- The net impact on the US economy of the Sino-US trade policy should be modest
- The pause in the Federal Reserve's tightening cycle should prove supportive of business investment
- Downside risks to growth appear to have receded
Developments in the first quarter of 2019 confirm that the US economy is transitioning from a (temporary) above-trend growth phase – in which growth was super-charged by fiscal stimulus, lower corporate tax rates and deregulation – to a more sustainable growth phase as fiscal stimulus wanes. Our forecast is that US growth will slow from 2.9% in 2018 to around 2.25% in 2019. Though growth slowed to 2.2% annualised in fourth quarter 2018, and seems set to print 1.5% in first quarter 2019, we anticipate seeing signs of stabilisation and economic green shoots in the second quarter data.
The moderation in US growth reflects the influence of both international and domestic factors. On the domestic side, interest rate-sensitive sectors of the economy such as housing and business investment have shown signs of softening. Mortgage rates, which peaked in November, have begun to depress both residential purchases and construction (as evidenced in existing home sales, and building permits), despite the robustness of the labour market.
However, the renewed drop in mortgage rates in recent weeks should provide support, and we have recently seen a bounce in the National Association of Home Builders (NAHB) index, as well as in the volume of home purchases.
Pullback in business investment as tax cut euphoria fades
On the business investment side, a softening of business sentiment surveys in the fourth quarter augured a pullback in business investment. Business confidence surveys, such as the Institute for Supply Management’s (ISM) regional Purchasing Managers’ Indices (PMIs), have retreated from the euphoric levels reached after the Trump corporate tax cuts, although they generally continue to indicate expansion. The moderation in business confidence in the fourth quarter reflected the softening in global growth prospects, amid heightened risks around international trade policy and the threat of tighter monetary policy. The most recent numbers, however, suggest stabilisation.
The Trump administration’s threats to (i) expand punitive tariffs on Chinese imports if China does not amend its practices on intellectual property and market access, and (ii) impose tariffs on European vehicle imports increased uncertainty for both foreign and domestic businesses in the fourth quarter. However, the Trump administration’s decision to push back the initial 1 March deadline suggests a willingness to negotiate, and BNPP AM’s view is that the US will ultimately reach an accommodation with China, before turning its attention to the European Union (EU). The bottom line, however, is that on trade policy the administration’s bark is likely to be worse than its bite, and that once the uncertainty diminishes, the net impact of trade policy on the economy should be modest.
On the monetary policy side, meanwhile, it is clear that the Federal Open Market Committee (FOMC) changed its policy tack in January, which has fully reversed the tightening in financial conditions that we saw late in fourth quarter 2018. The FOMC’s newfound determination to hold off on further tightening until stronger core inflation emerges promises a significant pause in the tightening cycle. This should reduce the threat of an unintended slowdown in growth that is ultimately supportive for business investment.
Downside risks to growth appear to have receded
In conclusion, a slowing in growth in 2019 has been our base case for some time given the fading of fiscal thrust and tightening of monetary policy. Furthermore, the moderation of growth is both welcome and inevitable since the economy has likely been growing faster than potential. Looking forward, the downside risks to the outlook emanating from trade and policy tightening that we worried about in fourth quarter 2018 appear to have now receded, which should keep growth modestly above trend in 2019, and push back the likely timing of the next recession.
Furthermore, we do not see large imbalances in the US economy such as inflationary overheating in the labour market, or credit-driven asset bubbles. Indeed, both households and non-financial corporate sectors are running financial surpluses. The risk, of course, is that corporate debt remains high and earnings could falter, US / China trade negotiations could hit the rocks, and the fiscal and monetary policy headroom to deal with a shock remain very limited. As a result, should a slowdown turn into a recession, populist administrations could opt for more radical policy responses.
Developments and prospects for inflation
From the perspective of TIPS investors, consumer price index (CPI) inflation has continued to disappoint in the first quarter. The commodity price declines seen in the fourth quarter have partly retraced, of course, helping to support headline inflation. But core inflation measures have remained muted, with the year-over-year core CPI actually retreating slightly to 2.1% in the last data release (for February). So the inflation picture remains one where core inflation sits just below target, supported mostly by robust shelter inflation, while core goods price inflation hovers at around zero (despite the imposition of 10% tariffs on some Chinese imports) and the cyclical components of the CPI remain muted, despite evidence of pipeline pressures and a tightening labour market.
Exhibit 1: Procyclical versus non-cyclical inflation
Source: BEA, BNP Paribas Asset Management Macro Research Team, 31 March 2019
The limited sensitivity of procyclical-component inflation to changes in labour market slack remains a puzzle –as much to the Fed as to investors. Suggestions that companies do not have pricing power and must therefore absorb higher costs into margins are at odds with evidence of margins being high in many industries. An alternative explanation may be that productivity, after many years of stagnation, is now growing faster than official measures suggest, which may be keeping unit labour costs contained.
 Treasury inflation-protected securities
This is an extract from the Q1 2019 Inflation-Linked Bonds Outlook published in March. To read the full version, click here > For more articles by Cedric Scholtes, click here > For more articles by Jenny Yiu, click here > For more articles on the Fed, click here >