U.S. Quarterly Economic Forecast

The Art Of The Deal Makes A Late Appearance

Date Published: December 17, 2019

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  • We ended 2018 with a report discussing the many event risks that required political solutions in 2019, from U.S.-China trade tensions, to USMCA, to Brexit. We close 2019 with movement on all three fronts, but not nearly as much as is needed to remove global and business uncertainty and kick-start the investment cycle. But, beggars can’t be choosers. 
  • Some de-risking in market sentiment is a net positive, but now the ultimate test will be the extent in which it is transmitted into economic outcomes. The wheels were set in motion this year with trade disruptions that not only lingered far longer than expected, but also proved more detrimental to global economic momentum. This led to a series of downgrades, with world real GDP now tracking the slowest pace in a decade at 2.8%. For 2020, we anticipate a modest improvement to 3.0%.  
  • With interest rates nearing effective lower limits in regions like Europe and Japan, the push is on for more fiscal stimulus. This can turn into a wildcard that generates better economic outcomes in 2020, but based on fiscal plans announced so far, the boost to 2020 global GDP appears similar to that of this year (+0.4 ppts).
  • Regionally, the U.S. will continue to lead the G7 in economic growth by a good margin, and recent progress on negotiations with China offer upside potential to near-term exports. However, the absence of a broader trade deal that offers clear line of sight and assurances on the business backdrop is likely to still restrain investment. Plus, trade policy uncertainty will persist with other nations, particularly Europe which is a larger trading partner to the U.S. than China.  
  • The threat of U.S. auto tariffs on the EU and Japan remains in place, but we are counting on no material tariff escalation to major trading partners during a re-election campaign that could cost jobs in key battleground states. 
  • Putting aside trade tensions and casting our eyes to other economies, many face idiosyncratic domestic challenges. This is particularly true for emerging markets that face knock-on impacts from a slowing Chinese economy, political unrest, and the risk that nervous investors divert capital at the first sign of trouble.

Other Forecasts

U.S. Economy: Fed Pivot Shores Up Demand

  • At a high level, the American economy has performed close to our expectations in 2019. Growth is on track to slow from 2.9% in 2018 to 2.3% this year. However, beneath the surface, the composition of growth is different from what we expected a year ago in two areas.
    • First, the global slowdown and elevated uncertainty stopped business spending in its tracks by mid-year and turned down manufacturing activity.   
    • Second, the Federal Reserve needed to respond by pivoting to cutting rates (a total of 75 basis points). This succeeded in normalizing the yield curve slope, but we anticipate a relatively flat curve will persist in the absence of compelling evidence of stronger inflationary or economic pressures. 
  • The good news is that the almighty consumer has responded to the lower rates in textbook fashion by increasing demand for interest-sensitive durables as well as home sales. Continued strength in job markets has also generated a positive impulse for household income and spending growth.
  • Table 1: Economic & Financial Forecasts
      2019F 2020F 2021F
    Real GDP (annual % change) 2.3 2.0 1.9
    Rates (%)      
    Fed Funds Target Rate  1.75 1.75 2.25
    2-yr Govt. Bond Yield  1.65 1.90 2.30
    10-yr Govt. Bond Yield  1.90 2.20 2.60
     WTI ($US/bbl) 56 59 60
    F: Forecast by TD Economics, December 2019; Forecasts for yields are end-of-period. Source: Bloomberg, U.S. Federal Reserve.
  • Provided that inflation remains close to the Fed’s 2% target (as we expect), the central bank is likely to move to the sidelines and patiently observe the interaction of past rate cuts on the economy as well as developments on the global and trade fronts. .     

U.S. Outlook

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    Chart 1: U.S. Growth Meets Expectations, But Makeup is Very Different
  • The U.S. economy has performed very close to expectations for 2019. We had forecast real GDP growth would slow from 2.9% in 2018 to 2.3% in 2019. With three quarters of actual data, 2019 is on track to hit our forecast. 
  • However, as global growth slowed over the year, and trade uncertainty escalated, the Federal Reserve pivoted from raising interest rates, to cutting by 75 basis points. 
  • As a result, the composition of economic growth looks different than what we expected a year ago (Chart 1). Notably, consumer spending has held up well thanks to lower rates. But business investment has disappointed as uncertainty increased, and trade and inventories proved more volatile.
  • Since last quarter’s forecast, market-based recession risk probabilities have fallen. In the wake of three Fed rate cuts, the yield curve is no longer inverted, and financial markets have calmed from the heightened worries in late summer. Inflation also remains well contained, and there are few signs of overheating in the labor market. To add to the positive developments, the year is also closing with reduced trade tensions with China and the USMCA deal inching closer to ratification. We expect the Fed to remain in a holding pattern, but stand ready to act should the outlook unexpectedly sour. 

Temporary Factors to Flatter 2020 Growth

  • We expect U.S. growth to modestly edge down to 2.0% in 2020, with a few temporary factors flattering the near-quarter headline. First, the six-week strike at GM subtracted from growth in the fourth quarter of 2019. As production ramps back up, it could add as much as 0.5 percentage points to annualized growth in the first quarter of 2020. Second, the production slowdown at Boeing due to the grounded 737 Max has also been weighing on investment through 2019. If regulators clear the plane to fly early in 2020, the ramp-up in production will also add to growth. These two factors combined could add 0.1-0.15 percentage points to GDP growth for 2020 as a whole.
  • In addition, activity related to the 2020 decennial census will lift government spending largely in the second quarter of 2020. We have included this impact in our forecast for some time.
  • There is a new wild card in the forecast related to the very recent announcement of a Phase 1 trade deal between the U.S. and China. At the time of writing, details were lacking, as was a mutually agreed-upon date for formal implementation. The end result could lead to a level-shift up in U.S. exports for a particular quarter or two, further flattering the GDP growth profile. However, this needs to be in consideration on whether a corresponding increase in U.S. imports would offer a partial counterbalance.  

Resilient Labor Market Makes Impressive Gains

Chart 2: Women Make Biggest Gains in Labor Force Participation
  • Perhaps the most encouraging trend in the U.S. economy is the sustained improvement in labor force participation among core-aged Americans. This has occurred despite heightened business uncertainty and slower economic growth. Participation rates for women have made rapid gains, and young women’s (aged 25-34) participation rate has reached an all-time high (although a significant gap remains versus men of the same age). In contrast, participation rates remain depressed for certain groups, primarily younger males (Chart 2). Despite these challenges, the share of core-aged individuals working full-time is nearing a record, which offers a key support to income growth going forward. 
  • Depending on the measure, wage gains have been between 3-4% over the past year, below the pace seen in hot labor markets in previous expansions. The Fed has also pointed out that looking at wages, it is hard to call the labor market hot. Adding to this more lukewarm picture is the modest downturn in job openings that has occurred through the year. While all regions exhibit a slowdown, the epicenter of this softness is the manufacturing-heavy Midwest. 

Lower Rates Boost Consumer and Housing

Chart 3: Boost From Lower Rates has Lifted Consumer Durables
  • The consumer remains the linchpin of U.S. growth. Solid job, wage and income gains explain the persistence in elevated consumer confidence. Household spending has also received a notable boost from one factor that was not anticipated at the start of this year: lower interest rates. Purchases on interest-sensitive durable goods have picked up noticeably through the middle of 2019 (Chart 3). 
  • Just as important, lower borrowing rates have driven an improvement in the housing market. Existing home sales are volatile on a month-to month basis, but zooming out, sales have been trending upwards through 2019 after a notable downturn in the latter half of last year. The 100-basis point drop in the 30-year conventional mortgage rate since November 2018 has helped boost demand for homes, although tight inventories are a constraint on sales and have pushed prices higher.
  • New home construction has also picked up after a period of weakness, particularly for single-family homes. Combined with stronger activity in the resale market, residential investment grew for the first time in seven quarters in the third quarter. Monthly housing indicators are also pointing to another solid outturn in the fourth quarter. 
  • The revival in the housing market will drive up housing-related purchases. Even so, consumer spending is on track to slow from a red-hot pace through the middle of 2019, to roughly 2.3% in the fourth quarter. It should hold near 2.5% through 2020, which is an upgrade from our previous forecast in a nod to strengthening household fundamentals. However, since another leg lower in borrowing rates seems unlikely, the impulse to consumers and housing will gradually fade. Consumption growth should move more in line with income growth.

Uncertainty Chills Business Spending

Chart 4: Investment Growth Slows as Uncertainty Spikes
  • The other side of the coin to brisk consumer spending is the utter stall in business investment in 2019. Business spending fell in the second and third quarters and is only expected to grow by 1% in the fourth. This is far weaker than the pace we had expected a year ago. 
  • All categories of spending are down from their 2018 pace, with investment in structures (includes oil and gas) falling at a double-digit pace in the second and third quarters. The uncertainty that has been created by tariff policy has weighed on business sentiment and held back investment (Chart 4). In our recent report, we estimate that over and above any tariff-induced price effects, uncertainty shaved a total of 20-40bps off growth since the first quarter of 2018.  
  • Investment should solidify in the coming quarters, but we don’t expect a return to its robust pace of 2017-2018 as slower global and domestic economic growth limit the need for capacity expansion. The Phase 1 trade deal is unlikely to materially alter this perception for businesses. 
  • An ongoing inventory drawdown is also expected to weigh on growth for a couple of quarters following a build-up in manufacturing and wholesale inventories in the latter half of 2018 and early 2019. This is in part related to businesses adjusting stocks in advance of tariffs, but also due to the disruptions at Boeing and GM preparing for strike action. The subsequent drawdown will continue to weigh on growth over the next few quarters. 

Benign Inflation Gives Fed Room to Breathe

Chart 5: Inflation is Still Benign
  • Despite tariffs and low unemployment, the Fed’s preferred inflation measure has not sustained the 2% target this cycle. Other measures of underlying inflation trends, which strip out the most volatile price changes rather than just food and energy, are running closer to 2% (Chart 5). However, there are few signs that inflation is about to break higher or lower.
  • As a result, after cutting rates 75 basis points in 2019, the Federal Reserve can remain patient to see how the domestic and global backdrop unfold before adjusting the fed funds rate further. 
    • The Fed’s rate cuts have helped to reverse the yield curve inversion that had been in place since the spring. Due to the resulting reset in market expectations, the 10-year Treasury yield is about 30 basis points higher from its low in September (Chart 6). Recession probability readings, which showed a greater than 50% chance of recession by the middle of 2020, have now fallen to approximately 20-30%.
    • Chart 6: Treasury Yields Following the Fed
    • With smaller interest rate differentials versus many of the other major global economies and a reduction in recession risks, the U.S. dollar has fallen nearly 2% from its peak in early September. This move was largely against Emerging Market currencies, reflecting expectations of a trade deal between China and the U.S. Now that it has lurched closer to reality, the broad trade-weighted dollar should sustain a flat-to-lower pattern in the coming quarters.

Forecast Tables & Research

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Contributing Authors

  • Beata Caranci, Chief Economist | 416-982-8067

  • Derek Burleton, Deputy Chief Economist | 416-982-2514

  • James Marple, Senior Economist | 416-982-2557

  • Fotios Raptis, Senior Economist | 416-982-2556

  • Brian DePratto, Senior Economist | 416-944-5069

  • Leslie Preston, Senior Economist | 416-983-7053

  • James Orlando, Senior Economist | 416-413-3180