Upward Revision Largely a Boost from Trade
|U.S. Overview
Upward Revision Largely a Boost from Trade
Our January forecast puts the annualized rate of GDP growth for the fourth quarter at 2.3%. That is a material upgrade from our prior forecast of 1.5% and is largely a function of an unexpected narrowing in the trade deficit in November.
The November trade report revealed, that after surging earlier this year, imports have fallen for three straight months. It may be that U.S. businesses rushed to get inventory into the United States ahead of an expected escalation in the trade war with China. But a Phase I trade deal reached just prior to the scheduled increase of tariffs on additional consumer goods took those tariffs off the table, for now, while reducing some of the existing tariffs.
We had previously expected a modest boost from trade, but we now look for net exports to add 1.4 percentage points to the headline figure in Q4. That said, the narrowing comes with some offset. If businesses are importing less, but consumer and business spending remains roughly unchanged, that implies that inventory investment will slow. We now expect inventories to lop off nine tenths of a percentage point from GDP growth during the period.
Elsewhere, the adjustments have been more modest. Business fixed investment is now expected to come in a little softer than we forecasted last month with both equipment spending and nonresidential construction outlays revised lower. Our consumer spending number ticked incrementally higher to a 2.2% pace in Q4 from 2.1% previously.
International Overview
Iran Emerges as a Wild Card
As the calendar turned to 2020, the geopolitical landscape seemed as though it was settling down. The United States and China had agreed to a Phase I trade deal, while the Conservative Party's victory in the U.K. elections helped ensure Boris Johnson's Brexit deal would pass parliament. The killing of Iranian General Qasem Soleimani on January 3 jolted financial markets, and, although tensions have eased a bit since, the events of the past couple weeks serve as a reminder that geopolitical issues can emerge onto the scene at any time.
When turning to the fundamentals, the global economy continues to sputter along. Economic growth in China and the Eurozone appear to have held steady in Q4-2019, neither slowing further nor picking up. Data out of the United Kingdom have been a bit weaker over the past month and indicate economic growth may have been close to zero in the final quarter of 2019.
Our forecast for the European Central Bank (ECB) remains that the ECB will cut rates one more time 10 bps at its March meeting. We also continue to expect the Bank of England (BoE) to keep its main policy rate on hold for the foreseeable future. We view both of these projections as close calls, however, and if in the next few weeks the economic data are a bit better in Europe/weaker in the United Kingdom, it would not surprise us if it is the BoE, rather than the ECB, that cuts rates during the early part of 2020.
After Stronger 2019 Finish, What is in Store for 2020?
If our fourth quarter forecast turns out to be correct—and with no major revision to prior data—full year GDP growth for 2019 would come in at 2.3%, which, as it happens, is also the average annual GDP growth rate during this record long expansion.
The headline growth rate drops noticeably in the first quarter of 2020 before rebounding in the second quarter and eventually settling into a range of 2-2.5% throughout the rest of the forecast period. So what is going on here?
Once again, the inventory dynamic is having a big influence on the top-line figure. Inventories are expected to be a drag on Q1 growth due in large part to the production stoppage of the 737 MAX at Boeing (bottom left chart). The aircraft were previously being produced but not shipped, meaning they were showing up in the inventory component of GDP. But with production of the 737 MAX stopping at the start of January, inventory building and production are set to slow. Reflecting this Boeing effect, we have industrial production declining at a 3.9% annualized rate in Q1-2020, after a scant 0.6% drop in the fourth quarter.
In the second quarter, even if the stoppage continues, inventories will likely boost growth, although if Boeing restarts assemblies (but not shipments), the magnitude of the boost could get larger. We will update our forecast when and if there are formal announcements from the manufacturer.
than that, fundamentals suggest slow but steady growth ahead, with consumer spending growing at about a two percent pace throughout the forecast period and equipment spending gradually climbing out of its present slump before resuming a 3-4% pace of growth (bottom right chart). Another factor in the steady rise in equipment spending is that the 737 MAX should eventually be cleared to fly again, and once those aircraft ship, equipment outlays will rise.
What About the Fed's Dual Mandate?
Employers continue to add new jobs throughout our forecast period, despite some Census-induced volatility in the 2020 quarterly hiring estimates. Still, the pace of hiring is simply not sufficient to match the expected growth of the labor force so the jobless rate is expected to tick modestly higher in 2021.
Real disposable income growth remains positive over our forecast horizon. That said, we expect it to moderate slightly, reflecting slightly slower growth in the jobs market and somewhat higher inflation compared to 2019. Headline inflation is expected to rise near the Fed's 2.0% target in coming quarters after increasing just 1.4% last year.
Still, we expect only modest price pressure over the next two years. Inflation expectations remain broadly anchored around 2%. The University of Michigan's measure of year-ahead price expectations fell to its lowest rate since 2016 in December, and longer-term expectations notched their lowest rate on record. With low price expectations, muted wage growth and unit labor costs only around 2%, an overshoot in core inflation remains unlikely.
As such, the core PCE deflator, which informs Fed policy, is expected to remain close to, but just below, 2.0%. On that basis, upcoming FOMC meetings will be less about what will happen with the fed funds rate and more about some of the more esoteric topics of Fed policy—like the rate it pays on excess reserves, the size of its balance sheet and the composition of asset purchases. Early this year, we may finally get details on a long-anticipated standing repo facility to help smooth some of the recent flare-ups in the short-term funding market, while mid-year, attention will likely turn to the results of the Fed's policy review of its tools and communication.
The bottom line for the U.S. economy is that aside from some noisy headline figures and inventory swings, slow growth is expected to continue over the next few months, which should keep the Fed on hold.
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