Last week, the June jobs report continued to suggest that the U.S. economy is still riding the sugar high from late-cycle fiscal stimulus.
Use of “sugar high” there suggests the current level of activity isn’t sustainable and look, that’s not necessarily to offer up some dour prognostication or to otherwise knock this recovery. Sure, this expansion has been a bit tepid on some measures, but if length is your thing, this is the second longest expansion in U.S. history (in keeping with the trend during the Great Moderation):
The worry currently is that piling expansionary fiscal policy atop a late-cycle dynamic risks overheating the economy and indeed, the Fed warned about that in the June minutes. “Some participants raised the concern that a prolonged period in which the economy operated beyond potential could give rise to heightened inflationary pressures”, the account of the June meeting reads.
Fiscal stimulus at this point in the cycle could well exacerbate the situation if the Phillips curve reasserts itself as it’s prone to doing in late-stage expansions (remember “Cheshire cat’s smile“?):
In any event, the rest of the world is falling behind and the “synchronous global growth” narrative that defined 2017 and, together with “still-subdued inflation”, underpinned the low vol. regime, is giving way to a narrative about American exceptionalism. The threat of a global trade war doesn’t help.
“Our current activity indicator is tracking at 4.4% in June, down from 5¼% around yearend 2017”, Goldman wrote, in a note out Monday, adding that their “leading CAI is pointing to some further slowdown to 4% or a bit less in coming months.”
Goldman goes on to decompose that indicator to show you how the slowdown has evolved. It was DM-centric in Q1, with EM taking the weakness baton in Q2 on the heels of Fed tightening and trade jitters:
What does this mean for volatility – and no, that isn’t a non sequitur. Again, it was the synchronous nature of the upturn in growth that, along with subdued inflation across DM economies, underpinned the low volatility regime that made 2017 so amenable to risk asset performance. That’s what “Goldilocks” means: synchronous global growth and still-subdued inflation.
And so, Goldman was out with a piece late Monday called “Feeling the heat – but still too early for a high vol. regime” in which the bank updates their “volatility regime heatmap” to see where things stand in light of recent events.
“Five months after the volatility spike in February, realized and implied equity volatility have settled but remained somewhat elevated compared to 2017, and picked up at the end of June”, they note, suggesting that this has prompted clients to “wonder how vulnerable the current environment is and which will be the catalysts for volatility in the coming months.” Here’s more:
We updated and extended our heatmap to assess the drivers of volatility regimes – we added some global variables as the previous version was very US-centric and recent US data has been stronger compared to non-US. The result is still a healthy picture but with more indicators turning less green/more orange. The Goldilocks backdrop of 2017 has continued to fade YTD and the average percentile of macro, markets and uncertainty indicators has increased but remains green in aggregate.
Where to from here? Well, Goldman of course takes a relatively benign view on things, but as ever, continued uncertainty around trade policy and tension around the midterms are risks (of course trade policy and the midterms are inextricably bound up with one another).
“Overall, the broad picture remains healthy, recession risk is low, and we expect global growth to stabilize at rates of 4%+ level,” Goldman says, before concluding with the following caveat:
At the same time, with US mid-term elections likely to drive equity volatility, risk of further trade conflicts and a worse growth/inflation mix, we also do not expect a low vol regime as we have seen over the last year.