. We’re seeing a lot more pressure on all businesses to have higher wages.
The increase in economic data started in the second quarter of 2017 where we saw GDP start to jump. It’s now, on a quarterly basis, coming in around 3% up from about 1.5-2% a year earlier. Job growth has continued to increase. The unemployment rate has dropped down to 4.1% which is extremely low. We’ve been waiting to see when this would turn into the two things that the Fed really cares about. They have what is called a dual mandate. They care about full employment and they care about stable inflation.
The Fed has specifically targeted 2% inflation. When we look at the employment side, the unemployment rate, the natural or full employment level in the U.S. should be at 4.6%. We’re currently at 4.1%. So we’re below that level. And what happens when you get below that 4.6% is that as you get further and further down it starts to create wage pressure. It starts to create inflationary pressure.
The struggle that the Fed has had up until now is that the very low unemployment rate has not yet turned into higher wages or higher inflation. In fact, inflation has been under the Fed’s target. The core inflation rates have been around 1.5%, which is below that 2%. But the Fed fears, and we may start to see this going into 2018, that there’s going to be a pop in wages and a pop in inflation. We may actually start to see some overheating in the economy. It may start to grow too quickly. We may start to see wages increasing too quickly and inflation raising too quickly.
Right now the Fed has committed that they’re going to raise rates three times in 2018. They raised rates three times in 2017. Usually when they meet they raise rates by 25 basis points. So we should expect to see rates that are about 1% higher by this time next year. Now if the economy starts to overheat as they’re fearing then we could see the Fed getting more aggressive and raising rates even quicker.
Lisa Christensen: So when you say the economy overheating, what do you mean? What does that do?
Robert Spendlove: The Fed tries to maintain a level but increasing growth. They don’t want to have the wide fluctuations that we saw for back in the Great Depression where we had huge increases in the 1920s and then huge drops in the 1930s. They try to even those swings out a little bit.
Lisa Christensen: So kind of a stable slope?
Robert Spendlove: Exactly. Upward sloping, but no big swings. Those big swings can turn into real economic pain where we have unemployment rates of about 20% or inflation in the double digits. The Fed has been pretty aggressive over the last 20 years in actively steering the economy. And they did that coming out of the great recession of 2008. The Fed dropped interest rates from around 5% to essentially zero. The message that sent to the market was, do not save money.
If you put money in a traditional savings account or a CD or a money market it’s not going to pay you anything because they dropped the rates so low. The message to investors is, don’t put your money in the bank, put your money in investments such as the stock market, real estate, or other more speculative investments. So that’s what people did. So what’s the result? It’s as we talked about. The stock market is up dramatically. The real estate market is up dramatically. We’ve seen big increases in home prices and apartment prices and commercial real estate.
The Fed is starting to get nervous that their very accommodative monetary policy may be creating bubbles. We’re already seeing signs of some of these bubbles in cryptocurrencies. Cryptocurrencies have been way up this year and now we’re starting to see a pretty major correction. Now that’s such a small sliver of the market that we’re not too worried, but what if the overall stock market is also in a bubble? What if we see a 20% or 30% correction? Remember, I said the DOW is up 44%. So it’s not out of the question to see a drop of 20-30%. The Fed is trying to head that off and slow down some of that speculation and bring the economy back into the middle ground again. But as we’ve seen many times in our history, it’s really tough to do.
Lisa Christensen: Right. And you’ve said before that sometimes the Fed will even try to push the economy into a slight recession to avoid a larger downturn.
Robert Spendlove: Exactly. The Fed is more worried about the job market. They’re more worried about long-term inflation and that overall stability. It’s a really technical term, but the actions of the Fed can be measured by something called the yield curve. The yield curve looks at what bonds pay at different maturity rates. These days the Fed primarily operates in the overnight market. The federal funds rate is the rate that the banks charge each other for overnight loans to maintain liquidity. That is what the Fed has impact on.
As you move out to longer term loans or bonds those interest rates tend to go up because there is greater associated risk. And then you can get a two month, a six month, a two year, a five year, or a ten year all the way up to a thirty year mortgage. Traditionally the very short term rates should be low while the higher term, like, thirty year loans should be higher than that. But remember, the Fed only controls that very short term. So if they get aggressive in raising those interest rates because their focus is on employment, inflation and wages, then it can actually cause the short term rates to be higher than the long-term rates. That’s when that yield curve inverts. And generally when that happens it will cause the economy to slip into a recession. The Fed would rather see a small recession happen that they can manage than another bubble popping like we saw in the recession of 2008.
Lisa Christensen: So it’s looking likely that we will go into a recession. But that’s not necessarily a bad thing, right?
Robert Spendlove: Exactly. One of the things we know about the economy is that we go through expansions and contractions. And that’s a natural part of any economy. So a recession by itself isn’t necessarily a bad thing. It can actually strengthen strong businesses. It can kind of reset the economy.
When you look at our national economy, we’re about eight and a half years into our expansion. That makes it the third largest expansion in the past century. So we’re in one of the longest expansions in a long time. If you just look at the data, we’re due for a recession. Now I don’t see the signs of it happening in 2018, but we are starting to see some signs of slowing down. It’s very clear that we’re in the late stages of our expansion.
Maybe in the next 12-24 months we’ll start to see more signs that we’re approaching a recession. The Fed may actually guide the economy into that if we see too high of inflation or those bubble situations getting too dramatic. But the Fed’s goal is to make sure that if and when we go into our next recession, that it’s kind of a controlled recession. They will try to make it as quick and as painless as possible to hit reset on the economy and prepare for the next expansion.
Lisa Christensen: So yield curve aside, what are some other things that people need to be on the watch for or aware of in the coming months?
Robert Spendlove: I think that there’s a lot of things that we’re watching really closely. I’m watching the housing market, but more specifically, the value of new residential construction. So the United States population is growing strongly. Specifically, the state of Utah is seeing very strong population growth. We’re the third highest in the country. Our net migration is still very strong with around 22,000 people moving into Utah last year. Our overall natural increase is around 50,000 a year. So we have really strong fundamentals. That creates good household formation.
The demand for housing has been very strong, which has also been a nationwide trend. What we’re starting to see is that we may have become a little bit overextended on our building. The value of new construction has gone up pretty significantly. We’re now above where we were pre-2008. So if interest rates continue to go up, it will make the borrowing costs go up as well.
On a $300,000 house, if the interest rate is 1% higher, you could see your monthly payments go up by $300 a month. That could have a significant impact on people’s finances. We won’t see the demand for homes dropping, but maybe the kind of homes they’re building will go down a little bit. We’re already starting to see it in some of the really rich markets. The New York and San Francisco markets are already starting to see some weakness on the high-end and we may start to see that happening nationwide as well.
Lisa Christensen: So when you have houses and some of them are in varying amounts of value, for example, you’ll see more demand for the middle and lower end ones than the higher end ones? Is that correct?
Robert Spendlove: Yep. And we’ve already started to see some signs of that in the Utah market. I was talking to a property assessor recently and they were saying that a year ago the high-end homes were sitting on the market for about a week or two. Now that has extended out to about a month. So we’re starting to see those markets slow down a bit. It’s not quite as hot as it was a year ago. Now this is not a bad thing. I think we were probably a little bit overheated in that market for a while.
One of the biggest struggles we’ve been having nationwide as well as throughout Utah is as housing prices go up, it’s great if you own a home. But what if you’re trying to get into a home? What about the person that just graduated from college or the family that just got married and is just starting off? For those individuals it gets really tough to get into the housing market if prices go up too much. That’s why we’ve seen such a big increase in the building of apartments, but even apartment rents are starting to get a little bit out of control, especially in those hot markets. Utah County specifically is seeing big increases in not only their housing market but also their apartment market.
Lisa Christensen: Is there anything that we have to worry about more or less than the rest of the nation here in Utah for this coming year?
Robert Spendlove: You know, Utah is such a strong market right now. We are number one in the country for employment growth. We are number three in the country for population growth. So our biggest struggle is just dealing with all of the growth. It’s a good problem to have. I’d much rather be in Utah than in Michigan or Ohio where a lot of their struggles are out-migration. But when you’ve got very strong employment and population growth it does create struggles to keep up with infrastructure needs. We’ve got to have a strong focus on building roads, building water systems, building electrical systems and building our cell network. Those are all things that we need to be looking at.
I forgot to mention education. We’ve got a huge influx of kids coming into the system every year and we’ve got to put the investment into education to be able to continue to prepare students for the future. That brings in another one of the long-term struggles that Utah is experiencing Because we have such high employment growth and we have a very low unemployment rate we are starting to see a lot of labor shortages. In the past it was really just in the hot markets like software or healthcare, but now we’re starting to see that spread out into more and more markets. It’s becoming more difficult for employers to find the people that they need.
Labor shortages, if they get too big can actually constrain overall economic growth. An employer may want to grow by ten employees but they can’t find ten people to fill those jobs. That may actually slow down their growth plans. And so that’s a struggle that we’re going to have. A way that we deal with that is by addressing education. We’ve got to do a better job of educating students and preparing them for the needs of the workforce. We’ve got to have better workforce alignment and give children the tools that they need to succeed.
Lisa Christensen: Alright, well it sounds like it’s a good economic outlook for the next year, but we’ve got to prepare for the future. Is that right?
Robert Spendlove: Exactly. That’s definitely true.
Lisa Christensen: Well thank you so much for coming in today. I really appreciate it.
Robert Spendlove: I’m happy to help.
Lisa Christensen: And thanks also to Mike Sasich for production help. You can read a little more about the economy in a related story in the January issue of Utah Business magazine. You can also find out more about us on social media at @utahbusiness or on UtahBusiness.com. Drop us a line at email@example.com. Thanks for listening.