Moving Forward, Slowly And Not In A Straight Line
April 2019
Our main theme in last month’s edition (“Crystal Ball Of Confusion”) was how difficult it has been trying to get a read on where the U.S. economy was, let alone where it was going, given what have been some erratic patterns in the economic data. We ended our discussion with a brief preview of the March FOMC meeting, noting that the FOMC’s crystal ball was no less murky than anyone else’s so, as such, nothing they did at their March meeting would surprise us. As it turns out, we were correct on the crystal ball part, but, wow, were we wrong on the surprise part.
At their March meeting, the FOMC executed a dovish pivot that surprised virtually everyone with just how dovish it was. The updated “dot plot” implies no Fed funds rate hikes in 2019, and the FOMC announced an earlier end to the run-off of the Fed’s balance sheet than had been anticipated. This pivot came despite there being virtually no change in the FOMC’s economic outlook. This strongly implies that the FOMC had become more concerned with the downside risks to their baseline outlook given abnormal volatility in much of the U.S. economic data, global growth having slowed more sharply than anticipated, and a still uncertain outlook for the resolution of the ongoing U.S.-China trade dispute.
In short, with muted inflation pressures giving them cover, the FOMC has adopted a “wait and see” approach. Or, as Fed Chairman Powell put it (four different times) in his press conference following the March FOMC meeting, “the data that we’re seeing are not currently sending a signal that suggests moving in either direction,” at one point adding that “it’s a great time for us to be patient.” Contrast this with the December 2018 FOMC meeting, at which the FOMC raised the Fed funds rate by 25 basis points, issued a “dot plot” implying two funds rate hikes in 2019, and made no changes in the run-off of the Fed’s balance sheet – which Chairman Powell described as being on “auto pilot.”
If you recall how badly the financial markets reacted to the relatively hawkish stance the FOMC took at their December 2018 meeting, you’d be reasonable in assuming the markets would have fallen head over heels in love with the dovish pivot the FOMC executed at their March meeting. As it turns out, the markets weren’t even mildly infatuated with the FOMC’s policy pivot. Repelled might be a better term, and the main takeaway for many market participants was something along the lines of “what does the FOMC know that I don’t?” This was best seen in the fixed income markets, with sharp declines in long-term market interest rates indicating a pessimistic view of prospects for economic growth. Indeed, between March 19, the first day of the FOMC meeting, and March 22, yields on 10-year U.S. Treasury notes fell by almost 20 basis points, which left the spread between 10-year and 3-month Treasuries inverted, triggering fears that a recession was only a matter of time. Indeed, futures markets began pricing in the probability of cuts in the Fed funds rate. We’re guessing this was not the reaction the FOMC was going for.
To be sure, the inverted Treasury yield curve didn’t last long, but though the spread between 10-year and 3-month Treasuries turned positive at the end of March, it nonetheless remains uncomfortably narrow, indicating a fairly dour outlook for the economy over coming quarters. Granted, the economic data remain somewhat difficult to interpret, given what have been some wild swings in some series, such as the retail sales data, but our interpretation is that while economic growth in the U.S. is decelerating, as we have for some time been expecting would be the case in 2019, fears of recession are overdone. Moreover, there have been signs that global growth is stabilizing and, given added fiscal and monetary stimulus in many nations, growth could pick up a bit over coming months. A U.S.-China trade deal would only improve the prospects for U.S. and global economic growth.
Both the ISM Manufacturing Index and the ISM Nonmanufacturing Index have come off their recent highs, but both remain firmly in expansionary territory, consistent with our premise of growth settling into a slower pace. One positive side effect of the sharp decline in long-term market interest rates is a renewed burst of activity in the housing market. To be sure, the month-to-month data are inherently volatile, but single family construction and sales have responded to lower mortgage interest rates. Relative to their Q4 2018 average, purchase mortgage applications are up 9.3 percent thus far in 2019, and prospects for the spring sales season are much brighter than they seemed at the start of 2019. More than any other data series, it is the labor market data that make us comfortable with our assessment of the U.S. economy. After wild swings in the January and February data, total nonfarm employment rose by 196,000 jobs in March, with job growth remaining notably broad based. The March employment report was relatively free of the sampling issues, seasonal adjustment noise, and weather effects that plagued the January and February reports. The unemployment rate held at 3.8 percent in March, and though growth in average hourly earnings disappointed in March, a longer view of the data shows wage growth continues to trend higher.
Though Q1 real GDP growth may come in a bit soft, keep in mind that the GDP data remain beset by residual seasonality, which tends to bias Q1 growth in any given year lower. We continue to expect full-year 2019 real GDP growth between 2.0 and 2.5 percent. If nothing else, the bond market is a daily caution against becoming too complacent in assessing the economic data and a daily reminder to respect the downside risks to our baseline outlook. Still, while the U.S. economy may be moving at a slower speed, it nonetheless continues to move forward.
Source: BEA; BLS; Census Bureau; ISM; Mortgage Bankers Association
