US: The big growth scare

The big correction of US equity markets since the end of September reflects increased investor concern about the growth outlook
The data for the 4th quarter nevertheless point towards ongoing sustained growth
Data released since the start of the year provide conflicting signals with a big decline in the ISM manufacturing index and a strong increase in non-farm payrolls
Uncertainty about US-Chinese trade remains a key factor weighing on business sentiment

The new year is only four days old, but the journey has already been exhausting. Most equity markets are down and US treasury yields have dropped reflecting a flight to safety and a reassessment of future Fed policy. Markets are no longer expecting a policy tightening this year, but this doesn’t help sentiment, which is dominated by growth fears. This is the signal sent by the flattening of the yield curve, the widening of the spread between corporate bonds and treasury yields and the S&P500 which, since its peak on 20 September, is down 16%.

Historically recessions have been preceded by big equity market drawdowns, an inversion of the yield curve and a significant widening of the corporate bond spread. So, quite understandably, these market movements have raised growth concerns. There is a risk of circular reasoning however, with growth concerns weighing on markets, which in turn cause investors and companies to question the growth outlook. Better look at the economic data then.

The latest reading of the ISM for the manufacturing sector didn’t provide comfort with the index dropping 5.2 points in December, the biggest monthly decline since 2008. Neverthless the current level (54.1) still corresponds to expanding activity. This is confirmed by the latest nowcast of the Federal Reserve of Atlanta, which incorporates the disappointing ISM data. It is pointing at a growth rate of 2.6% for the 4th quarter. This is in line with the Federal Reserve of New York’s nowcast for the 4 th quarter, which stands at 2.5%. Even though the available evidence may point towards ongoing growth in the US economy, recent market behaviour reminds us that for investors it’s the outlook that matters. Fed tightening worries have moved to the background and with the meeting next week between US and Chinese officials, there might be some progress at last on what has become a dominating source of uncertainty in the second half of 2018. Against his background, the very strong growth in jobs in December has been most welcome: it suggests that, barring shocks, the expansionary phase of the business cycle is not about to end soon.

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