The U.S. economic expansion seems to be approaching an inflection point. Two-plus years of steady acceleration in year-over-year growth are likely to end either with the current quarter or in Q2. The question now is how much deceleration we will see as this year unfolds. Estimates range from all the way to zero and beyond (extreme pessimism) through a drop back to the “new normal” of 2% growth (moderate pessimism) to an old normal with growth in the mid-2% area (optimistic) or even stabilization at around 3% (extreme optimism). Our model comes out in the optimistic category. This represents a modest downgrade from a month ago.
NIPA Data
The third release of data for the third quarter lowered overall real output growth by a tick to 3.4%. Final sales growth came in at just 1.0%, down two ticks from an already weak 1.2% reading. The changes were mostly due to a slightly reduced estimate for consumer spending. Growth in business investment remained a disappointing 2.5%. Government spending growth was also unrevised at a strong 2.6%. On the negative side, for both housing and exports the magnitude of negative growth was increased. Overall, an inconsequential set of revisions.
Recent Data
Monthly data during the past month show clear signs of the inflection mentioned above. [Note: Most of the data during December arrived as anticipated. The government shutdown has produced some disruptions in the past two weeks, however.]
The employment report for December was very strong. Payroll employment jumped by 312 thousand, plus another 58 thousand in revisions to October and November. There were large gains in manufacturing, construction, professional and business services, and health care. Wage increases moved up slightly to their highest rate of the expansion. The household report showed an increase in the labor force of 419 thousand, raising the participation rate to 63.1%, which matches its highest level in over five years. This jump did have the side effect of raising the unemployment rate to 3.9%, however.
Other hard economic data are also holding up reasonably well. Total industrial production registered a strong gain in November, although the manufacturing sector was flat, its third straight weak number. November housing starts bounced back from two weak months, but still show little indications of significant growth.
Subjective indicators, long a source for optimism, are flashing warning signs. Consumer confidence, although still high, was lower in December. Most of the decrease came from consumer expectation (as opposed to their evaluation of the current situation). Business sentiment also took a hit, with both ISM indexes down in December.
Finally, Wall Street was unhappy. The stock market had one of its worst Decembers ever. The Dow Jones Total Stock Market Index (which is an exogenous variable in our model) fell 12% in the fourth quarter – 48% at an annual rate. On the fixed income side, the yield curve flattened. At year end the gap between the yield on 3-month and 10-year Treasury securities was just 24 basis points. A month earlier it was 64 bp and a year earlier 102.
Overall, not an encouraging month, but also not a disaster.
Baseline Forecast
As can be seen in the chart, our updated forecast for 2019 is somewhat below that of last month. The difference is largest in the first half when we now expect growth to average 2.6%, down from 3.0% in our December outlook.
The primary source of the deceleration is slower growth in business investment. We now put it at 4.5% for the year, a full percent below our December estimate.
In the labor market the forecast now has job creation falling below 200 thousand per month in the current quarter and averaging 174 thousand for the full year. The latter is 22 thousand lower than our December forecast. The unemployment rate ends this year at 3.6%, up 0.1% from last month.
Summary
Hard data have recently been at best status quo. Subjective measures have moved lower (although from extremely positive to merely solidly positive). Financial markets have been negative, and international conditions have clearly deteriorated. Compared with a year ago, not an encouraging environment.
In this situation our outlook for the next year has weakened. On the positive side, we do think there is at least some upside. If, say, a trade deal with China is reached and growth there recovers some. But there are more risks to the downside: lack of progress on trade, total political warfare in Washington, further growth shortfalls in China and Europe (a hard Brexit), another leg down in the stock market.