The economic news over the past month has been mostly bad. What hasn’t been negative has been neutral. The question for the U.S. economy going into 2020 is how much in the way of self-inflicted wounds it can take without being dragged under along with a weak (and weakening) international economy. Our model is still relatively sanguine, but subjectively we are apprehensive.
The third estimate of data for the second quarter left real output growth at 2.0% and had very little in the way of sectoral revisions. The basic picture – moderate growth resting entirely on consumption and government spending, weak investment, and tariff deformed trade – remains unchanged. Overall, not an encouraging situation.
Monthly data during September, with two exceptions, were generally troubling.
(Partial) exception #1 was the labor market report for September. The establishment survey estimated an employment gain of 136 thousand. This is about 30 thousand below the numbers for July and August (which were revised upward), and well off the 223 thousand averaged in 2018, but still an adequate number. More troubling, private sector employment was up only 114 thousand, with nearly all of that gain in the service sector. Employment in goods production has been averaging just 16 thousand per month in 2019 and is flat since June. By comparison, it averaged 53 thousand in 2018. The household survey was more encouraging. It showed a two-tick decrease in the unemployment rate to just 3.5%, the lowest since 1969. This was achieved along with enough labor force growth to hold the participation rate constant, meaning that the unemployment decline reflected workers moving from unemployed to employed. Unemployment dropped across demographic categories
(Possible) exception # 2 was housing data for August, which had significant jumps in both housing starts and in building permits. Both series came in at their highest levels since mid-2007. The caveat here, of course is that one month does not make a new trend.
Other new data are decidedly less encouraging. Real income registered a nice gain in August, but that followed a weak rise in July. Real consumer spending was weak in August after a string of good monthly gains. Looking to the future, consumer sentiment declined in September for the second straight month. In all, the household sector seems strong enough to have carried the economy through Q3 and probably the current quarter.
Business sector indicators are weak and getting weaker, especially in manufacturing. The Institute for Supply Management manufacturing index is down six straight months including August and September in its contraction range. September came in at 47.8. This gives a decline of 7.5 points since March and marks the lowest reading since June 2009 at the end of the Great Recession. The ISM non-manufacturing index registered 52.6, well off from its 59.7 in February. These negative sentiment indicators are confirmed by more objective data: (1) New orders for capital goods have been discouraging, possibly implying continuation of the weak Q2 investment data. (2) Industrial production is down from a year ago for manufacturing (and barely positive overall).
To summarize, monthly data during Q3 indicate to us that the household sector situation remains reasonably healthy with a continuing strong employment environment producing enough income growth and confidence to yield adequate consumption growth. The business sector, on the other hand continues to send warning signals. The question for the overall economy as 2019 grinds to an end is: Will consumer spending be sufficient to maintain the now record-long expansion in the face of a manufacturing recession?
As can be seen in the chart, our model continues to say that it will. Our updated forecast puts overall third quarter growth at just below 2.5%, essentially unchanged from a month ago. We now expect growth in Q4 to be just above 2.5%, down two ticks from our September forecast.
As suggested above, we expect consumption to show continued growth, although below its Q2 rate. The same is true for government spending. The forecast shows flat spending on housing construction, and sluggish growth in business investment. We expect the trade deficit to widen, but more slowly than in the second quarter.
There is huge uncertainty in the current situation. The current trade war makes any forecast for exports or imports mere guesswork. In the current political environment consumer confidence (and hence consumption spending) must be considered up in the air. Our model’s forecast for investment seems subjectively to be optimistic. There are a lot of clouds out there, and we see little in the way of possible silver linings.