November 30, 2019


The distinguished economic philosopher, Yogi Berra, once said, “When you come to a fork in the road, take it.”  A wedge has been driven into the U.S. economy as weak global growth and uncertainty surrounding trade has caused the goods producing sector to flounder.  The story of the global growth slowdown is simple if one views tariffs as taxes on trade.  Taxes on trade hurt exports.  Uncertainty about trade hurts investment particularly for large companies with complicated global supply chains.  In turn, businesses have delayed and/or been less enthusiastic in making long-term investments, with equipment spending bearing the brunt of the impact.  The goods producing sector accounts for a minority of the U.S. economy, but combined with the GM labor strike and setbacks by Boeing’s woes, made for notable signs that the economy’s momentum has softened.  The Conference Board’s Leading Economic Index declined for the third consecutive month.  The largest drags came from the new orders component and a shorter workweek for production workers.  On an annual basis, the LEI held at a +.03% change year-over-year, a sign of ongoing economic sluggishness.


Leading Economic Indicators GDP



However, the U.S. economy did not and is not likely to fall off a cliff but momentum has rolled down the hill some.  Unlike large businesses, the U.S. consumer remains resilient, as they do not expect meaningful declines in employment or income.  Their confidence has also been bolstered by ongoing gains in equities and house prices.  Consumption represents about 70% of the value added into the U.S. economy and kept it afloat, offsetting faltering business investment.  The overall U.S. economy has and is weathering the storm from the global manufacturing slump.  There are tentative signs that the slump may be bottoming out as business surveys have shown some stabilization. The data company, HIS Markit, released lesser-watch composite Purchasing Managers Index (PMI), a measure of business activity.  While still muted on a historical basis, it posted a four-month high of 51.9 in November, up from 50.9 in October a level above 50 points to growth in business activity, while a reading below that level points to a contraction.  The larger-followed Institute for Supply Manufacturing (ISM) Manufacturing PMI also improved modestly in October but remained under the 50 level for the third straight month.  A composite ISM PM moved further into expansion territory.  The housing sector has turned into a bright spot for the economy.  Activity and sales have picked up due to lower mortgage rates, high affordability and builders’ optimism remaining elevated on renewed demand.

Housing Market

With the briefest of hints that the worst of the global growth slowdown might be over, recession fears in the U.S. have eased somewhat.  Nevertheless, with geo-political and other uncertainties, including trade, worldwide political turmoil and Brexit, the possibility of weak business spending spilling over to the labor market and consumers behavior remains an elevated risk.  The main take-away is that weak growth is still more of a threat to the U.S. economy than inflation.  The inflation picture remains tame, which is consistent with a strong dollar, lower import prices, slower growth and low corporate pricing power.  Lower commodity prices and high inventories for some consumer products are also constraints to price pressures.

Fed Funds vs Core Inflation

Based upon the minutes of the October 20-30 Federal Open Market Committee (FOMC) meeting and comments from policy makers since that meeting, the Fed is content to pause monetary policy after 25 basis point reductions at three consecutive meetings.  The minutes underscored that Fed officials are comfortable with the current stance of policy and level of interest rates and has shifted to a wait-and-see mode to see how the rate cuts play out for the economy, as policy moves tend to lag.  The Fed has effectively raised the bar to move rates in either direction.  The only thing that seems likely to cause the Fed to raise rates is a breakout to the upside in inflation.  That is not likely to happen in the foreseeable future with all seemingly quiet on the inflation front.  The Fed will not be in any hurry to take away this year’s rate cut and remove any excess accommodations, especially since they see the balance of risks tilted to the downside.  A very sharp deterioration in either the economic data or geo-political environment that would trigger a “material reassessment” of the economic outlook could result in additional easing policy moves.  The markets continue to believe the odds are skewed in favor of at least one more rate cut and has priced a probability that it will happen around mid-year 2020.  Without any further negative shocks, our base case is the Fed has completed its insurance rate cuts.