February 6, 2020 | Bill Handel
How did we do in our industry predictions for 2019? Here are the predictions we offered up one year ago, along with an assessment of our foresight. Overall, our crystal ball was good, but with a few notable exceptions, which were due to the Federal Reserve’s reversal of its interest rate course.
What We Said: There are a number of factors which will drive this, but a major factor is uncertainty. Continuing threats of government shutdowns as well as trade conflicts contribute to this uncertainty. Global economic weakness could also influence conditions in the U.S. The stimulative impact of the reduction in tax rates will be lessened. Perhaps most importantly, by July of 2019 this recovery will officially rank as the longest in U.S. economic history, exceeding the 10 year recovery from March 1991 to March 2001 during the Clinton and Bush administrations. Interestingly, it will also have the dubious distinction of being the lowest growth recovery in modern times. All recoveries end, and this recovery is at its tail end, which means lower growth.
We don’t expect a recession to happen in 2019, but we anticipate that GDP growth for the year will be less than two percent.
Assessment: On target. While final GDP growth will almost certainly be greater than 2% for 2019, it will be significantly below the 2.9% GDP growth rate for 2018. The trend in GDP by quarter was also very directional; 3% in the first quarter but only 2% in each of the final three quarters.
What We Said: Recent articles in the popular press suggest that we are re-entering the debt crisis of ten years ago. A more robust analysis illustrate that this concern is perhaps overblown. If you examine consumer loan growth since the start of this recovery in June 2009, it has averaged 4.7% per year, which is fairly robust growth. However, if you back out student loan debt, then consumer debt has risen by only 2.7% per year. Further, the number of households has grown since 2009 by slightly less than 1% per year. As a result, growth of non-student loan consumer debt has risen by less than 0.3% per year per household when adjusted for inflation. What this says is that other than student loans, consumers have not grown their consumer debt at any appreciable level.
We expect this to continue in 2019. We anticipate a reduction in new car sales in 2019 versus 2018 results, and expect stabilization of credit card balances. And while we don’t expect a dramatic slowdown in student loan debt growth, it will begin to slow to some degree. Expect total consumer debt to grow less than four percent next year and total consumer debt less student loans to grow less than two percent.
Assessment: On target. All categories on consumer loans grew at less than 4% in 2019 with the exception of student loans, although non-student loan consumer debt did grow faster than the predicted 2%. Over-heated consumer loan growth is not an economic concern. If we examine non-student loan consumer debt in 2019 and adjust for inflation and household growth in 2019, that debt grew at less than 1% in 2019. Consumer loan growth is slowing, which is also an indicator of a weakening economy.
What We Said: Despite the rapid expansion of the Federal Reserve’s balance sheet since the onset of the financial crisis in late 2007, we have seen little evidence of inflation. In fact, in examining the GDP Implicit Price Deflator data, in no year other than 2011 have prices risen faster than two percent since this recovery began.
We anticipate that prices will rise at a faster pace this year. Increasing competition for labor will drive up wages and this tends to have a ripple effect on general price levels. We expect a rate of increase in general price levels between 2.5% and 3.0% for 2019.
Assessment: On target. While we did not meet the 2.5% estimate we suggested, inflation in 2019 of between 2.3% to 2.4% was higher than any previous year since the early 2000s.
What We Said: In 2018, the Federal Reserve increased rates four times by 25 basis points each time. This was a dramatic increase; the last time the Fed raised interest rates four times in one year was 2006. Many if not most prognosticators are predicting that the Fed will stand pat for 2019 – no rate increases – and this is indeed very possible. The Fed continues to watch the 2 year – 10 year Treasury spread and is unlikely move rates up if it causes the yield curve to invert.
However, we anticipate the economic conditions will stabilize, unemployment will remain very low and inflation will ratchet up. The result will be the Fed increases its target rate in the third quarter.
Assessment: Off target. This prediction was badly off-base. The Federal Reserve in fact reduced its target rate in 2019 three times. In our defense, the Fed’s behavior was much more proactive than normal in lowering rates prior to hard evidence of recession. Our anticipation was one rate increase in 2019 to provide the opportunity to be more aggressive in future rate reductions. We were wrong.
What We Said: In 2012 over 70% over mortgage volume was refinance. How times have changed. In 2018 refinance activity was less than 30% of total volume. Three factors are behind this change. First, rising interest rates have reduced or eliminated the economic value of refinancing for most consumers. Second, and related to the first, is that almost all who can refinance have done so. The third factor is the migration of the Millennials into their 30s, the traditional home-buying decade. The Millennial population is so large that it is impacting the purchase market in significant ways.
We anticipate that purchase activity in 2019 will be higher than it has been in any year since 2006 and will be 2.5 times higher than it was at its nadir in 2011. We expect that purchase activity will account for more than three-quarters of all mortgage activity.
Assessment: Off target. The Fed’s decision to alter its interest rate strategy in 2019 impacted this projection. Falling interest rates refueled mortgage refinance activity; as a result, while total origination activity in 2019 at $2.06 trillion was at its highest level since 2007, purchase activity in 2019 was 62% of total activity, less than the 75% we anticipated.
The reality is that purchase activity has accelerated as we projected; however, as interest rates declined, a higher percentage of consumers were able to refinance their mortgages and this drove the new purchase percent down.
What We Said: A major factor that has helped industry earnings in 2018 is improved net interest margins. Older, lower rate loans have been replaced with new, higher rate loans; loan volume has increased and replaced generally lower yielding investments; and the cost of funds has not increased appreciably, at least for credit unions and many community banks.
Expect this to change in 2019. While loan yields will continue to rise in 2019 as older loans are replaced with new loans, the paucity of rate increases will limit the increase in loan yields. At the same time, we are seemingly entering an era of deposit wars in many markets, with increasing levels of competition for deposits. Increasing generational wealth transfers will also impact deposit rates, as financial institutions compete more vigorously for these deposits which are at play. The depositor has awoken and the impact on cost of funds will be felt in 2019.
Assessment: Off target. Net interest margins did not decline in 2019 so our prediction was not accurate. However, even as the Fed reduced rates three times in 2019, industry cost of funds increased, which suggests that our assertion of increasing interest rate sensitivity for deposits has been borne out. Continuing improvement in loan yields but especially in investment portfolio yields helped to propel improvements in overall net interest margin.
What We Said: In 2018 branch counts declined by slightly more than 2%, led by the largest banks who, with the exception of U.S. Bank, closed 3% or more of their domestic locations, a few much more than that. On the other hand, credit unions grew the number of locations in 2018. It’s important to remember that even with these branch closures, the number of banks and credit union branches relative to population remains at very high levels historically, a result of rapid branch expansion in the 1990s and early 2000s.
We expect this trend to continue in 2019. The largest banks will continue to shed physical locations at a rapid pace, reducing market redundancies and closing locations that are not economically viable. They will continue to push the consumer on the digital path and by this reap the rewards of lower expenses and higher efficiencies. The increasing mobile-centricity of consumers will support this trend. Remaining branches will continue their migration from transaction hubs to sales and service centers.
Assessment: On target. Branch counts declined by 2% in 2019, which was slightly less than the 2.5% we projected. Wells and U.S. Bank both exhibited a 5% branch count decline; Chase was down slightly more than 2%, and Bank of America down by 3%. Expect this trend to continue in 2020.
All in all, aside from Fed rate policy, our predictions for 2019 were on target and provided a good look forward for the year. Look for our forthcoming predictions for 2020 coming soon.
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