Consumers prop up U.S. economy

---

The economy is on a gently slowing trend as spending by consumers continues to buoy growth and the Fed signals a pause in cutting rates.

The U.S. economy expanded during the third quarter at a 1.9% annual rate; little changed from the 2% growth rate in the second quarter. Consumer spending and housing investment increases offset the drop in business investment. For the third quarter, the story is clear: The economy maintained a steady pace of growth because of the resilience of household spending. That said, corporate spending is expected to erode further in the fourth quarter. And consumer confidence looks to be decreasing a little as the labor market falls onto a weaker growth path.

Manufacturing wavers as job gains hold steady

A gauge of U.S. manufacturing showed the sector contracted in October. Although the manufacturing purchasing managers index (PMI) from the Institute for Supply Management (ISM) was a bit better than September, it was weaker than consensus expectations. This suggests that manufacturing remains under pressure although that pressure is not increasing. The ISM's manufacturing index came in at 48.3% in October compared with a 47.8% reading in September. A number below 50% represents a contraction in the industry.

The labor market continued to hold strong, and employment growth in October was better than expected. Employment grew by a seasonally adjusted 128,000 jobs last month, according to the Labor Department. The strike by General Motors (GM) workers during the month may have muddied the reading. The drag from the GM strike (strikers were not counted as working during the survey week just before the strike ended) and negative census hiring were offset by gains elsewhere. So, the pace of job creation and the revisions to hiring in the prior months point to a continuation of the decent health of the labor market. Wage gains were a little weaker than expected.

The Fed cuts and pauses

The Fed cut interest rates for the third time this year in October but signaled it wouldn't reduce them further unless the economy slowed sharply. Fed Chair Jerome Powell indicated the bar for further easing was high. The current policy is "likely to remain appropriate" as long as the economy expands moderately and the labor market stays strong, Powell said on October 30 after the conclusion of the two-day rate meeting. He didn't rule out additional cuts if that favorable outlook faltered.

There were two dissents in favor of no cut, and no dissents in favor of more aggressive easing. The Fed seems to have declared its mission accomplished and its "mid-cycle correction" completed. Our view is that risks remain tilted to the downside and that the next move by the Fed will be a cut, although it's hard to see the Fed moving again in the near future.

Trade talks move forward

As far as we can tell, negotiations between the United States and China on a "phase one" deal are continuing to make progress. Plans to sign a deal at the upcoming APEC summit in Santiago were thrown for a loop when the Chilean government cancelled that summit (and a UN climate meeting) because of a domestic political crisis. While progress on this deal is a welcome sign that an escalation of trade tensions is unlikely in the near term, the prospects for a more comprehensive settlement remain bleak. We are increasingly pessimistic about the future of Sino-American relations.

Recession watch

The economy is not currently on a trajectory that will lead to a recession, but it is decelerating, and will be growing only slowly over the winter. The Conference Board's (CB) Leading Economic Index is slipping closer to zero (in year-on-year terms). This index, which measures U.S. business trends, declined 0.1% in September, falling for a second straight month. For this reason, we believe the probability of a recession happening is somewhat higher than current models suggest.

The economy is not currently on a trajectory that will lead to a recession.

With the economy growing only slowly, a shock or a policy mistake is more likely to push the U.S. into a recession. It is easy to see where a shock could come from. A further trade policy misstep by the Trump administration is clearly a risk, and the Fed may get its policy wrong. Instability in the Middle East is a source of risk to global energy markets. The economy's internal dynamics might also change; an inflection in the labor market, driven by pressure on corporate profits, for example, could shake household confidence and spending. We know how important steady consumption growth is to the economy's performance. While these events are not our central scenario, they are likely enough to worry about.