Speaking in Sydney last week, Standard Life Investments chief economist Jeremy Lawson said the current business cycle in the US is likely to be “elongated” compared to previous cycles.
“The question is: how late in cycle are we in the US? It’s already a longer than average business cycle. You have to think about what brings a business cycle to an end,” Mr Lawson said.
The first event that often ends a business cycle is a “big oil shock”, but that seems unlikely to occur in the near term, he said – “but you never know”.
The second indication that a downturn is imminent is a “really big build-up of assets and credit imbalances”, Mr Lawson said.
“We wouldn’t say that US equities are cheap, but they’re not as overvalued as they’ve been at other times in the past.
“We don’t think that even though there are pockets of excess leverage particularly in the high-yield sector and energy, we don’t think that’s broadly based enough to present the sorts of problems we saw in the financial crisis,” Mr Lawson said.
Finally, it seems unlikely that the Fed will be raising interest rates in order to curb inflation in the near term, he said – particularly given that the central bank has not met its inflation target in four years.
However, while none of the typical forces that typically bring business cycles to an end are on the horizon, there are “obvious things to observe in the near term”, Mr Lawson said.
“Through the first few months of normalisation I think it’s worth paying very close attention to what happens in credit markets.
“It would be a bad sign if credit spreads widened. Not just in high yield but broadly based,” Mr Lawson said.
Similarly, the Fed will not be looking for lending standards to tighten, he said.
“If that were occurring, that would suggest that policy is probably tighter than they desire.”
Wage growth is “the dog that hasn’t barked so far in the expansion”, he said.
“I don’t think that’s surprising given that the best measures of labour market slack still suggest that the economy’s operating below potential,” Mr Lawson said.
“As the labour market tightens, most models suggest that labour costs will start to pick up more aggressively.
“But the pace at which that occurs will be very important in dictating the pace of how slowly the Fed can normalise rates,” he said.
