U.S. Quarterly Economic Forecast

Global Economy: Peak Uncertainty

Date Published: March 14, 2019

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Summary

  • The slowdown in global activity has intensified since November, particularly in Europe and East Asia. This is occurring due to a mix of temporary and more insidious influences that are muddying the waters on the underlying growth trend. Global economic growth is expected to trough just below its 3.3% trend pace in 2019, which is a mark-down from our previous estimate of 3.4%. 
  • Europe has the misfortune of a collision of two downdrafts. The first includes temporary production disruptions related to new environmental standards. This influence should slowly unwind in 2019. The second downdraft, however, has the potential to be more detrimental to the outlook. Early data signals point to an underlying malaise in core European economies that likely reflects the layering of elevated trade uncertainty, slowing foreign demand, and related declines in consumer and business sentiment. This bears closer monitoring for evidence of stabilization.
  • Peak global uncertainty and slowing economic activity have caused policymakers to pivot towards greater patience. As a result, last year’s global stock selloff has largely reversed, and other measures of financial market stress are easing. This relative calm in the market can easily be disrupted if the economic data consistently disappoint and/or political tensions reignite global uncertainty. 
  • Political trade uncertainty remains the biggest near-term risk to market sentiment and global growth prospects. Despite some optimism recently expressed on a China-U.S. trade compromise, there is little scope for a quick resolution on the weightier topics of corporate malfeasance. Furthermore, a China deal would not remove trade risks altogether. The U.S. administration would then pivot to the EU as its next target, wielding the threat of auto tariffs to enhance its position in trade negotiations this year.

Other Forecasts

U.S. economy slowing, but resilient

    Economic & Financial Forecasts
      2018 2019F 2020F
    Real GDP (annual % change)      
    Canada 1.8 1.2 1.8
    U.S. 2.9 2.4 2.0
    Canada (rates, %)      
    Overnight Target Rate  1.75 1.75 1.75
    2-yr Govt. Bond Yield  1.86 1.85 1.85
    10-yr Govt. Bond Yield  1.96 2.10 2.10
    U.S. (rates, %)      
    Fed Funds Target Rate  2.50 2.50 2.50
    2-yr Govt. Bond Yield  2.48 2.50 2.50
    10-yr Govt. Bond Yield  2.69 2.85 2.85
     WTI, $US/bbl 59 62 66
     Exchange Rate (USD per CA 0.73 0.75 0.76
    F: Forecast by TD Economics, March 2019; Forecasts for oil price, exchange rate and yields are end-of-period. Source: Bloomberg, Bank of Canada, U.S. Federal Reserve.
  • Economic activity decelerated at the close of 2018, but remained on steady footing at 2.6% in Q4. For the year as a whole, the economy likely expanded by 2.9%. These estimates remained consistent with our December forecast cycle. 
  • The 2019 quarterly GDP pattern carries through a softening trend. This has been a main feature of our forecast for some time, as fiscal and monetary stimulus wanes. The 2019 forecast is tracking a tad softer than in December, at 2.4% (with Q1 carrying an extra weight from the government shutdown). Real GDP in 2020 is projected to be 2.0%, as fiscal stimulus shifts to fiscal drag. 
  • Consumer spending has been a pivotal source of strength in 2018, despite December weakness due to a perfect storm from equity volatility and the government shutdown. Persistent strength in the job market still offers upside risk in this area of our 2019 consumer forecast profile. 
  • In contrast, slower global growth and softer business confidence will manifest in softer business investment in our upcoming forecast. Likewise, housing investment has remained soft, as we expected. The recent drop in mortgage rates should offer a helping hand. 
  • Fiscal policy has not left the landscape as a downside risk. Although a second government shutdown has been averted, a bigger hurdle will present itself at the end of 2019, when Congress needs to reach a new spending deal. The alternative would result in damaging automatic spending cuts taking effect. All else equal, this would significantly compromise our 2020 real GDP growth estimate, bringing it to 1.3%. Given recent difficulties within Washington in agreeing to funding levels for the current fiscal year, this risk is as important as ever. 
  • In the wake of a larger diffusion of softening economic momentum across countries and persistent downside risks, the Federal Reserve has shifted to a wait-and-see stance. We removed rate hikes from our forecast, and any further move is highly conditional on solid economic momentum ultimately feeding into higher inflation expectations, which is currently lacking.   

U.S. Outlook - Slowing, But Still Topping G7

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    Chart 1: Beyond quarterly volatility, growth moderating
  • Economic activity decelerated in the final quarter of 2018, but held a steady footing at 2.6%. For the year as a whole, the economy expanded by 2.9%, consistent with our published forecast in December. 
  • For 2019, the U.S. outlook faces a number of crosscurrents. A global slowdown is unfolding precisely as the domestic economy gets off to a slow start due to idiosyncratic reasons. The typical “residual seasonality” phenomenon that has historically depressed growth in the first quarter was compounded by the 35-day partial government shutdown. Tallying it up, real GDP growth is expected to hover near the 1% mark (annualized) in the first quarter. Since both of these depressing forces are temporary, activity should rebound to roughly 2.8% in the second quarter. 
  • Looking through the quarter-to-quarter volatility, the GDP pattern is likely to average roughly 2% over the year (Chart 1). This is consistent with our long-standing narrative that the economy will continue to face a gravitational pull towards potential growth under fading fiscal stimulus. That pull becomes more forceful in 2020, weighing real GDP towards a sub-2% print, as fiscal policy faces the reality of becoming a drag after priming the pump for two years. Ongoing fiscal injections may yet occur, but it would be hard-pressed to be of the scale and scope of past measures due to ballooning deficit and debt levels.
  • In fact, the two main risks to our outlook stem from policy in Washington. The current budget deal expires at the end of September, and we assume that Congress will agree to extend spending at 2019 levels. This would avoid automatic spending cuts – sequestration – which would shave half a percentage point from our current 2020 GDP estimate. 
  • In a test of Congress’ resolve around higher debt, they will first need to agree to raise or suspend the debt ceiling, which came into effect on March 2nd. The Treasury can fund government operations until roughly September, using accounting moves called “extraordinary measures”. However, if the clock runs down, volatility would likely kick-up in financial markets.
  • The other policy-induced risk to our outlook comes from the impact to business confidence from ongoing punitive tariffs and unresolved trade disputes. Although recent news headlines have been more positive on China and the U.S. reaching an agreement, the devil will be in the details. We hope an agreement occurs in short order because the toll on manufacturing sentiment domestically and globally is already evident. Should a deal roll back the tariffs that were put in place, we estimate that this, in combination with a boost to sentiment, could add about 0.1-0.2 percentage points to growth in our 2020 outlook. However, this will not mark the end of the trade journey for the Administration, whose sights are already set on Europe, where the threat of punitive auto tariffs continue to dangle. Any goodwill to market sentiment from a China-U.S. deal could be undone by a souring of the European-U.S. relationship. 

Consumer fundamentals solid

    Chart 2: Strong labor market healing the scars of the great recession
  • To gauge the health of consumers, it’s important to look past the volatility captured in the month-to-month data and focus on the overall trend. After an impressive 311k jobs were added in January, momentum ground to a halt in February, with only 20k net new positions. Averaging out the past three months places the job tally at a solid 186k pace. This remains slightly below, but consistent, with our December forecast. Softening momentum is in complete alignment with slower economic growth. By no means does it suggest a collapse in the job market is in the offing. The jobless rate has been fairly steady, as new positions are being filled by rising labor force participation.  
  • The healthy labor market is healing the scars caused by the recession. Labor force participation among core-aged workers (Chart 2) deteriorated in the wake of the financial crisis and struggled to improve until after 2015. We expect this metric to make further headway over the year, supporting income and consumer spending.
  • Wage growth has also accelerated. Average hourly earnings have risen by more than 3% (year-on-year) since August. In other words, it is outstripping inflation by a healthy margin, boosting the real spending power of households. 
  • Despite these strong fundamentals, consumer purchases weakened sharply at the end of 2018, as confidence took a hit from the government shutdown and stock market rout. A rebound in January retail sales proved that consumers had not left the building, but the first quarter will still be weighed down by a weak hand-off. Overall spending for the quarter is expected to be around 1% annualized. A rebound in Q2 is already in the making, and healthy labor markets suggests a slightly above-trend pace of 2% thereafter. 

Business investment a downside risk

  • Business investment ended the year on a surprisingly solid note, rising 6.2% annualized. This occurred in the face of continued weakness in nonresidential structures, which declined 4.2%. Overall investment spending has two areas to thank for its strength in the quarter. Outlays for intellectual property jumped up 13%, while equipment outlays also chalked up a healthy and accelerating pace of 6.7%. 
  • Overall we expect business investment to moderate in 2019 and 2020, in line with slower growth in the economy, both domestically and abroad. However, it’s important to bear in mind that spending should be cooling from what proved to be a high watermark.  
  • Uncertainty about the trade environment has weighed on business confidence and presents both upside and downside risk to our investment forecast. Much will depend on how the trade negotiations go with China, and whether some of the pressures alleviate on global growth prospects. 
  • Residential investment has long been the sore spot in the economy’s balance sheet. This category fell 3.5% at the end of 2018, marking the fourth consecutive quarter of contraction. Housing starts rebounded in January from a large drop in December, but the weak hand off combined with muted activity in the resale market  still points to another contraction in residential investment in the first quarter. It is only thereafter that we embed a modest pick-up. Fortunately, the recent move lower in mortgage rates and healthy consumer backdrop should help the recovery along. 
  • Chart 3: Mortgage rates have come down since October 2018
  • Of all the areas in our forecast, the housing sector probably has the greatest potential to surprise on the upside. Housing affordability has improved recently due to the combination of a 60 basis point drop in mortgage rates and softer home price growth relative to incomes (Chart 3). This could unleash demand from the coming wave of millennial households (see our report Room to Grow: U.S. Housing Demand to Rebound from 2018 Setback). Despite recent weakness in housing indicators, both rental and owner housing vacancy units remain low. The low vacancy rate combined with a pickup in housing demand implies that if and when supply constraints diminish, housing construction could move higher than our current assumption. If housing proves stronger than our current modest expectation, than it means that we may also prove too modest on our consumer spending profile due to the tight correlations between the two markets on items like furniture, appliances, renovation activity and so forth.

Benign inflation gives Fed room to be patient

    Chart 4: Expectations for the Fed declining with inflation expectations
  • Amidst it all, the Federal Reserve can afford patience. Their preferred measure of inflation, core PCE price index (excludes food and energy), has only recently edged slightly above a 2% annualized pace in both November and December. Previous soft readings left the year-on-year pace at 1.9%. Given that the central bank sees the target as “symmetrical” around 2%, we suspect that it would take a much larger breach above that mark to fuel concerns of falling behind the inflation curve. 
  • Even with this in mind, financial markets may have swung too far into dovish territory by driving 10-Year Treasury yields down 68 basis points over seven weeks. This is because recent inflation data suggest only a modest softening in inflation pressures. Core CPI inflation, which is two months ahead of PCE data, has decelerated to 2.1% on a three-month annualized basis as of February, but the move does not appear overly concerning. On net, inflation is playing out in line with our December forecast, and we expect it to remain in the Fed’s comfort zone over the year. This supports a longer term yield closer to 2.80% by year-end.
  • Global concerns have caused market participants to ratchet down expectations for Fed rate hikes and tempered inflation expectations (Chart 4). More recently, the Federal Reserve capitulated to this view in its decision to shift to a wait-and-see monetary stance at its January meeting.  However, wait-and-see doesn’t mean absolutely no more hikes. 
  • Now that the fed funds rate is at the lower end of the estimated neutral range (2.50% to 3.50%), the data must make a compelling case for further rate hikes.  The timing for a possible rate hike is highly dependent on a number of preconditions we laid out in Market Insight
  • The greenback has remained quite stable over the last few months. While many major economies have hit a major growth slump, the U.S. economy is still chugging along. We would normally think this economic outperformance would cause capital flight into U.S. dollar assets and an appreciation of the greenback. However, against advanced economies, the greenback is effectively unchanged since the start of the year. Relative to emerging market currencies, it is down just over 1%.  
  • Going forward, we expect other major currencies to gain some ground against the U.S. dollar, as the pessimism currently priced into many of those currencies does not come to pass. These forces are forecast to lead to a modest depreciation in the trade-weighted U.S. dollar over the next two years, but the road may be choppy along the way. 

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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

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