The U.S. economic expansion continues to lose momentum, aided considerably by our incomprehensible policy on trade. Recent data are worrisome, but not yet at a panic level. Our revised forecast is a little below last month, but possibly still tinged with optimism.
The second release of data for the first quarter put real output growth at 3.1%, down by an insignificant 0.1% from the advance report a month earlier. The main sources of the negative revision were weaker growth estimates for business investment in equipment and in intellectual property (partly offset by a shift in structures investment from decrease to growth) and a higher estimate for imports (partly offset by stronger export growth. The decline in residential investment was also increased. On the positive side there were small increases in consumption and in government spending. None of the basic characteristics of the quarter were changed. Top-line growth, especially if you ignore the increase in inventories, was good, but not great. Consumption and business investment were relatively weak. Housing remained dismal, while government spending was strong. And tariffs (actual and prospective) render the trade numbers imponderable. Overall a quarter that raises more questions than it answers.
The most recent monthly readings give a mixed picture of the economy’s immediate direction, but a longer perspective clearly suggests a downward trend.
Labor market data illustrate these observations. The June data from the household survey were pretty good, while the establishment survey numbers were disappointing. In the former, unemployment held steady at 3.6% and the labor force rose by 176 thousand after three months of contraction. On the establishment side, payroll employment rose just 75 thousand and there were negative revisions to March and April totaling -75 thousand (leaving the level of employment exactly unchanged from its initially reported April value). Longer term, employment growth is clearly slowing – so far this year averaging 164 thousand per month compared to 223 thousand for all of 2018. On the household side unemployment continues to have a slight downward trend, but with the current level at a fifty year low and below virtually every estimate of “full employment”, the trend has to end soon.
Other indicators are qualitatively similar. Consumer confidence rose slightly in May, but is basically flat with a year ago. On the business side the ISM manufacturing index continues to be in expansion territory, but it was down in May and significantly lower than a year ago. Their non-manufacturing index for May was up slightly, but its trend is down. Housing starts rose in April, but are flat longer-term. April industrial production had its third significant decrease in four months. Its 12 month growth is now just 0.9%, with the manufacturing component now below its year-ago level.
Finally, longer-term interest rates have declined significantly since late last year. In the past month the benchmark 10-year Treasury rate has “inverted,” falling below short-term rates.
Overall, to us, the monthly data contain nothing that is flashing red with warning sirens, but there are a lot of blinking yellow caution signs.
As can be seen in the chart, our updated forecast for the rest of 2019 is slightly below that of last month. We now expect GDP growth for the rest of this year to be 2.4%, down 0.2% from our May outlook. For 2020 our new forecast is just over 0.1% below last month. Farther out the two forecasts are very similar with growth averaging a little below 2.5%.
In the current quarter we now expect output growth of 2.4%. This is well down from Q1 but substantially higher than most other forecasts reported in the media. We suspect that the primary source of this difference is our model’s forecast that consumption will grow at a 2.8% rate this quarter, which is more than double its first quarter rate. If instead consumer spending continued at its Q1 rate, it would lower our GDP forecast by a full percent. We also expect some improvement in business investment, but slower growth in government spending and a reversal in the international sector of the Q1 shrinkage in the trade deficit.
Our subjective feeling is that our current outlook is too optimistic. A model like ours is not good at predicting changes in direction by the economy. Objectively, the lack of imbalances in the present situation implies that a change of direction should be unlikely. But bad policy can overcome a lot of positives, and right now policy is bad on all sides. The administration's stance on trade is mindless; many of the positions being put forth by the Democratic opposition are at least as bad; the Federal Reserve seems to be totally at sea.
It is a good time for a forecaster to be humble.