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Gloom, Despair, Agony . . . And Above-Trend Growth

2019 de enero

As 2018 came to a close, considerable turmoil in the financial markets, uncertainty over the course of trade policy, and trepidation over the course of monetary policy made it easy to lose sight of the fact that the U.S. economy stepped into 2019 on firm footing. Indeed, those of us who have pointed out that the economic data remain fairly solid have found that seems to not matter much these days. The release of the December employment report is the latest illustration of our point. Total nonfarm payrolls rose by 312,000 jobs in December, but before the ink was even dry on the December employment report there were those who felt compelled to point out past instances in which outsized job growth in one month was followed by a recession several months down the road. Which is on the order of saying that the economy keeps on growing until it doesn’t. In any event, as we do each January, we’ll use this month’s edition to outline what we see for the U.S. economy this year.

Though the GDP data for Q4 2018 are not yet available, Q4 real GDP growth was tracking right around 3.0 percent, which would put full-year 2018 real GDP growth at 2.9 percent. This would be just above the 2.8 percent growth our 2018 forecast anticipated, and would make 2018 the best year of economic growth of the current expansion. While we were fairly close on top-line real GDP growth in 2018, the mix of growth was a bit different than our forecast anticipated, with consumer spending, business investment, and government spending a bit stronger than anticipated and residential investment weaker.

Our baseline forecast anticipates real GDP growth of 2.6 percent in 2019. We do not look for the mix of growth to change materially, with consumer spending, business investment, and government spending more than taking up the slack from flattish residential investment and a wider trade deficit. We will, however, point out that by year-end 2019 we expect fading fiscal stimulus and the cumulative effects of tightening financial conditions will begin to weigh on real GDP growth, with Q4 2019 real GDP growth right at 2.0 percent and a further deceleration in growth in 2020.

PBI real

Real GDP chart

Sources: Bureau of Economic Analysis; Regions Economics Division

Our 2019 growth outlook is consistent with further tightening of labor market conditions. While we do not think we’ll come close to matching the 2.638 million nonfarm jobs added in 2018, we do look for job growth of just over 2.0 million jobs in 2019. We look for the unemployment rate to end 2019 at 3.5 percent, compared to the 3.9 percent unemployment rate in December 2018. While we expect some further acceleration in wage growth in 2019, we look for Q4/Q4 growth in average hourly earnings to be below 3.5 percent (year-on-year wage growth was 3.15 percent in Q4 2018).

As labor becomes increasingly scarce and costly, firms will have more incentive to push for efficiency gains in the form of faster growth in labor productivity. This, along with what is an aged and less efficient capital stock, accounts for why we look for further growth in business investment in 2019. To be sure, business investment ended 2018 on a soft note, but our view is that this was mainly a reflection of heightened uncertainty over trade policy and worries over the ill effects on global economic growth from a bad outcome on that front. We are, at least implicitly, assuming a benign resolution of current trade disputes, meaning trade policy poses a clear downside risk to our baseline forecast.

Thanks to sharply lower energy prices over the past two months, headline inflation will be pushed lower in the early months of 2019, meaning that core inflation (or, inflation excluding food and energy prices) will take on added significance. While we do anticipate some acceleration, with core PCE inflation at 2.3 percent at year-end 2019, we do not expect core inflation to pick up to the point that it would concern the FOMC.

We look for a single 25-basis point hike in the Fed funds rate target range in 2019. While the FOMC’s December 2018 “dot plot” implied two 25-basis point hikes in 2019, as 2019 began the futures markets were pricing in no funds rate hikes, and some even argue that the next move by the FOMC will be a rate cut in an attempt to fend off recession. That seems a bit much to us, given our expectations for growth and inflation in 2019, but our thinking is that steadily tightening financial conditions and the ongoing reduction in the Fed balance sheet are in essence making monetary policy tighter than what is embodied in a rising Fed funds rate. This should result in fewer funds rate hikes than would otherwise be the case. At the very least, the FOMC has the latitude to be patient, and we could easily see them being on hold for the first half of 2019 until there is more clarity on: trade policy; the extent to which growth is slowing; and whether, or to what extent, core inflation is accelerating.

Additionally, while the FOMC is treating it as a nonevent, many market participants see the unwinding of the Fed balance sheet as draining liquidity from the system and effectively making monetary policy tighter than the FOMC seems to think is the case. It was on this point that the markets melted down during Fed Chairman Powell’s press conference after the December 2018 FOMC meeting. As such, rather than the path of the Fed funds rate, the Fed balance sheet could pose the biggest policy and communications challenges to the FOMC in 2019. We do agree that the downside risks to growth have intensified of late. That said, while not impossible, the reality is that an awful lot would have to go wrong for the U.S. economy to slip into recession in 2019.

Source: BEA; BLS

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