U.S. Quarterly Economic Forecast

Living on the Edge

Date Published: September 19, 2019

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Global economy: Early-Year Greenshoots Nipped by the Frost from Trade Winds

  • Amid mounting trade tensions and geopolitical uncertainty, we have revised down our global growth outlook for 2019 and, to a lesser extent, 2020. This year’s estimate of 2.9% would mark the weakest pace in a decade, leaving the world economy with a thin cushion to absorb political and economic shocks. 
  • Within the advanced world, Europe has been home to the greatest data disappointments in recent months, including Germany and the UK. Growth downgrades have also been incorporated for a number of emerging market economies, especially those in South East Asia, where the current slump in global manufacturing has been highly visible.  
  • Historically, deteriorating economic conditions in Europe and Asia have not led to recessions in North America. The economic and financial linkages generally flow in the other direction. However, a further weakening in foreign demand and trade flows will continue to restrain growth in the U.S. and Canada. 
  • Fortunately, moves by central banks around the world to ease monetary policy are expected to help soften the negative cycle taking hold in sentiment and ultimately sow the seeds for a modest recovery in 2020. In addition, there seems to be more appetite to complement supportive monetary policy with fiscal stimulus. Actions remain in the planning stage for a number of countries and will be closely monitored.   
  • At the end of the day, economic outcomes will remain closely linked to political outcomes. As of yet, no off-ramp has been identified to the trade battle between the U.S. and China. Moreover, the U.S. continues to wield the threat of auto tariffs on the EU to enhance its position in trade negotiations. Other geopolitical risks have also moved back to the forefront (Brexit, Argentina, Iran and Hong Kong). Political risks offer the dominant downside risk to our forecast, but could quickly transform into upside risks in the event of timely resolutions. 

Other Forecasts

U.S. Economy: Fiscal boost cushions tariff hit

  • Economic growth remains in line with our June forecast.  Although we have lowered our 2019 annual average forecast by 0.3 ppts, to 2.3%, that reflects downward revisions to the historical data that weakened this year’s starting point. 
  • Looking ahead, we have edged down our 2020 growth projection to 1.7% (from 1.8%). This average masks a slowdown in the quarterly pattern that would have been even larger were it not for two well-timed offsets. The recent spending deal in Washington will raise outlays above the levels assumed in our prior forecast.  The outlook for the consumer is also a little brighter following upward revisions to the historical data on personal income. 
  • Table 1: Economic & Financial Forecasts
      2019F 2020F 2021F
    Real GDP (annual % change) 2.3 1.7 1.8
    Rates (%)      
    Fed Funds Target Rate  1.75 1.75 1.75
    2-yr Govt. Bond Yield  1.60 1.80 2.20
    10-yr Govt. Bond Yield  1.70 2.00 2.40
     WTI ($US/bbl) 57 59 60
    F: Forecast by TD Economics, September 2019; Forecasts for yields are end-of-period. Source: Bloomberg, U.S. Federal Reserve.
  • Although consumer fundamentals are currently strong, we remain on the lookout for broadening signs that cautious business behavior is spilling into hiring decisions. Should this occur, it would risk kicking the legs out from under the expansion.     
  • Unfortunately, it will be difficult to get a clean read on the data in the coming months. The expansion of tariffs to many consumer goods in September and those planned later this year will distort economic data through volatility in imports and inventory accumulation. Trends in domestic demand tend to provide the truer picture of underlying growth, but here too we may see distortions if consumers pull forward activity to front-run potential tariff-related price hikes. 
  • Due to the evolution of global and political risks, we expect an additional interest rate cut by the Federal Reserve by year end.

U.S. Outlook

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    Chart 1: Government Spending Helps to Cushion Growth Slowdown
  • Economic growth in the first half of 2019 has been roughly in line with our June forecast. However, a downward revision to the historical data caused a downgrade to the annual average for 2019 (to 2.3% from 2.6% in June). Real GDP growth has run just above 2.5% in the first half of this year, but we expect that pace to slow to 2% for the remainder of the year. 
  • Looking ahead to 2020, the economy will remain on two tracks. Positive tension in the forecast is coming from government and consumer spending, which incorporate upgrades relative to our June outlook (Chart 1). Negative tensions remain centered within business investment and trade, where forecast downgrades have been incorporated.
  • All told, we expect growth to cool to 1.7% in 2020. This is slightly lower than our June forecast as the well-timed boost from fiscal policy partially offsets further weakness due to the escalation in tariffs. However, the downside risks on the external trade front have also increased. With the Fed taking a risk management approach (and in light of the latest trade action), we expect one further quarter-point interest rate cut later this year on top of moves that occurred in July and September. 

Consumers carry the weight of the forecast

Chart 2: Personal Income Revised Up Upside for Consumer Spending
  • Despite the clouds on the global outlook, the U.S. consumer spending outlook remains supported by strong fundamentals. Unemployment is low and wage growth is still decent. Consumer confidence has held up, as have consumers’ intentions to make major purchases on cars, homes and big-ticket appliances.
  • These healthy fundamentals manifested in a rebound in consumer spending in the second quarter to an impressive 4.7% (annualized), following a soft start to the year (+1.1%). Much of the strength has carried into the third quarter, which is on track for 3.5%-plus. 
  • Adding to the positive momentum, personal income growth was revised upwards, lifting the saving rate (Chart 2). This places upside risk to household spending growth over the next several quarters if confidence holds. 
  • That said, we’ll have to see how rattled consumers are over the recession-talk headlines and latest escalation in the China-U.S. trade war. The next round of import tariffs on Chinese goods will affect more consumer goods than previous rounds. While a 15% tariff is not game changing, particularly given offsetting movements in exchange rates, it will add to the upward pressure on prices that’s already materializing in the data, crimping purchasing power. In addition, volatility in financial markets since the new tariff announcement may prompt consumers to become more cautious.

Fiscal risks recede

  • In late July, Congress agreed on a two-year deal which raises spending caps for fiscal 2020 and 2021 and suspends the debt ceiling for those two years. This eliminates two key fiscal risks from the forecast.
    • First, the automatic spending cuts mandated by the 2011 Budget Control Act will not occur on October 1st. (In fact, with the BCA set to end after 2021, the risk of automatic spending cuts is now permanently off the table.) 
    • Second, suspending the debt ceiling for two years removes the tail risk of a confidence-damaging eleventh-hour standoff or debt default. 
  • Incorporating the impact of the budget deal into our forecast raises real GDP growth in 2020, all else equal. Our previous forecast had assumed the automatic spending cuts would be avoided, but the current spending deal lifts the caps by more than we had assumed, adding roughly 0.2 percentage points to the GDP outlook for 2020.

Domestic investment reflects slowing global growth

Chart 3: Slowing Global Growth has Dented U.S Manufacturing
  • As expected, business investment contracted in the second quarter. Production shutdowns at Boeing contributed to the weakness, but the pullback went much further than that. Investment in nonresidential structures also fell nearly 10% on broad-based weakness. Monthly construction spending data suggests weakness has continued and the category is expected to decline again in the third quarter. 
  • Other  forward-looking indicators are not encouraging. The ISM Manufacturing Index fell below 50 in August, indicating the sector is contracting. As we discussed in our recent report, there is solid evidence that slower global growth is hurting U.S. manufacturing activity, particularly those sectors which are most exposed to external demand (Chart 3). 
  • The next round of tariffs on Chinese imports is yet another hit to business confidence and investment, and is estimated to take a bit more than a tenth of a percentage point from economic growth in 2020. Much of this will come from lower business investment. However, the confidence channel remains the wildcard should it deteriorate more than expected.
  • The strike at GM also presents a downside risk to growth in the fourth quarter. If it is prolonged it could subtract a couple of tenths in the fourth quarter, which could be recouped quickly in the subsequent quarter as production returns to normal. 
  • The one saving grace to business investment is strong spending on intellectual property. But, this makes up only one-third of all business investment and will be hard-pressed to fully push against the impact of deteriorating confidence, weakness in corporate profits and slower demand from abroad. Investment is on track to slow from 6% in 2018 to around 2.5% this year, and decelerate further in 2020.

Housing remains constrained

Chart 4: Homebuyers Less Sensitive to Changes in Mortgage Rates
  • Healthy consumer fundamentals and lower mortgage rates have not yet translated into better data for the housing market. Indeed, housing demand appears to have become less sensitive to falling interest rates in recent years relative to the pre-recession period (Chart 4). 
  • Still, we would not give up hope on at least a modest housing recovery. There is typically a six-month lag between the drop in mortgage rates and rise in home sales.
  • On the supply side, housing starts rebounded strongly in August following several months moving sideways. Should an increase in supply be sustained it will help alleviate existing inventory pressures, which are starting to show up in accelerated price growth, reducing some of the past improvement in affordability.
  • We expect housing starts to continue to gain ground over the forecast. However, affordability constraints mean that the sector won’t contribute much to economic growth over the next couple of years. 

Lower growth expectations = lower yields

Chart 5: Trade Worries Send the U.S. Yield Curve on a Wild Ride
  • The re-escalation of trade tensions has caused government bond yields to crash the world over. After falling over 100 bps from October 2018 to May 2019, the U.S. 10-year Treasury yield fell another 60 bps over the summer, before rebounding by almost 40 basis points more recently. Even with the Federal Reserve cutting its policy rate in July and September, the negative yield spread between the U.S. 10-year and 3-month T-bill remains at around 15 basis points.
  • The yield curve has a strong track record in predicting recession, but its history is not perfect. Other models relying on forward-looking economic indicators point to lower recession odds. Still, the sustained yield curve inversion is a significant development that will put pressure on the Fed to deliver another cut in the policy rate to shore up market confidence (Chart 5).
  • We expect the Fed will cut rates 25 basis points for a third time this year, to further cushion the economy against uncertainty. The Fed’s research has shown that since monetary policy affects the real economy with a significant lag, it needs to act preemptively to get ahead of any slowdown. 
  • Our expectations on the Fed’s policy path materially hinges on political outcomes. Should the U.S. succeed in achieving a credible and lasting trade deal with China, the Fed could step away from further cuts with a key area of uncertainty receding from the outlook. 
  • The U.S. trade-weighted dollar had reasserted itself after the recent wave of risk-off sentiment in financial markets. The Broad Index appreciated approximately 3% from mid-July to early September, with the Emerging Market index up nearly 2% in the first week of August alone. This move was largely due to the depreciation of the Chinese renminbi, which broke through the psychological 7-threshold per U.S. dollar. Should the U.S. follow through on further tariff action,  risk-off trading would continue to put pressure on the renminbi and other emerging market currencies versus the U.S. dollar. 
  • The U.S. dollar has appreciated relatively less compared to advanced economy currencies over the past two months (about 1.6%). Much of this comes in the form of euro depreciation. With the German manufacturing sector hard hit due to the slowdown in global trade, the euro has depreciated about 3% from its peak in June. 
  • Trade tensions are expected to persist, keeping the greenback well supported. A stronger greenback will help to keep inflation contained as tariff pressures build on product prices. Even if inflation remains modestly above the Fed’s target, they will likely show tolerance and place the emphasis on the building downside risks to the outlook that would ultimately exert downward demand pressures on prices in the medium term.

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