Chief economists Emily Kolinski Morris and Constance Hunter took the audience on a quick tour of key markets and trends with the potential to impact the automotive industry.
Chinese auto sales have been declining on a year-over-year basis for the first time since 1989–1990, back when their total annual vehicle sales were less than one million, according to Morris, Ford’s Chief Global Economist. The first half of 2019 is projected to remain very challenging until government stimulus kicks in and turns things around by the second half.
“The only thing I've learned in covering China is that it's usually a mistake to count them out too soon,” said Morris. “They tend to have a way to pull levers and make things happen.”
However, longer-term worries exist, she added. Hunter, KPMG’s Chief Economist discussed her observations from a recent meeting with economists from across the U.S. and China that she has attended biannually for a decade.
“Our Chinese colleagues were the most pessimistic they have ever been on the Chinese economy,” she said. “There were a number of people really expressing concern that this may be a bigger set of problems than these policies can fix…. I think we might have a situation of China sneezes and the world catches a cold—or possibly even the flu.”
One key headwind is that China’s growth has been predicated upon the build-up of significant debt: nonfinancial corporate debt is up 270 percent in eight years, totaling 170 percent of GDP, Hunter said. Second, China has been trying to lower interest rates and increase liquidity, but their currency is still “virtually pegged” to the U.S. dollar and, hence, to U.S. monetary policy.
Finally, stimulative measures such as tax cuts and more bank lending will continue increasing the debt while the country’s working age population is shrinking, she said. “We may discover that China is, in fact, pushing on a string… that these stimulus measures are too little, too late.”
“I think even with a modest decline [in U.S. auto sales] this year, we're still going to be looking at a very healthy industry,” Morris said, referring to industry estimates of approximately 17 million SAAR for 2019.
The market has not been significantly oversold, compared to the mid-2000s when the federal government last raised interest rates, and the industry experienced very aggressive negative pricing and a huge supply push. “It's a very competitive industry, everybody’s wanting to maintain their market position,” she said.
Additionally, U.S. population has grown significantly since then, and the buy rate, vehicles per household, is in a normal range today, Morris said. “I think with continued solid economic fundamentals, there's no reason the sales pace can’t be sustained.”
However, both Morris and Hunter acknowledged there are macroeconomic clouds on the horizon.
The rate hikes and the balance sheet unwinding over the last year will start to take a bite out of the economy and act as a countervailing factor to the fiscal stimulus of the 2018 budget, Hunter said. A decline in residential investment in real estate also is concerning.
“I've been saying that 2019 is all about recession watch,” she said, citing KPMG’s forecast for a slowing U.S. economy with a recession beginning in either late 2019 or mid-2020.
Further, Hunter said she has become increasingly concerned that shocks from the global economy, such as the China slowdown and Brexit, could act as additional headwinds to the U.S. economy. She also noted that the unemployment rate has been below the natural rate for 8 quarters, this is an economic condition where “the Fed has never been able to engineer a soft landing.” It is also a condition that is only sustainable for so long before the shortage of workers contributes to a lower pace of expansion.
However, Morris said she sees the recovery in household formation over the last couple of years as a positive indicator for the auto industry. As more young people move out of their parents’ homes and become independent heads of households, “that absolutely drives the need for transportation, as opposed to sharing the family car.”
Morris warned that it’s important to distinguish between prognostications that allude to slower growth versus a significant downturn. “We’re absolutely expecting a slower pace of growth this year, but not all those [comments] necessarily mean that you're leading down the slippery slope into recession,” she said.
Hunter agreed, saying that we shouldn’t anchor our idea of a recession to our experience during the financial crisis, which was “extraordinary.” She added that recent research by the Cleveland Fed indicated that the longer the expansion, such as the one the U.S. has enjoyed to date, the shallower the recession. “The more people that get pulled into the labor force, the more savings that accumulate, and so the steadier and more stable the economy is.”
Hunter continued that while we are looking at a recession, consumption will not likely decline, rather, investment would decline or trade could go negative for several quarters. “But these things eventually kick back in.”
The rejection of the Brexit plan in January 2019 wasn’t unexpected, but the magnitude of its defeat was a bit of a shock, Morris said. Ford has been planning for a smooth exit, but will maintain a scenario for the alternative outcome until there is a definitive resolution, and won’t adjust until it sees a definitive resolution.
Additionally, just as in the U.S., some slowing is expected in Europe, but it’s more of a reversion to a trend than a downturn, she said. In particular, the U.K. industry has not seen significant declines, and German auto manufacturing is doing pretty well despite some exposure to China.
Regarding Brexit, “My gut on this is that the EU is kind of like the Hotel California. You can check out anytime, but you can never leave,” Hunter said. On the one hand, she said she thinks that “somehow, someway, they're actually not going to leave, but I'm pretty scared that the alternate scenario could occur. So certainly do what Ford is doing, and keep your scenario planning active and vigilant.”