We believe this is a more sustainable rate of growth and that a deeper slowdown is unlikely in 2019...Jan 2019
Slowing, but not stalling. That is our current assessment of the U.S. economy. As we have noted in prior Commentaries, the current expansion has been very long, now approaching ten years in duration. Extraordinarily low interest rates and central bank asset purchases have provided much of the stimulus for growth. Corporate tax reform also provided a late-cycle boost, leading to above-trend GDP growth of 3% in 2018. Although we expect growth to slow to around 2.0% this year, as the initial boost from tax reform fades and the impact of higher interest rates takes hold, we believe this is a more sustainable rate of growth and that a deeper slowdown is unlikely in 2019. We highlight the following factors to support our view:
- We expect fewer interest rate hikes from the Federal Reserve (Fed) than previously forecast – even as recently as December. After hiking interest rates four times in 2018, the Fed took the short-term policy rate up to 2.5% in December. At that time, their official forecast called for two more hikes in 2019 followed by a pause. The combination of further predicted rate hikes amid slowing growth sent stock prices sharply lower and equity market volatility higher. At the same time, longer-term bond yields fell leading to further “flattening” of the yield curve, a signal often associated with a slowing economy. Taken together, we believe these factors will cause the Fed to reconsider their approach in 2019 and scale back or even pause entirely from further rate increases. Two of the factors which the Fed was most concerned about – a potential asset price bubble in equities and higher inflation – seem to be less of a threat and Fed Chair Powell has acknowledged this as well. All of this suggests that short-term rates may stay at the current level of 2.5% for some time, with the Fed taking a more cautious “wait and see” approach. This pause should give further room for the economy to grow.
- The labor market remains especially strong and continues to improve, which typically occurs later in an economic cycle. After 99 months of positive job creation, the most recent December monthly data showed a gain of 312,000 jobs, compared to the average gain of 215,000 per month over the past five years. While the unemployment rate increased from 3.7% to 3.9%, the rise is due in part to formerly discouraged workers re-entering the labor force and actively seeking work (but still counted as unemployed). The economy has not been this close to full employment since 1969. While pockets of “underemployment” remain among certain demographic, geographic, and industry groups, the overall health of the job market supports consumer spending – the largest contributor to economic growth. Throughout the long recovery, wage growth has lagged behind job creation but recently wages are rising strongly and we expect the trend to continue in 2019. Wage growth may pose a headwind for corporate profits next year and we are watching closely to see how earnings are impacted by upward pressure on wages.
- Finally, there is lingering uncertainty around the impact the rest of the world could have on the U.S. economy. Growth in Europe, U.K., China and other Emerging Markets weakened in 2018, and we expect a mix of economic and political factors to weigh on non-U.S. growth in the year ahead. However, we also expect progress from ongoing trade disputes between the U.S. and China as political leaders see it is in their best interests to chart a more constructive course. In our view, the odds are high for a compromise deal that allows both countries to claim victory and prevent further economic harm that might otherwise result from a full-blown “trade war.”
Our belief that economic growth will slow next year is already recognized by financial markets, which may be discounting some likelihood of a potentially greater setback to growth in the coming quarters. We believe the chances of an economic downturn in the next two years will increase in the event worsening trade tensions coincide with the Federal Reserve continuing to tighten monetary policy through next year. For now though our expectation is that these forces should moderate resulting in less uncertainty about growth in the near future.0