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2020-01-10Macro `n Cheese

Ready for Trends to Break in 2020?

In his first blog post of the year (and decade!), our favorite economist gives a somewhat different outlook for the coming year, primarily using charts available to all Macrobond users in the Market Maps library. The picture he paints of developments in 2020 looks quite different from market consensus.

The longest expansion

It’s hard to avoid discussing that we’ve been experiencing, since July of last year, the longest US expansion on record; currently 127 months and counting. Moreover, the 2010s is the first decade on record without any recession at all. – At least as long as there are no abnormal revisions to outcomes in the recent past that will make a back-dating case for the NBER Business Cycle Dating Committee. In the chart below, you can see the number of quarters of expansion on the X-axis and the cumulative growth in GDP per capita on the Y-axis. The accumulated payroll gains is revealed by the size of the bubbles.


Apart from it being unusually long, there is nothing extraordinary about the current expansion. Despite its longevity, both payroll and income gains have been rather weak. Tellingly, this expansion is also the only one on record where we haven’t (yet) seen a single year with full-year GDP growth above 3% y/y, which stands in stark contrast to the massive fiscal and monetary policy stimulus that has been unleashed.

This combination – very active policy responses and slow but rather steady growth – seems to have lulled most forecasters into believing that 2020 will be no different to previous years. The trend is a good old friend to us all – right?


“Priced to perfection”

I see it another way. – Not despite but because of very active economic policy and a steady improvement in many important economic aggregates, I believe we’ve now reached a position where many a trend cannot go further. Take interest rates for example:

Macrobond moment: If you right-click on the x-axis of a chart and chose ‘fill-range’ and ‘import’, you can choose between a number of colored bands to highlight recessions (from, e.g., NBER), banking crises or any other period of your own choosing.


No matter whether you believe that current interest rates are sustainable or not (i.e., what you believe r* should be), it will be difficult to expand monetary stimuli considerably, especially considering that we still haven’t figured out if the effects of unconventional monetary policy (UMP) measures come from levels (as academics/policy makers claim) or from changes (as market participants claim). Moreover, the long-run implications of UMP may still be in front of us.

What is becoming clearer, nonetheless, is that the central banks who made forays into negative interest rate policies (NIRP) have become more reluctant to hold them there, due to foreseen negative side effects.

Not only by policy rates, but also if we look at market rates, we can conclude that interest rates are extremely depressed from a historical perspective. The fact is that quite a few (European) companies are able to raise funding at rates close to zero!


But it’s not just a US or advanced economy phenomenon. Especially when taking the low US interest level into consideration, rock bottom interest rates are also a way of life for emerging markets these days:


As if that wasn’t enough – equity markets are at all time highs in almost all corners of the world:


Admittedly, high valuations are not a clear-cut case for valuations being stretched, but at least in the US, valuations do seem a bit stretched also from a fundamental perspective:


Now, you are forgiven for thinking that this will end in the usual dismal conclusion. But that’s actually not my point. My point is, instead, that both fixed income and equity markets (all over the world) have now trended stronger for so long that something will need to give. Either the bond market is right, or equity markets are. So, what’s the trigger, you ask?


Surprise, surprise

Inflation is low, wage growth meagre, and labor markets continue to be strong. Meanwhile, productivity and GDP are continuing on an uninspiring and slow ascent, still in the wake of the global financial crisis (GFC) of 2007/08.

*Note: Before 03/2004 values on AHE for 'Total Private Sector' are spliced and scaled with AHE for 'Private Production & Non-supervisory Employees'


As we have discussed for the better part of the past decade, wage growth has not really kept up with the improvement on labor markets. That said, when looking at how real hourly wages have responded to stronger labor markets, a more constructive pattern develops.


The graph unequivocally demonstrates that real hourly earnings (yellow-ish? stars) are now very much in line with what they were at the last cyclical peak (red squares). Now, we can debate the causality between wages and inflation until we are blue in the face, but as current productivity is similar to current wage growth, it should be obvious that the productivity gains (however meagre) over the past couple of years are starting to accrue to wage earners (instead of capital owners).


Of course, a chart with two y-axes begs a more detailed explanation. Unit labor Costs are basically productivity-adjusted wages, hence; when ULC rises, it implies wages are growing faster than productivity (to, i.a., compensate for inflation). As can be seen from the graph above, developments in ULC (blue, lhs) have historically been the (exact) opposite of productivity developments (red, rhs).

What can also be read from the chart, with some difficulty perhaps, is that this is not a stable (negative) 1:1 relationship. The amplitudes of swings in ULC and productivity are very different from one era to another, and in the period after the great moderation, the amplitudes even become comparable for swings in ULC and productivity[1].

Also, there are two quite distinct time periods when the covariation has been positive[2] (highlighted in red in the chart): First during the 1990’s and then again just recently, from 2016 onwards. In the former period, during the 1990’s it was probably – but arguably – an effect of the surprisingly strong productivity growth which pushed up both wages and profits (and simultaneously kept inflation low). But how should we, then, read the most recent period?

– Since we unfortunately cannot attribute recent developments to surprisingly strong productivity, I read it as directly related to stronger demand and tighter labor markets finally having the desired effect on wage developments. And I, for one, am not ready to give up on the idea that high labor demand and low labor supply will eventually produce higher wages.

You’d best say it out loud: Wages are currently growing faster than both profits and inflation!

Consequently, we are – at long last – at a juncture where things start to get interesting from a monetary policy perspective, and one or more of the trends from recent years should (must?) break:

  • If real wage growth rises, as the two charts immediately above indicate, and without companies being able to cut other costs (or raise prices), corporate profit growth will suffer and stock markets plummet – e., the bond market was right;
  • However, if companies in order to protect their profit margins from the rising costs, start hiking prices, inflation will surge, and interest rates rise and bond markets crater – e., the stock market was right;

Admittedly, there is also a slim chance that due to advancements in, e.g., robotics and machine learning, productivity growth accelerates beyond any current expectations pushing profit and wage growth up, while inflation remains subdued. This would probably constitute a tie as (real) long rates would rise dramatically with difficult knock-on effects on highly leveraged corporates. Alas, we cannot detect anything like this in data

Rest assure, whatever road we will take during the coming year, it will be detectable in economic data and give rise to strong effects on economic developments. And that is a discussion we will return to in this blog over coming months.

The main message here is that the commonly held belief that 2020 will provide “more of the same” will be proven wrong, at least concerning financial market developments. Be prepared.


To Macrobond users: I hope you haven’t missed the opportunity to browse our ever-growing library of ready made charts for countries as well as markets! 


[1] In the document a rolling regression is used.

[2] Beyond the expected cyclical pattern in conjunction to slumps.


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We don’t usually have views and opinions about economic and financial states of affairs, (not ones that we express publicly as a company, anyway). We do believe, however, that people can and do appreciate a variety of perspectives. What you’ve just read is the perspective of our resident chief economist. While we think he’s very smart, Macrobond Financial does not expressly endorse the views he presents here. And, as the old adage goes, you shouldn’t believe everything you read (not without finding the data, performing a few analyses and presenting it in a nice chart). We want to make it clear that we are not offering this information as investment advice. That being said, if you have the application you can easily check everything that’s mentioned here, and decide for yourself. If you don’t have the application, now you have a great reason to get it.