2020 Economic Outlook: Policy Deemed “Appropriate,” for Now, Despite Evidence of Weakness
After a third-round rate cut, the Committee appears convinced earlier action is already working to stabilize domestic activity, propelling the economy toward sustained 2% growth and inflation. Evidence of ongoing weakness in business investment, manufacturing and other key sectors of the economy, however, suggest the economy may be continuing to lose momentum despite further accommodation. While the Committee appears confident in navigating a soft landing, policy makers will remain vigilant in assessing the evolution of the data; should the fundamentals continue to weaken, falling materially and perpetually below the central bank’s forecast, coupled with the risk of a reduced global growth profile, particularly in the wake of an unlikely lasting, structural U.S. trade resolution with China weighing on international output, rates are likely to resume their downward trend, forcing the Fed to step back into the market come 2020 and provide additional support. For now, a new lower range of 1.50% to 1.75% has been deemed “appropriate.”
Consumer, Labor Market and Housing
As a consumer-based economy, personal consumption has been and remains the primary driver of economic growth in post-recessionary times. Even more so over the past six months, consumer spending has acted as the engine of the economy and the sole organic support to growth with all other key categories of activity trending into net negative territory. While confidence remains elevated, albeit noticeably below the recent peak, slowed hiring and modest wage improvement will likely limit further optimism on a relative basis, and more importantly, on a nominal basis, the consumer’s ability to indefinitely carry the economy – alone.
By a number of metrics, the labor market remains positive, yet hardly robust heading into 2020. Businesses continue to put Americans in a position of gainful employment, however, nonfarm payroll growth has slowed from 223k in 2018 to an average pace of 180k in 2019 as of November. Going forward as businesses curtail plans for expansion and increasingly rely on technology, projections suggest a further loss of momentum to under 150k in 2020. Furthermore, while the unemployment rate remains at a near 50-year low, the structural displacement of millions of workers continues to distort an accurate account of the country’s unemployed and underemployed. As Minneapolis Fed President Neel Kashkari recently noted in a CNBC interview, the civilian unemployment rate is “basically meaningless.”
“I think the nominal unemployment rate is basically meaningless. It only counts people who self-identify as actively looking for work. And yet many people who entered the job market the last month…many people who took jobs this month, in the prior month said they weren’t even looking. And so this is just a flawed measure. To me, we need to look at wage growth.”
- Minneapolis Fed President Neel Kashkari, CNBC Interview, November 4, 2019
Factoring in those on the sidelines of the labor market pushes an augmented measure of unemployment nearer 7%. While painting a more dire picture of joblessness in the country, a broader measure of unemployment is also more easily reconciled with circa 3% wage gains. If the true level of “unemployment” was sub 4.0% as it has been for the past ten months, and the minimal amount of slack that implies in terms of the pool of available labor, wage pressures would be mounting to the tune of 3.5%, 4% or even 4.5%.
On an individual basis, some firms continue to report difficulties finding specific talent to fill particular needs amid an ongoing and deep-rooted skills mismatch. Other firms, however, reporting longstanding job vacancies have increased reliance on alternative means to supplement their labor needs using automation or other technologies to fill open positions. In the longer-term, technology can act to displace workers, fueling fears of a technological takeover and emboldening those who call for a “robot tax” or other limitations on businesses’ ability to automate. Innovation and technological advancements, however, can also create new job opportunities, some of which haven’t even been thought of in this day and age. In the early stages, the former can be more prevalent, resulting in lingering disruptions and downward pressure on labor market metrics, particularly wages. While some advocate policy protection to mitigate these potentially negative or painful impacts, arguably the best – and most fair – solution is simply time to allow the labor market to settle at a new equilibrium.
Further restrictions on the consumer via stagnant wage growth or reduced employment opportunities – save for those with engineering, IT or similar highly desirable skills – will act as a restraint on consumers’ ability to ramp up discretionary purchases of everyday items such as big screen TVs or a new spring wardrobe. Retail sales, a proxy for the financial flexibility of consumers, is already raising red flags with increasing volatility and more recent slower-than-expected growth heading into the key holiday spending season. Firm footing on the part of the consumer would imply consecutive months of solid upward momentum in spending. Additionally, within each month, a simultaneous rise across most, if not all, categories would imply a strong consumer. More recently, however, consumers have been dramatically shifting the goods and services in their basket on a month-to-month basis more indicative of fragile financial footing. Earnings limitations will also curtail consumers’ ability to make big-ticket purchases, such as autos or homes. Reduced mortgage rates have helped stabilize housing market activity on the margin, creating a welcome incentive via a reduced monthly mortgage payment, but while cheap financing is desirable, cheap homes are even more enticing.
Home prices had been appreciating at an aggressive 6% average annual pace from 2017 to 2018, more than double wage growth and reaching a peak of 6.7% in March 2018, according to the S&P Case-Schiller 20-City Home Price Index. Since then, however, due to a rising inability – as well as an equally intense unwillingness – consumers have curtailed home purchases at such elevated costs. Home prices, while still gaining ground year-over-year, have slowed to an average 2.4% growth rate, now noticeably below average wage acceleration. Although, while the run-up in housing costs has slowed, after years of aggressive price increases, the nominal cost of a home still remains well beyond the average American’s means. Assuming an average savings rate and median income, for example, it would take most 30-40 years to save for a down payment of a median priced home in many of the country’s top cities. Furthermore, with household debt at $13.95 trillion, including $1.50 trillion in student loan debt, many potential home buyers, independent of the lack of affordability, continue to snub their nose at the prospect of taking on an additional liability against already massive levels of outstanding debt.
With an expected continued minimal growth level of production, investment and trade, the reliance on the consumer will only intensify heading into 2020. Without meaningful wage improvement, however, consumers’ contribution to topline activity, while positive, is likely to weaken, undermining the economy’s ability to maintain even a moderate growth profile and threatening a rising risk of negative output. A more pronounced consumer pullback would likely be the end to the expansion outright. While positive market news, including an initial Phase One trade deal, could help stave off weakness in the short-term with a slight acceleration in GDP growth over a 3-6 month period via pent-up exuberance, the balance is already tilted toward a further slowdown in growth next year, falling well shy of the Fed’s 2.2% forecast as well as the economy’s expected longer-term run rate of 1.9%. While sustained negative growth for at least two consecutive quarters remains a growing probability in the coming 18-24 months, the economy is more likely to stay afloat, although minimally, with GDP periodically slowing below 1% on a quarterly basis and stalling nearer 1.2% annually as opposed to meeting the Fed’s forecast of 2.0% in 2020.
Investment, Technology and Inflation
Significant tax reform as well as pent-up orders demand from earlier sluggish activity prompted an improved environment of business investment in 2017 that carried into the end of 2018. Plateauing more recently with an outright decline in the second and third quarters of 2019, however, business investment has waned almost as fervently as it had earlier ascended. A reflection of slowed global growth as well as a deteriorating domestic outlook and divisive politics, corporations have curtailed capital flows and instead stockpiled cash. A contentious political environment, in particular, has seemingly overshadowed many of the positive incentives available to corporate America in an environment of low interest rates and ample liquidity. Yet with partisan politics making it virtually impossible to understand, let alone predict the future “rules of the game,” uncertainty has become a paralyzing force, pushing businesses to the sidelines. Additionally, on an international front, unresolved policy issues including a disorderly Brexit, geo-political strife in Hong Kong, Russia and the Middle East, and most prominently, unfavorable global trade relations have curtailed market activity around the world and disrupted international business lines, resulting in declining demand for American-made goods and undermining healthy export growth.
As business leaders increasingly question the viability of the domestic expansion now in its 11th year amid a veil of unknowns, there is an increased hesitancy on the part of corporate America to invest in everything from new office space to warehousing and manufacturing facilities to large equipment. Corporations have, however, been willing to invest in technology and automation, or more broadly, any system or machine that can assist to drive higher efficiencies while reducing costs. Going forward, such a narrow allocation of funds is likely the beginning of a longer-term trend driving business decisions well into 2020 and for years to come.
Technology, however, comes as a double-edged sword: on the one hand, investment in automation, for example, can help increase productivity which has languished in the United States for the better part of the past decade at just 1.4%. On the other hand, a further integration of robotics and AI could act to displace traditional labor force participants, compounding the negative pressures in the labor market, including a lack of momentum in wages. After all, as businesses become less reliant on the labor component for production, there is less pricing power on the side of employees, which can result in reduced hiring, hours worked, wages or a combination of the three. In other words, laborers’ share of output becomes less of a factor influenced by the Fed or monetary policy than by other arms of public policy driven by an adaptation of technology. According to a Brookings analysis of BLS data, 22% or 36 million Americans in the workforce are at high risk of being replaced by automation, including those in food services, short-haul truck drivers, and clerical office workers. An additional 32%, or 52 million, jobs are furthermore at medium risk of being replaced by technology.
Of course, in the longer-run “most” economists would agree technology is actually not labor replacing but labor augmenting, meaning some jobs will be lost but other jobs will be created. After all, as productivity rises, such efficiencies translate into lower costs or a reduced cost of production, freeing up capital to be invested in new and innovative areas – many that haven’t even been considered in today’s market – as well as creating new jobs and opportunities. While from a humanistic standpoint, such a structural adjustment can be very painful and financially crippling on an individual level, from a broader economic perspective, technology will likely aid in further perpetuating the U.S. economy to a more efficient, more productive level of activity while offering a further restraint on inflation.
Unimpressive wage growth – along with other key indications of reduced price pressures – offered the Fed welcome room to cut borrowing costs earlier this year, a trend that is likely to continue as companies seek to raise productivity via technology as opposed to additional employees, and cooling global demand results in a further importation of deflationary pressures. A reduced European outlook, furthermore, as a result of a disorderly Brexit or another dysfunctional political outcome, as well as a more pronounced showdown in China beyond the weakness already evident in the last 18 months would further compound global deflationary pressures, as would potentially a near-term and superficial trade deal absent a pathway to a longer-term agreement. After all, reduced tariffs can actually retard near-term inflationary pressures. Additionally, in regards to trade specifically, it will take an extended timeframe for meaningful improvement in the world’s growth profile if – and that remains a big if – international trade barriers are permanently removed.
In the meantime, as a global trade war looms, tariffs on more than $350 billion of Chinese goods and $7.5 billion of European goods, including potential duties of up to 100% on $2.4 billion of French products, as well as reinstated tariffs on steel and aluminum from Argentina and Brazil due to a "massive devaluation" of those countries' currencies have acted to reduce international access to global markets and products, raising the cost of parts and materials for manufacturers and producers. That in turn has increased the price of goods using those inputs, reducing private-sector output. The end result, however, has largely been a reduction in income for both owners of capital and workers via reduced profits and capital income as opposed to higher consumer prices. In other words, at this point, suppliers and producers have, to a great extent, absorbed the price increases offsetting higher costs with lower wage growth, reduced hours worked, or both, rather than passing along the increased cost of production to the final consumer for risk of losing market share. Producers’ hesitancy to raise the costs of end goods reinforces concerns regarding the fragility of the consumer. If American shoppers were as solid as some monetary policy makers would suggest, businesses should have no problem passing along the increased costs from the imposition of tariffs onto the final good. Without a much improved footing on the part of American shoppers, producers facing limited pricing power, will be forced to further absorb cost hikes with fragile demand restricting overall market inflation metrics below the Fed’s preferred measure.
The Fed has emphasized the importance of anchoring inflation and inflation expectations at the Committee’s 2% objective, which much of the Committee feels confident it has done. With the latest read of the PCE at 1.3% and five-year forward inflation expectations subdued at 1.7%, however, it appears there remains a lingering gap of more than 50bps, a spread that could continue to grow without a meaningful solution to international pressures or independently, a surge in domestic output. The Committee is currently undergoing review of its monetary policy strategy, tools and communications, with a focus on potential alternative strategies, including targeting an average rate of inflation or price level targeting. However, with the Committee falling short of its inflation target for the better part of the past decade, it remains to be seen whether policy makers will make an adjustment even if the review concludes that a change should be made.
Government, Trade and Market Pressures
In the absence of positive growth in inventories, trade, and investment, and behind the primary, organic support from the consumer, government spending has provided nominal fuel to assist the economy’s moderate growth over the past year. Of course, government expenditures, while technically a positive contribution to the quarterly calculation, provide only artificial “support,” representing an – inefficient – reallocation of private-sector capital, with little, if any, indication of a return to a longer-run pathway to prosperity. Furthermore, at such minimal levels of support, contributing less than three-tenths of a percentage point to headline growth mid-year and given the bloated and rising size of the government’s balance sheet, federal outlays will more likely become a liability to growth as opposed to an asset in the coming year(s), placing an increased burden on the American taxpayer and further ensuring the consumer’s inability to perpetuate the expansion.
The U.S. government deficit rose 26% or $205 billion, from $779 billion in FY 2018 to $984 billion in FY 2019, the largest deficit since 2012 when it topped $1 trillion and the economy was still crawling out of recession. As a share of GDP, the deficit increased to 4.6% in 2019, up from 3.8% in 2018 and 3.5% in 2017. Last month, Chairman Powell emphasized monetary policy makers’ concerns over the massive and growing size of federal debt, and the potential inability for federal spending to help supplement future economic weakness. Without fiscal stimulus, the burden to support a faltering economy would rest solely on the Fed already restrained by a low interest rate environment.
“The federal budget is on an unsustainable path, with high and rising debt. Over time, this outlook could restrain fiscal policy makers’ willingness or ability to support economic activity during a downturn.”
- Federal Reserve Chairman Jerome Powell, Speaking to the Congressional Joint Economic Committee, November 13, 2019
Along with an expansive debt, political discourse has risen – or perhaps more aptly phrased, fallen – to a new level, with elected officials on both sides of the aisle resorting to harmful and divisive rhetoric which – justified or not – has retarded the ability for civil discourse, let alone compromise. No longer based on the merits of policy, political strategy has been reduced to personal attacks with such visceral and unbecoming behavior increasingly visible – and showcased – in today’s social media environment. Intensified by the upcoming 2020 election and the pending impeachment inquiry, the inability for government representatives to reach across the aisle has eliminated any prospect of bipartisan support for much needed legislation including but not limited to, infrastructure spending, which could have acted as a large and welcome stimulus for the economy as well as much needed funds which both sides agree are needed to upgrade America’s antiquated roads, bridges, and tunnels.
[Unfortunately] The political focus at present remains on destroying the “other side,” creating a proverbial wedge amid countrymen as well as growing the divide between the two potential political environments come 2021. Historically, politics has created an uncomfortable level of uncertainty for businesses and consumers alike, disrupting or mitigating spending and hiring plans even as both Democrats and Republicans tend toward the center. More recently, however, as the right and the left move further to their respective ends of the spectrum, the extremes proposed by each party has made it virtually impossible for corporations to outline a longer-term strategy. Further tax cuts or tax increases including a wealth tax? Increased regulation and pressure to break up large companies or protectionist policies and higher import costs? Forced investment and liquidity limitations or investment in domestic industry? Medicare for all or medical cost transparency? Immigration restrictions or open borders?
Whether Democrat or Republican, as investors, the unknowns across the potential presidential platforms seem to be more numerous and consequential than ever before, further exacerbating an already tepid investment environment, which will likely continue to muddy the waters and restrain capital flows until election results shed light on which direction voters choose to send the country – and by extension, the economy. In the meantime, a broad, negative reaction to the impeachment hearings or other political pressures will expectedly continue to upset financial markets with extreme volatility whipsawing between higher highs and lower lows with equities in particular acutely focused on policy as opposed to fundamentals.
Policy uncertainty, furthermore, is not limited to domestic concerns or issues. The ongoing trade and tariff war continues to wreak havoc on international relations and realized activity across borders. Increasingly a quantifiable drag as opposed to the qualifiable impact resulting from political nonsense, rising tariffs have led to a significant loss of productive utilization in the domestic market as well as restricted access to global markets. While China, as an export-dependent economy, has without question suffered the brunt of the pain from deteriorating relations and a reduced trade platform, the U.S. has not escaped unscathed. Domestic production, for example, as of November has trended into contractionary territory (a reading below 50) for four consecutive months, with the pace of manufacturing hiring broadly declining, averaging just 5k over the past six months.
After nearly a year-and-a-half of the ongoing trade war, more than $350 billion of Chinese goods are already targeted with tariffs from 15% to 25%. As a result, Chinese imports to the U.S. have declined to $382 billion from $413 billion two years prior, with U.S. exports to China slowing from $104 billion this time in 2017 to $88 billion as of October. Agricultural exports, in particular, have fallen 4% to $112.148 billion, down from $116.281 billion this time last year, and further complicating the political landscape with a disproportionate amount of pain being shouldered by American farmers, some of President Trump’s most fervent supporters in 2016.
More broadly, with more than $473 billion in goods trading hands between the two countries, it is a sober reminder of what remains at stake with the layers of barriers that have been placed on the free flow of goods and capital across borders. A Phase One deal specifically between the U.S. and China appears to have been struck, already prompting the Trump administration to bypass an intended increase in tariffs back in mid-October and, if signed, should result in the administration bypassing the next round of levies set to go into effect December 15th. There have also been preliminary indications – although uneven – that tariffs already in place are on the table to be rolled back if a longer-term deal structure can be agreed to.
Grandiose visions of global trade aside, the more near-term success remains a Phase One deal. A step in the right direction, a round-one deal remains very limited in nature with the majority of the focus on agriculture – increasing agricultural purchases of U.S. farm exports as well as adhering to international safety and regulatory standards – which could help alleviate pressure on America’s heartland just in time for the administration to regain support for the 2020 election but does little to solidify a broad-based agreement. Such an agreement, however, fails to address tougher issues like China’s industrial subsidies; there are also very few details regarding forced technology transfers and counterfeit of goods according to those familiar, two issues that the Trump administration has reiterated as a key focus since the onset of the trade and tariff war. In other words, even if a Phase One deal is officially struck by year-end, with a removal of “some” tariffs on Chinese goods in “stages” into 2020 or even after next year’s election, as the President has suggested remains a possible timeline, there is still considerable ground to cover beyond the first step before a longer-term, lasting and meaningful deal addressing foundational variables is met between the world’s two largest economies.
Furthermore, while an initial deal is likely to be reached, the economic damage has already been done and will take an exponentially longer timeframe to unwind and ease distortions in the production pipeline than it took to create them. Policy adjustments often take twice as long to undo the damage done. Thus, a near-term deal may stop the bleeding, but the global economy has still taken a sizable hit and will need time to recover with only a minimal probability for a longer-term structural adjustment in terms between the U.S. and China. With key structural issues no closer to being resolved, a mini deal would, at best, simply delay a breakdown in the negotiations into next year or beyond – when the 2020 election results are in. Of course, a more favorable outcome or a reduced timeline for a lasting deal to be signed and delivered would no doubt represent a rare upside risk to the baseline forecast.
Meanwhile, investors seem to be discounting such longer-term concerns, instead viewing any further news – no matter how insignificant or unfounded – of a potential de-escalation of trade tensions as justification to push risk assets to new record levels. In in the last 90 days, the market has set 11 new session highs. Of course, on the flip side, discouraging comments or details can have an equally negative impact on the market along the way to a more uncertain end-game. Earlier this month, for example, the President suggested a U.S.-China trade deal may be postponed until after the 2020 election, a lengthy prospect that forced equities down more than 550 points over two days of trading. Less than 24 hours later, however, unnamed trade officials were quoted as being hopeful that the pact could in fact be completed before another tariff deadline on December 15, reinstating market participants’ optimism and offsetting earlier declines with the Dow gaining 512 points over the next three days. Going forward, hope of further progress beyond an initial and superficial Phase One agreement could continue to buoy stocks, but exuberance in and of itself only goes so far; a realized agreement will need to be reached in order for such momentum to be sustained. A sizable extension in the timeline or other setbacks could quickly deflate unsupported enthusiasm in the equity market back down to levels more closely aligned with a U.S. economy poised for a longer-term growth rate of less than 2%.
Monetary Policy and Global Pressures
The latest read of domestic activity reported a U.S. economy hobbling along at roughly a 2% pace July to September, the bare minimum expected for a developed economy assuming 1% from productivity gains and 1% from population growth. Third quarter’s 2.1% growth rate also marks the second consecutive quarter of waning momentum from a more robust rate of 3.1% at the start of the year. Although, a more positive assessment could argue the U.S. economy actually gained one-tenth of a percentage point in Q3 from second-quarter’s reduced activity level as the consumer continued to support the economy at a stronger-than-expected clip. The latter issue, however, raises another level of concern with the composition of domestic growth far from diversified and furthermore, begs the question of whether or not the consumer will be able to continue to carry the economy alone, particularly if weakness spreads further into the labor market.
Taken together, a 2% economy marred by slowed employment growth and contracting production not only justifies earlier rate cuts in July, September and October, but perhaps perpetuates the need for additional action to stave off a continued slide in economic activity levels should weakness persist into the new year. At this point, however, Fed officials have signaled a desire to move to the sideline, bypassing a rate increase at the December FOMC meeting. Convinced earlier action is already working to stabilize the economy, Fed officials have signaled a pause, perhaps indefinitely, with the latest third-round cut now more than 40 days ago.
Earlier rate reductions were characterized as “insurance against potential external risks” or preventative measures against unforeseen shocks stemming from abroad. After 75bps of increased accommodation, however, the market would undoubtedly find it increasingly difficult to see any additional action as insurance but rather outright support for a faltering economy. Thus, the Fed would no doubt prefer to remain on the sideline, least it be forced to acknowledge the weakness in the economy which could serve to undermine confidence and potentially offset or overshadow the benefits from a further reduction in borrowing costs for businesses and consumers.
The latest October rate cut was the “final” rate cut, at least for 2019. Going forward into 2020, however, as inflation moves closer to 1.5%, rather than the Committee’s 2% target, and growth moderates further, the Committee will expectedly capitulate to offering further rate reductions to stabilize the economy amid a sub-par growth and inflation profile, despite their perceived commitment to hold rates at the current “appropriate” level through the end of next year. The Fed remains data dependent, ready and willing to provide additional support, but will do so reluctantly. The threshold for further action has very clearly increased – meaning more of the same or further evidence of a continued moderate economy in terms of activity and prices will not be enough to force the Fed’s hand. A marked deterioration in the data through the first half of 2020, however, with GDP slowing below 1% and the PCE stubbornly below 1.5% will expectedly offer the needed evidence to convince officials that additional stimulus is warranted. The Fed is on hold for now, but a compelling argument above and beyond “more of the same” will likely reinvigorate the easing train.
With rates already at historically low levels, however, the Fed has an arguably reduced level of ammunition to combat further weakness in 2020 and beyond, undermining the potential benefits from easy monetary policy. Such a limited arsenal, therefore, potentially compounds the need for the Committee to act more aggressively than they otherwise would with ample room to lower rates. While the Fed may be confident three rate cuts were enough, at least for now, if weakness persists, the Fed may not have the tools needed to boost growth and consumption this time around without turning to non-traditional metrics, such as growing the balance sheet. In other words, with interest rates already historically low, the Federal Reserve may quickly find itself at the lower bound of monetary policy, resorting instead to extraordinary instruments, such as quantitative easing (QE).
The impact of quantitative easing, however, may not be as sizable as it was the first time around during the global financial crisis and may need to be supplemented with other tools, including forward guidance. As Fed officials have noted, the – positive – impact from QE during the financial crisis was in good part predicated on the fact that financial markets were “really disrupted,” a scenario that may not render the same “bang for the buck” in more normal times. At the very least, the size of an asset purchase program would likely be substantially larger during a future downturn relative to the financial crisis given the reduced supplemental support from nominal rate reductions. Of course, a muted downturn relative to the ’08 recession could mitigate the need for additional stimulus from nontraditional metrics. Furthermore, fiscal policy stimulus remains an option for providing short-term support, although unlikely. Given a divided Congress and partisan politics, as well as a rising federal debt, there is little ability let alone appetite for cooperation, least reaching across the aisle be seen by voters as “working with the enemy.”
In an ideal scenario, the Fed would be able to orchestrate a soft landing by implementing the exact level of accommodation needed in 2019 in order to stabilize the economy at the Fed’s forecasted levels of 2% growth and inflation. However, much of the Fed’s confidence that earlier policy adjustments were the “correct” amount of stimulus is centered on a continued robust performance in the domestic economy and in particular, the labor market which may not be reflective of reality. Rather, a reduced trend pace of hiring and a continued decline in production suggests the economy continues to wane even after three rounds of rate cuts. As a result, first, the Fed may be making a gross misassessment of the current “strength” of the economy particularly on the consumer side, and second, further stimulus may be needed in short-order entering the new year if the economy continues to fall short of the Committee’s projections. After all, the Fed has set the bar at 2% GDP and 2% inflation, thus a perpetual pace below these targets would expectedly prompt a policy response.
While the Fed has all but removed the prospects of a near-term rate cut, should production and hiring remain anemic – independent of a one-off strong report – it will be difficult for the Fed to perpetually argue against a further reduction in rates given the Committee itself has set the bar for economic performance. Furthermore, with inflation likely to move closer to 1.5% as opposed to 2% next year, coupled with a disappointing resurgence in domestic – and global – growth in the aftermath of a Phase One trade deal rather than a longer-term agreement, rates are likely to resume their downward trend, forcing the Fed’s hand back into the game after a brief stint sitting in the bleachers. In fact, with the Fed clinging to an overly optimistic forecast, a material miss to the downside well into Q1 2020 suggests at least two additional rate cuts – or more – could be warranted to buoy the real economy up to meet the Fed’s heightened expectations.
The European Central Bank is similarly struggling to prop up growth and inflation in the Euro-region. Before handing the reigns to former IMF director Christine Lagarde, in his eight years of leadership Mario Draghi was able to prevent a breakup of the Eurozone but was unable to meet the price target of 2% with inflation stuck close to 1.3%. With the downside risks to the euro area now growing, the ECB has maintained its package of record low rates with the key rates at 0.0%, 0.25% and -0.50%, as well as a renewal of QE at 20 billion euros ($22 billion USD), which began in November with no expectation of being rolled back until "shortly before it starts raising the key ECB interest rates." Going forward, like in the U.S., economic growth in the Eurozone is likely to remain anemic well into 2020 with Germany continuously teetering on the brink of recession and minimal momentum in France. Incoming management will therefore expectedly offer further policy stimulus next year despite officials, like their American counterparts, seemingly anxious to buy time on the sideline before making any policy moves.
A hard Brexit or deeper-than-expected slowdown in China will expectedly result in further downward revisions to global growth and rate expectations. China’s economy has slowed to 6.0% in the most recent third quarter, although other indications suggest market activity has remained somewhat more resilient in recent months supplemented by a government-fueled surge in building. Although, with the “boom” in property construction arguably on borrowed time and headwinds from higher food inflation and cooling global demand likely to be amplified near-term, there are few pathways – if any – that map an alternative to a further slowdown into 2020. Meanwhile, for the U.K., while a number of scenarios remain in regards to orchestrating a divorce from the bloc, the most likely – a no deal departure on January 31, 2020 in the aftermath of U.K. Prime Minister Boris Johnson’s victory in the latest vote on December 12th or even a another round or two of delays – is likely to compound the pressure on the domestic economy already struggling to cope with earlier declines in demand and investment, and increasing pressure on the BOE to lower rates further from 0.75% as of November.
By all accounts, the risk of a reduced global growth profile and an outright recession rises noticeably in 2020 and beyond, particularly in the wake of an unlikely lasting, structural U.S. trade resolution with China weighing on international output. Rather than specifically back-to-back quarters of negative output – a technical recession that affords the opportunity for balance sheet clean-up – a more alarming scenario is a projection of a non-accelerating economy. In such a situation, growth continues to slow indefinitely with GDP falling well below the Federal Reserve’s forecast of 2%, perpetuating an environment of extremely low rates across the curve and further eroding the productive capacity of the country to organically jumpstart growth back into meaningfully positive territory and onto a pathway to longer-run prosperity. Of course, incoming data is more dependable than looking at longer-term models and should be more closely adhered to and analyzed to identify a recession or a potential slowdown in 2020, as well as appropriate investment strategies.
-Lindsey Piegza, Ph.D., Chief Economist