U.S. economic growth was solid at an estimated 2.6 percent in the fourth quarter of 2018, but we expect first quarter growth to slow to about 1.0 percent. This stems in part from tighter financial conditions, but reported growth is also likely to be weighed down by seasonal adjustment issues along with the temporary impact of the government shutdown.
The good news is that sequential growth is likely to rebound in the second quarter as statistical and shutdown distortions are reversed. Nevertheless, growth is now on a downward trajectory in year-over-year terms. The combination of tighter Fed policy and fading fiscal stimulus will ensure that growth in 2019 is weaker than it was in 2018. Leading indicators confirm that the peak in growth is behind us, and our recession forecasting tools continue to point to a downturn starting by mid-2020. However, there is a chance that a Fed pause could delay a downturn until late 2020 or even early 2021.
Leading Indicators Confirm that the Peak in Growth Is Behind Us
Leading Economic Index, YoY% Change
Leading indicators confirm that the peak in growth is behind us, and our recession forecasting tools continue to point to a downturn beginning by mid-2020.
Source: Guggenheim Investments, Bloomberg. Data as of 1.31.2018. *Note: includes cycles ending in 1970, 1980, 1990, 2001, and 2007. Shows the evolution of the LEI starting 48 months before the recession. Current cycle is assumed to end in February 2020.
Meanwhile, the steady softening in global manufacturing purchasing managers’ indexes illustrates how global growth momentum has faded. Growth in Europe is sputtering, and the ongoing Brexit saga is still unresolved. The steady slide in Chinese growth has prompted authorities to announce a series of stimulus measures with more forthcoming, but policy lags will delay any positive impact.
U.S. Is Still Outperforming as Global Growth Downshifts
The steady softening in global manufacturing purchasing managers’ indexes illustrates how global growth momentum has faded.
Source: Guggenheim Investments, Haver Analytics, Markit, JPMorgan. Actual data as of 2.28.2019. PMIs are GDP-weighted. Values above 50 denote expansion in manufacturing activity.
Against this backdrop, the Fed has moved to the sidelines. A pause in the hiking cycle is likely for the first half of the year, but we do not believe the Fed is done tightening just yet. The labor market continues to strengthen, and we see further wage gains ahead. And while core inflation should remain soft in coming months, we expect it to rebound in the second half. Our baseline forecast now envisions one more hike later in the year. Further rate hikes may be required in 2020 should inflation expectations begin to rise meaningfully. Balance sheet runoff should conclude in the third quarter, with details likely to be announced at the March meeting. This will allay market concerns about balance sheet reduction being on “autopilot.”
A more patient Fed and multi-pronged stimulus in China should foster a recovery in risk assets in the near term. Additionally, the ECB may add liquidity through long-term refinancing operations (LTRO) or targeted LTROs. This would support our call for an Indian Summer for risk assets, which is characterized by the warm spell that follows a cold snap. We see this as a window of opportunity to further de-risk portfolios in preparation for a 2020 recession.
—Brian Smedley, Head of Macroeconomic and Investment Research; Maria Giraldo, CFA, Managing Director; Matt Bush, CFA, CBE, Director
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