There are indications the economy is losing momentum, including a weaker housing market and lowing corporate investment.
There are emerging pockets of weakness in the United states, including in manufacturing, investment, housing, and job growth. The economy expanded at a 3.5 % annual pace during the third quarter, and the unemployment rate hit 3.7%, the lowest level in half a century. But that is just half the story.
The latest data indicate the United States has joined the global economic deceleration. The housing market has weakened, reflecting higher interest rates. But the weakness is spreading beyond housing. While the weekly jobless claims data has been hinting at a shift in the direction of the labor market, what really caught our attention was weakness in corporate investment. And in October, U.S. durable goods orders fell by the largest amount in 15 months.
The corporate tax cuts were supposed to usher in a new era of investment-led high productivity growth, and, so far, it just isn’t happening. Investment in energy production increased due to higher energy prices and “deregulation” of the fossil fuel industry by opening up public lands to exploration. Still, lower pollution control will shift the costs of pollution from the polluter to the economy as a whole. Relaxed pollution control does not lower costs overall or improve economic efficiency. Outside energy, there is precious little sign of a shift in investment behavior.
A main reason for this is the uncertainty generated by the trade war. Tariffs have harmed the profitability of some major industries, and everyone who is following the Trump administration’s trade policy is struggling to understand exactly what is going on. Will there be auto tariffs or not? When? How big? What exactly is going on with China? The difficulty in getting clear answers to these questions is apparent and could be harming investment prospects.
Core inflation ticks down
A closely watched price index ticked further below the Federal Reserve’s target in October, a fresh sign of weakening inflationary pressures. Core inflation as measured by the personal consumption expenditures price index (PCE) rose 1.8% in October from a year earlier and has hovered at an annualized 1.5% over the past six months. Our inflation forecast points to a dip in both headline and core inflation in the first half of 2019. Energy prices account for much of this. However, our forecast shows core inflation will not drift above the Fed’s 2% inflation target until the end of October 2020. We wonder about the optics of the Fed hiking rates in the spring of next year when inflation is falling. The Fed has already raised its benchmark interest rate four times as of the end of December 2018, and projects two hikes in 2019.
We wonder about the optics of the Fed hiking rates in the spring of next year when inflation is falling.
A senior official on the Federal Open Market Committee (FOMC), which sets rates, recently said it is puzzling and a problem that inflation has been so low over the long term. The Beige Book, prepared ahead of the December FOMC meeting, indicates the economy is slowing. According to the report, “optimism has waned…as contacts cited increased uncertainty from impacts of tariffs, rising interest rates and labor market constraints.” Many market participants and economists are forecasting annualized growth of around 2.5% in the fourth quarter of 2018. We would be lucky to sustain that pace of growth in 2019.
Wage pressures increase a little, but pace of job creation weakens
The November labor market report was consistent with the deceleration story. Some of the weakness in the jobs number was weather-related because in some parts of the United States, Thanksgiving was the coldest in a century. The Bureau of Labor Statistics said the number of people missing work because of the weather was larger than normal in November. Wages do look as though they are ticking up in some sectors of the economy. But the pace of job growth has clearly decelerated, and a few other details point to a genuine deceleration. The U6 unemployment rate, which includes workers who have quit looking for a job and part-time workers who are seeking full-time employment, ticked up, and there was a shift in the pattern of people who are not in the labor force.
Growth risks still asymmetrical
For the outlook, the economic risks remain asymmetric. The possibility that we are at the early stages of a capex/productivity growth phase seems more remote than it did last month given the data flow. Perhaps the risk the Fed will be too aggressive is slightly lower now because of market developments and the latest Fed commentary. Still, trade war risks linger.