Expansion Might Float Through Trade War

CUNA Chief Economist Mike Schenk said the trade war with China will further slow growth, but probably won’t sink the U.S. economy into recession.

“Credit unions should expect their seasonal loan growth to rev up this summer as usual, and will come in at healthy levels during the year,” Schenk said in the CUNA Economic Update released Thursday. “Consumers on the margin should remain willing and able to borrow in the current environment, in part because the Fed isn’t likely to increase interest rates anytime soon.”

But Schenk said President Trump’s unexpected decision to increase tariffs on another $200 billion in Chinese imports on May 10 “had the effect of pouring gasoline on a smoldering house fire.”

Over the next 10 trading days, the Treasury yield curve inverted four times and the S&P 500 and Nasdaq indices dove about five percentage points.

An article published Thursday by the New York Fed estimated that tariffs on Chinese goods imposed last November will cost the average U.S. household $414 per year – either to cover the tariff or to buy the same thing from a different country at a higher price. The 15% tariffs Trump imposed May 10 will cost households another $831 per year.

“Trade wars are not good, and they’re not easy to win,” Schenk said.

But Schenk said the immediate threat seems contained with trade negotiations scheduled to resume June 9.

“We think cooler heads will prevail,” he said. “But even if we’re wrong, and the administration does impose more sanctions, the effects should not be enough to push the current recovery off the tracks. The economy is in good shape, and consumers, including credit union members, are fairly confident.”

However, a sustained drop of yields of long-term Treasury bonds below yields on short-term bonds has preceded every recession since 1955. Typically, economists compare 10-year bonds to three-month bonds. On that measure, the curve inverted for the full week of March 22 to 28, and again for four days May 13 to 24.

Dallas Federal Reserve Bank President Robert Kaplan said May 22 that the yield curve was “flirting” with the kind of sustained inversion that predicts a recession, but the dips weren’t yet big enough or sustained enough.

On the bright side, “on average they led a recession by a year or more,” NAFCU chief economist Curt Long said. “There’s probably going to be a fair amount of time before a recession hits.”

Long said the economy is fundamentally good now, but economic risks have risen in the past six months.

“Markets are a little bit nervous right now,” Long said. “Regardless of how economists see things, if people think a recession is imminent, then one probably is.”

And, Schenk said the ability of the federal government to boost the economy during the next recession will be limited by its deepening budget deficits.

Between 1969 and 2018, deficits averaged 2.9% of GDP. In 27 of those years when the unemployment rate was below 6%, deficits ran at 1.5% of GDP.

In April unemployment was at 3.6%, its lowest level in 50 years. Meanwhile, the Congressional Budget Office forecasts the federal deficit will be in the red this year by $900 billion, or 4.2% of GDP, and will rise to 4.7% of GDP by 2029.

Schenk said the biggest factor is the demographics of an aging population: Fewer wage earners and higher medical costs. On top of that, Trump’s tax cuts have weakened the revenue stream.

“Current policy has the government spending big in the face of declining revenues, which is exactly the opposite fiscal policy pursued historically,” Schenk said.

“You have to wonder, what happens if the economy slides into recession,” he said. “Can we allow federal government’s automatic stabilizers to kick in? If so, then what will the deficit look like? Prospects for a fiscal crisis increase dramatically. It’s not a pretty picture.”