Recap
Ten years into the longest expansion in this country, the economy has remained in decent shape, as solid employment growth has continued to bolster household income and sustain consumer spending. While household finances have been solid, economic growth has moderated, reflecting the trade war, slower growth abroad and a persistent cloud of policy uncertainty weighing on business investment and manufacturing.
The combination of muted inflation, slowing global growth, and uncertainties related to trade and other global developments have led the Federal Reserve to trim interest rates three times in the last quarter and left the door open to do so again.
Global economic growth has ebbed this year to its slowest pace since the 2009 recession. The main culprit for the malaise has been the escalating trade war between the U.S. and China, which has disrupted supply chains, reduced investment, and rattled financial markets, trimming global output by 0.8% this year and projected output for next year.
Slower global growth has reduced demand for exports and put a dampener on both U.S. inflation and growth prospects. Germany, the UK, and China have all experienced slowdowns, and the euro area has been a concern. In response, the European Central Bank and several other central banks have either adjusted or indicated they will adjust their monetary policy stance to support their economies.
These concerns about global growth have been compounded by broader geopolitical uncertainty. The risk of a recession in both the United Kingdom and the European Union following Brexit is looming large (though this may abate if the withdrawal is resolved in the next few months), the political situation in Italy has remained fraught, political tensions have continued in Hong Kong, and conflict in the Middle-east could escalate almost anytime.
Retail Sales
American shoppers pulled back on spending in September, signaling key support for the U.S. economy this year could be softening amid a broader global economic slowdown. Retail sales decreased 0.3% in September from a month earlier, the first monthly decline since February. September’s decrease in retail sales was driven in part by a decline in spending on vehicles, which reflected a pullback from a strong gain in August.
This has suggested that consumer spending was on less solid footing amid concerns that trade tensions were weighing on the global economy and dampening consumers’ outlook. Consumer spending has been the main driver of the U.S. economy, accounting for more than two-thirds of economic output.
Inflation
Indeed, despite new tariffs coming into effect in September on many consumer goods, inflation has remained tame. Both headline and core inflation registered a muted 0.1% increase in the month, leaving the readings flat on a year-over-year basis at 1.7% and 2.4%, respectively. Unless a breakthrough in the trade impasse is reached, benign inflation and further signs of the domestic economy cooling off should lead to even more agreement at the Fed for the need of at least another rate cut this year.
Labor Market
Signs that the economy has lost momentum beyond the factory sector has mounted, but the labor market has not fallen off the rails. Employers added 136,000 new jobs in September. Private-sector job growth has been expected to remain on a downward trend in the coming months. As the trade war rages on, hiring in the manufacturing sector has continued to weaken. Even with a slower pace of hiring in recent months, the labor market has remained tight. The unemployment rate has been at a 50-year low.
Average hourly earnings stalled in September despite signs of a still-tight labor market. With demand for labor softening and many companies contending with higher input costs as the trade war lingers and broadens, no meaningful strengthening in wage growth is expected in the coming months. Along with slower hiring, income growth should also moderate as a result and contribute to slower consumer spending.
Manufacturing
The ISM Manufacturing Index declined to 47.8 in September from 49.1 in August. September marked the second consecutive month of contraction in the headline composite index, and the reading was the lowest since June 2009. The drop in U.S. manufacturing readings occurred as trade flows were set to grow this year at the weakest pace since the financial crisis, with rising tariffs and cooling growth.
U.S. manufacturing weakness has deepened and broadened to encompass almost every industry. Demand has clearly slowed, staff has been laid off, and new tariffs were at least partly to blame for boosting operating costs and generating some shortages. U.S. manufacturers should continue to feel more pain from soft foreign demand and less sturdy domestic demand at least through the end of 2019.
Non-Manufacturing
The ISM Non-Manufacturing Index posted a significant decline in September, falling 3.8 points to 52.6 in September from 56.4 in August. This has marked the lowest level since August 2016. Unlike its manufacturing counterpart, the non-manufacturing measure has remained above the critical 50-point threshold that separated expansion from contraction. However, the cushion has gotten thin, suggesting that the manufacturing slowdown and the drag from tariffs have been spilling over to the services sector and the broader economy.
Non-manufacturing industries represent nearly 90% of the U.S. economy and have avoided a deeper slump thanks to the resiliency of American consumers. However, the next few months will be a test of the U.S. consumers’ confidence in the face of recession-talk headlines, the next round of tariffs impacting consumer goods, financial market volatility and the latest political uncertainty in Washington.
Housing
The housing market sputtered in September as a lack of homes for sale and high prices disrupted what was shaping up as a rebound in the second half of the year. Existing home sales retreated in September, falling by 2.2% relative to the previous month. Low inventory levels continued to place upward pressure on prices. The resale housing market was caught in a crosscurrent of conflicting forces. On one hand, lower mortgage rates and a stronger labor market have improved buying conditions. On the other hand, low inventory and rising home prices have kept a lid on the pace of sales expansion. As the two effects have influenced market activity, volatility in existing sales is expected to continue in the coming months. However, another rate cut from the Fed should support an overall modest upward trend in the housing market.
Federal Reserve
The Federal Reserve cut rates for the first time since the Great Recession in late July, then followed that up in mid-September, likening the moves to taking out insurance. They were meant to give the economy a little bit of extra padding in case uncertainties on the horizon threatened to turn into realities.
Data has increasingly suggested that a slowdown is materializing. Both the ISM manufacturing and non-manufacturing surveys have posted declines for September. Consumer confidence has shown signs of weakening, and while spending has still grown, it has slowed from a robust pace earlier this year.
Against that backdrop, the Federal Reserve cut interest rates by another 25 bps as October ended.
Global Manufacturing
The deceleration in the global economy this year has been marked by pronounced weakness in manufacturing. In the United States at least, it has often been said that the U.S. economy can withstand such a slowdown because manufacturing is a relatively small piece of the total economy. Industrial employment in the United States has been about 10.6% of total employment. As a share of total U.S. output, industrial production has been about 13%.
Conversely, employment in manufacturing has been about 17% of total employment in the Eurozone, and for some European industrial powerhouses, even higher. Japan also has a relatively high share of workers employed in industry at roughly 16%. Thus, it would appear if sharp contraction in the manufacturing sector were to cause a recession somewhere, the Eurozone may be the first domino to fall.
China
China’s economy grew by 6% in the third quarter. This compared with a 6.2% rate of growth posted in the second quarter—which was driven by more lending—and a 6.4% figure in the first quarter, which was helped by a March tax cut. Growth across the board cooled, despite some recoveries in industrial production and retail sales at the end of the quarter. But investment in fixed assets, a measure of construction activity that has long been a major economic driver, was weaker in the first nine months, with a 5.4% rise from a year earlier. Investment in the agricultural, manufacturing and industrial sectors retreated in September while infrastructure investment accelerated.
Gauges of China’s manufacturing activity rebounded in September thanks to improving domestic demand, but orders from overseas markets remained subdued amid a protracted trade fight with the U.S.
The improvement in both official and private gauges of factory activity would seem unlikely to mark a turnaround from the deepening slowdown in the industrial sector, as China has continued to struggle with sluggish global demand and hefty debt levels.
Consumer confidence has waned just as businesses most need domestic spending, while mixed signals on inflation – agricultural prices surged 70% this year, while factory prices recently slid into negative territory – have made it difficult for authorities to simply adopt textbook policy prescriptions like lowering interest rates. A debt overhang, plus strict measures to curtail it, has dissuaded lenders and investors, including local governments, from undertaking projects that might create jobs.
China’s slipping economic momentum has sparked a shift in government priorities – away from curbing mounting debt levels and toward a renewing focus on infrastructure spending and official support for businesses, the kinds of policies that fueled borrowing – and economic expansion – after the 2008 financial crisis.
Growth has been expected to slow gradually in the coming years, reflecting a decline in the growth of the working-age population. Gradual convergence in per capita income should remain subdued, reflecting a moderate pace of productivity growth and slow labor force growth as their population ages.
Outlook
This summer’s fears about escalating trade tensions, slowing global growth and an inverted yield curve leading to a recession have let up somewhat as the year proceeded. The trade war with China went into another of its periodic phases of de-escalation, as the Trump administration seemed rattled about the possibility of a faltering economy. The Federal Reserve cut interest rates three times, something of an insurance policy against a recession. Much of the data on the economy, particularly on the job market and the service sector, have remained quite solid.
Crisis averted. That, anyway, has been the mood in financial markets in the last few months, as stocks have remained near record highs and the fearful tenor of economic commentary has subsided.
But it would be premature to declare a clean bill of health. Public attention may be focused on an impeachment battle in Washington, but the underlying forces that drove recession fears in the summer are still very much here – with some new ones potentially in play.
The latest, starkest reminder was the manufacturing sector contracting in September at its fastest rate since 2009. That might have been dragged down in part by a strike at General Motors, but the softness in the factory sector has been evident in other data that predates the strike. The delayed economic impact of a series of trade escalations over the summer and of a slowdown in the global economy is only now beginning to surface. It’s starting to show up in hiring and capital-spending plans, as the latest numbers demonstrate.
At present, slowing global growth and geopolitical uncertainty have posed challenges. Global growth is expected to be around 3.0% in 2019. Growth is expected to pick up in 2020, reflecting primarily a projected improvement in economic performance in several emerging markets in Latin America, the Middle East, and emerging and developing Europe that is under macroeconomic strain.
Yet, with uncertainty about prospects for several of these countries, a projected slowdown in China and the United States, and prominent downside risks, a much more subdued pace of global activity could well materialize. To forestall such an outcome, policies will be needed to decisively defuse trade tensions, reinvigorate multilateral cooperation, and provide timely support to economic activity where needed.
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