US economic growth slid to a 2.1 per cent annualized rate last quarter, down from 3.1 per cent in Q1/19. The result belies a robust 2.9 per cent growth in personal consumption and a nearly 1 per cent advance in government expenditures. Overall growth was weighed down by a 0.7 per cent contraction in net exports and a 1 per cent pullback in business investment. The latter suffered its most severe decline since Q4/15, as business decision makers grapple with trade uncertainties. The Federal Reserve is poised to reduce interest rates this week for the first time in over a decade, begging the question: Is the US economy at risk of an imminent recession?
Though segments of the economy are clearly weakening, we don’t currently see enough evidence to warrant concern.
The Good News
Job Market: Initial Jobless Claims is a monthly real-time indicator of the health of the labor market, measuring the number of new applicants for unemployment insurance. Historically, claims rise sharply leading into recessions. The 4-week moving average of claims, currently at 213,000, is situated in the lowest percentile of its historical range over the last 20 years. From this perspective, there’s no recession in sight.
Liquidity: Restricted access to capital to borrow, spend and invest is a good early warning indicator of trouble. Lenders tend to tighten their purse strings and limit lending as they anticipate economic uncertainties. The yield differential – measured as the yield premium, or spread, over Treasury yields lenders require to extend credit to lower-quality borrowers – has in fact been declining in recent weeks, placing it 5 per cent below its 200-day moving average, suggesting lenders are becoming increasingly willing to issue loans.
Consumers: Consumer confidence is at a level not seen in nearly 20 years, reflecting a strong job market and low interest rates. Historically, recessions tend to be preceded by sharp downtrends in confidence. While current confidence levels are off their October 2018 highs, in our view the decline is not large enough to warrant immediate concern. However, we will be closely monitoring confidence indicators for signs of further deterioration.
The Bad News
Yield Curve: The relationship between short-term and long-term interest rates has been a harbinger of economic conditions, both good and bad. A “steep” yield curve, when longer-term rates are higher than shorter-term rates, suggest growth ahead. An “inverted” yield curve, when longer-term rates fall below shorter-term rates, portends a slowdown and, often, a recession. The yield differential between 10-year notes and 3-month bills inverted several weeks ago and has remained flat. The correspondence between inverted curves and recessions is uncomfortably close. Perhaps the much-anticipated Fed easing will help bolster the curve.
Business Spending: Private domestic investment represents the business component of the economy. It’s not a surprise that contractions in US economic growth often correspond to pullbacks in business spending and investment. Businesses tend to sit on their wallets in anticipation of an economic decline. What’s troubling business decision makers right now is the unpredictability of the administration’s trade dispute with China, and this uncertainty has translated into in a decline in business spending. The ISM Manufacturing Index has markedly declined over the past 12 months, although the figure remains above 50, the dividing line between growth and contraction.
Conclusion: Cresset believes fear of an imminent recession is overdone. First, the data are inconsistent with a slowdown. Second, from a monetary perspective, the Fed is on it. Powell & Co are set to reduce rates this week and are willing to ease further as the data suggest it. Without an inflation threat, the Fed has the flexibility to ease with impunity. Lastly, 2020 is an election year. President Trump will use his bully pulpit to gin up support from business leaders, consumers and of course the Fed to ensure the economy cruises through the election without too many dents and scratches. In many respects, our economy reflects Americans’ attitudes. So, you should expect many more tweets in the year to come.