U.S. Outlook: Will Conventional Wisdom Hold? Next Week is Pivotal
Conventional wisdom on the strength and resilience of the U.S. expansion will be tested next week. Many economists, including ourselves, think U.S. GDP growth slowed to around 1.5% in the third quarter from its 2.0% second-quarter pace. However, many are forecasting, and the equity market is anticipating, a rebound in U.S. GDP growth to around 2.0% in the fourth quarter and for 2020 as a whole.
We will get our first peek at Q3 GDP on Wednesday when the Bureau of Economic Analysis releases its advance estimate of Q3 GDP. The report is expected to be another Rorschach test, where bulls and bears will both find something to love and hate. Bulls will point out that, despite a big slowdown in consumer spending in August, strong consumer spending in June and July is expected to keep third-quarter real consumer spending growth at a respectable 2.8% annualized pace. One just has to ignore the fact that real consumer spending was far stronger in the second quarter coming in at a sizzling 4.6% annualized pace.
Bears will note that U.S. growth is now resting on just one leg. Business investment spending is expected to contract for the second consecutive quarter, with big declines in structural and business equipment spending. The trade war and slowing global growth are curbing U.S. exports, making the U.S. trade deficit even worse. Turns out trade wars are not so easy to win.The Fed’s Medicine
The conventional wisdom in the markets today is we may get a phase one trade deal with China soon. Therefore, the U.S. economy could achieve a soft landing (with the Federal Reserve’s help) and growth can continue at around a 2.0% pace over the next five or six quarters.
The Fed will most likely give investors one more quarter percentage point “insurance” rate cut on October 30th, marking the third rate cut since July. The Fed may also signal that the FOMC is ready to pause awhile to see if the monetary medicine they just delivered is having the desired effect. Administer too much monetary medicine and you could be inflating unsustainable asset price bubbles. Administer too little monetary medicine and this growth slowdown we are in could quickly turn into something more serious for businesses and consumers.A Recession Indicator Flashes
If consumer spending misses a beat in the fourth quarter, there is little other support for the U.S. economy to fall back on. Growing deterioration in the University of Michigan’s Consumer Sentiment Index relative to the Conference Board’s Consumer Confidence Index isn’t a very reassuring sign of consumer resilience. Divergence of these two measures because of a drop in consumer sentiment has been a reliable indicator of future recessions. Historically, the trough in this measure occurs on average about six months before a recession begins. Unfortunately, the indexes are currently following a very similar path to other pre-recession periods today.
We expect some improvement in the ISM Manufacturing Index in October, but it probably won’t be enough to push the measure back into expansion territory. A manufacturing rebound could not be sustained anyway if the U.S. consumer starts to catch the slowdown flu. In short, next week will be pivotal for testing the market’s assumption about a soft landing for the economy and setting up U.S. growth expectations for the fourth quarter.
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