The contraction in world trade, exacerbated by President Trump’s tariff offensive against China, has begun to spread to the United States. The economic slowdown, which can also be attributed to domestic factors, has prolonged throughout the summer of 2019, and business surveys do not suggest any improvements in the months ahead. Corporate investment will remain downbeat, while household consumption, which has been resilient so far, should begin to falter. In the face of this environment, the Federal Reserve -- which no longer provides forward guidance on upcoming policy moves – is bound to lower its key rates again.
During the summer months, the US economy continued to slow although it seemed to be fairly resistant to the headwinds affecting world trade. The annual GDP growth rate dropped to 2%, one point below the 2018 level, which is still an enviable performance when seen from Europe, where recession is looming in countries like Germany, Italy and the UK. Yet, taking a closer look, the US economic slowdown is more severe than it might seem. The only factors limiting the fall in year-on-year GDP growth were public spending and inventory building in anticipation of new tariffs imposed by President Trump. Foreign trade provided a negative contribution, but the bulk of the slowdown was essentially due to domestic factors. It can be attributed to the decline in private investment, which was first seen in residential construction, and then spread to all sectors with the exception of software. Although consumption and employment are both resilient, they seem to be losing momentum. Lastly, business surveys are depressed and do not signal any improvements in the near future.
The drop in the Institute for Supply Management (ISM) index for the manufacturing industry, as well as the reversal of the capacity utilization rate, suggest a further decline in capital goods spending. The drop could be particularly severe in the very capital-intensive oil and shale gas sectors, where the first signs of over-investment have emerged (chart 2). With production volumes at an all-time high of 8 million barrels per day (b/d), the profitability of new wells can no longer be taken for granted. Producing less than expected after being drilled too close to one another and operated by heavilyindebted industry players, the number of new wells is trending downwards.
US household consumption – which at USD 14,000 billion a year is five times higher than French GDP – is by far the most powerful driving force of domestic demand. In 2018, the combination of tax cuts, job creations and consumer credit created a rather high-octane fuel, but the mixture has weakened in 2019. Companies are not only re-assessing market outlets and scaling back investment, they are also slowing the pace of hiring. Net job creations have fallen to a monthly average of 161,000 between January and September, the lowest number in nine years. Given the population inflow into the labour market (1.8 million on average in 2018), job creations hardly suffice to bring down the unemployment rate, already standing at all-time low (3.5% in September). Farmers and purchasing managers are no longer the only segments of the population suffering from President Trump’s trade war. Even though consumer goods are not affected much, higher import tariffs are having a nonnegligible impact on inflation (see box 3). Faced with higher prices for capital goods and inputs manufactured in China, there has yet to be a significant shift in demand towards other countries 2 . US companies are bearing the costs, modulating the efforts granted by suppliers and their reactions to exchange rates. In the end, the impact on prices paid by end consumers is estimated at a few tenths of a point3 . After holding to a slowing trend recently, core inflation rebounded to 2.4% in August. This has lowered the growth of real disposal income for US households. Consumer credit is also less buoyant, which is not unusual at this stage of the business cycle: household non-mortgage debt has increased 55% from the 2009 low, coming back to relatively high levels as regard of disposable incomes. Car sales have matched alltime highs, so that the fleet has been largely renewed. Lastly, banks are tightening lending conditions at a time when transformation conditions have deteriorated due to the inversion of the yield curve (Wheelock, 2018).
More key rate cuts
In the months ahead, the Federal Reserve (Fed) will need to steepen the yield curve, which means further monetary policy easing. The Fed funds target rate has already dropped from 2.5% to 2%, and we think it could be lowered further, to 1.75% at end-2019 and 1.25% at end-2020. Of course, the official position remains cautious and does not signal such a move. Having foregone “forward guidance”, Federal Reserve Chairman Jerome Powell has linked any policy changes to upcoming economic publications. He also pointed out that monetary easing phases can sometimes be very short5 . Yet he did not cite the most pertinent example: the Fed cut its key rates in the fall of 1998 to counter the potentially systemic effects of the quasi-bankruptcy of an entire hedge fund6 , not to accompany a cyclical downturn, as now seems to be the case.
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