Employment growth rebounded in June

U.S. Overview

Breaking Records

On net, our forecast for Q2 growth has been little changed since June, with GDP growth slowing to a 1.8% pace. Although that is a couple tenths weaker than our June estimate, the underlying story is the same: domestic demand rebounded in Q2, while Q1's boost from trade and inventories unwound.

While a further escalation in trade tensions has been avoided for now, the lack of a resolution has prolonged trade-related uncertainty. Capital spending plans among manufacturers reached a two and a half year low in June. As such, we continue to expect a lackluster pace of business investment in the current quarter. The ongoing suspension of shipments of Boeing's bestselling 737 MAX aircraft has also taken a meaningful toll on the near-term outlook for equipment spending and exports.

Employment growth rebounded in June, yet wage growth shows few signs of generating a burst in inflation. The continued run 0f below-target inflation is a key reason why the FOMC will still cut the fed funds rate 25 bps when it wraps up its next meeting on July 31. Although near-term uncertainty around trade has subsided a bit in recent weeks, Fed officials note it continues to weigh on the outlook. The FOMC's limited scope to cut rates this cycle will likely lead it to take a more proactive approach in fending off a slowdown. The FOMC has recently stated its specific intent to sustain the expansion. That leads us to expect an additional "insurance" cut in October, and for the current expansion—now the longest on record—to outlast prior cycles by more than merely a few months

This month the U.S. expansion enters its 11th year to become the longest on record. With the unprecedented duration has come anxiety about another downturn under the premise that all good things must eventually come to an end. While that may be, the U.S. economy remains in fairly good shape.

On net, our forecast for Q2 growth has been little changed since June, with GDP growth slowing to a 1.8% pace. Although that is a couple tenths weaker than our June estimate, the underlying story is the same: domestic demand rebounded in Q2, while Q1's boost from trade and trade and inventories unwound.

Upward revisions to household outlays early in the second quarter put real consumer spending on pace to increase 3.4% in Q2, about half a point higher than our previous estimate. That reflects some catch-up from an unusually weak Q1, so we expect spending will settle down to about a 2% pace in the second half of the year (bottom left chart). Household balance sheets generally remain strong, and real income continues to grow at a decent clip thanks to further job and wage gains, along with low inflation. Consumer confidence, however, has wavered slightly, which will keep spending on a subdued path relative to the past year.

As we assumed in our prior month's forecast, President Trump and Chinese President Xi did not make any breakthroughs on trade when they met at the G 20 summit, but they agreed to keep negotiating. While a further escalation in trade tensions has been avoided for now, the lack of a resolution has prolonged trade-related uncertainty. Capital spending plans among manufacturers reached a two and a half year low in June. As such, we continue to expect a lackluster pace of business investment. Spending on structures is set to decline in the second quarter amid a pullback in energy-related investment. Equipment spending is also poised to contract; nondefense capital goods shipments have fallen sharply over the past few months (bottom right chart).

 

International Overview

G20 Trade Truce and a Dovish Trend Continues

While the G20 summit did not result in a comprehensive trade deal, the outcome was certainly something to cheer about. In late June, President Trump and President Xi agreed to resume negotiations towards finalizing a trade deal, while they also agreed to not impose any additional tariffs for the time being. The trade truce may help support China's economy, especially after some weak activity and sentiment data in May and June; however, we maintain our forecast for the Chinese economy to grow 6.1% in 2019 and 6.0% in 2020.

Global monetary policy continues to move in a dovish direction, led by the Fed. Fed Chairman Powell's recent statements are consistent with a July rate cut, while the June Dot Plot indicates several FOMC policymakers expect multiple rate cuts this year. In response to a dovish Fed, we believe many emerging central banks will pursue policy rate cuts before the end of the year, which should provide some support to emerging GDP growth towards the end of 2019 and into 2020. As of now, we forecast developing economies to grow 4.0% in 2019 and to accelerate to 4.3% in 2020.

We expect G10 central banks to pursue easier monetary policy by the end of the year as well. Given deteriorating growth and inflation dynamics in Europe, we now expect the ECB to cut rates in September, while we also expect the Reserve Bank of Australia and the Reserve Bank of New Zealand to continue cutting rates this year.

A significant portion of the weakness in equipment spending can be tied to Boeing suspending shipments of its best-selling 737 MAX model. Ex-aircraft, private capital goods shipments continue to grind higher, although the 1.5% clip over the past three months is less than half the pace of Q1. We now assume 737 MAX shipments will resume in the fourth quarter, with the longer grounding and broader weakness in capital goods orders leading to another negative print for equipment spending in Q3. Boeing's suspension of shipments has also taken a toll on exports. Along with a pickup in imports and broader slowdown in exports as global growth flounders, trade is on track to shave about half a point from topline GDP in Q2. Inventories are also aligned for a steeper correction. We now estimate inventories will lop off nearly a full point from headline growth.

Employment growth rebounded in June, allaying fears of a sharp deterioration in the labor market. While job growth is expected to cool further in the coming months, it should remain strong enough for further tightening in the labor market. Yet wage growth shows few signs of generating a burst in inflation. Core PCE inflation is likely to remain below 2% on a year-ago basis until early next year given solid productivity growth and low inflation expectations.

The continued run 0f below-target inflation is a key reason why the FOMC will still cut the fed funds rate 25 bps when it wraps up its next meeting on July 31. Although near-term uncertainty around trade has subsided a bit in recent weeks, Fed officials note it continues to weigh on the outlook. The FOMC's limited scope to cut rates will likely lead it to take a more proactive approach in fending off a slowdown. Markets are currently pricing in a 100% chance of a cut at the July meeting, risking a visceral reaction a la December if the FOMC holds fire. Moreover, the committee has recently stated its specific intent to sustain the expansion. That leads us to expect an additional "insurance" cut come October, and for the current expansion to outlast prior cycles by more than merely a few months.

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