More of the Same
Last year began with concerns of a slowing global economy, substantial uncertainty around central bank policy, and heightening trade tensions. As confidence in the U.S. economy faltered, manufacturing weakened, and the yield curve inverted intermittently, the Federal Reserve reversed its tightening cycle. The Fed’s shift towards quantitative easing combined with a de-escalation in trade tensions and a solid labor market ultimately diminished investors’ fear of an impending recession. As a result, economic growth merely moderated. BBVA USA Research estimates economic growth in 2019 will come in around 2.3%. Looking forward to 2020, we expect more of the same – meaning easy central bank policy, tepid inflation, strong consumption, and a stable labor market – which should contribute towards moderate growth in the economy.
Improvement from last year’s manufacturing slump should materialize. As measured by the ISM Manufacturing Index, manufacturing PMIs have weakened over the past few years, especially due to weakness in China presumably caused by the trade conflict. Notably, Germany and the rest of the Eurozone have realized the brunt of the slowdown. On a global scale, firms scaled back on production, inventories, and future investment in 2019 in order to cope with the slowdown. At the end of December, US tariffs declined from a threatened high of 26% to a reported 17% after “Phase One” was agreed upon verbally. While industrial production and business investment should stabilize as we see a pause in trade disputes, political uncertainties, including the US presidential election, should keep business spending subdued.
Consumers Hold the Key
No matter your outlook, the consumer is the heart of the equation. In the US, but for a weak reading in the fall, the service sector has remained solid. Employment in service-related jobs has significantly increased in the past twenty years across the globe and now makes up nearly half of all jobs globally. While industrial jobs have remained a consistent portion of global employment, agriculture has moved from 45% of all jobs in 2001 to less than 30%. Although a global deceleration is manufacturing is certainly felt, the strength in services has more than worked to offset this change.
In the U.S., consumption accounts for around 70% GDP, which also happened to be one of the strongest components of U.S. growth in 2019. Consumption, in turn, is driven by employment and consumer confidence. To date, despite slowing economic growth globally, US consumer confidence has remained strong. If there is an apparent worry, it is the dip in CEO confidence.
CEO confidence has historically acted as a leading indicator to employment. If expectations are for economic difficulties, the thought is that leadership works to tighten the belt. CEO confidence, as measured by The Conference Board, rebounded to end the fourth quarter at 43 from a decade-low reading of 34 in the third quarter. While 43 is not an especially strong number, readings over 40 are generally not considered recessionary. Despite the decline in CEO confidence and rising minimum wages across the country, wage pressure should not impact margins too much.
Job growth was weaker in 2019, with job gains coming in at 2.1 million jobs versus 2018’s pace of approximately 2.7 million. The slower pace is likely attributable to the declining pool of available workers as the labor market has tightened significantly throughout the expansion.
Job gains continued to remain solid in the fourth quarter with the economy adding an average of 184,333 jobs per month. Even though job gains came in under expectations for the month of December at 145,000 versus the expected 160,000, other key components of the labor market remain unfazed. The unemployment rate was unchanged at 3.5% - a fifty-year low. A broader measure of unemployment, the U-6 rate, which gauges those too discouraged to look for work and those who want to move from a part-time job to a full-time job, fell to 6.7% - its lowest level on record.
Wage growth, however, continues to be constrained. Despite the low unemployment rate, average hourly earnings of private sector workers rose 2.9% on an annual basis in December, falling below the 3% mark for the first time since July 2018. While the gain is still above inflation, it is a relatively modest number given the tight labor market. It is possible the weakness in wage growth suggests the economy is not yet at full employment giving the labor market more room to grow in 2020.
Despite the moderation in wage growth, household finances remain solid and should continue to benefit from mortgage refinancing. In turn, declining mortgage rates and healthy household balance sheets should continue to boost housing demand. In December, housing starts jumped to a 13-year high at an annualized pace of 1.61 million – 41% higher than a year earlier. Sales of previously owned homes also rose in December, up 10.8% from a year earlier.
The Fed on Pause
Expectations have been set high for the Fed to raise or lower interest rates this year. In the second half of 2019, the Fed’s actions were reminiscent of the Alan Greenspan-led Fed in the mid-1990’s in which the central bank cut interest rates three times and then paused in order to prevent an economic downturn and sustain an expansion. Starting in July of last year, the Fed cut short-term interest rates three consecutive times between July and October to a target a range of 1.50% to 1.75% due to “the implications of global developments for the economic outlook as well as muted inflation pressures.” At the Fed’s December meeting, officials held the rate steady and signaled they were unlikely to reverse those cuts anytime soon.
The central bank will maintain its accommodative stance until there is a “significant” or “sustained” pick-up in inflation, despite stronger confidence in the economy – a key difference between the Fed’s current policy and the Greenspan cycles. In 2019, price pressures were negligible and eluded the Fed’s 2% inflation target. Core CPI, which excludes the volatile food and energy categories, rose to 2.3% in November on a year-over-year basis. However, the central bank’s preferred measure of inflation, the core PCE index, rose 1.6% on a year-over-year basis in November – a decline from 1.7% in both September and October. Given that there are not many upside risks to core PCE presently, inflation is expected to remain muted this year.
Overall, 2020 is likely to be a continuation of tame inflation and growth. BBVA USA Research is forecasting GDP in 1Q20 will come in around 2.1%, while growth for the year will come in around 1.8%. While consumer fundamentals are likely to remain supportive of the economy, geopolitical uncertainties and the presidential election may serve as headwinds to market sentiment.
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