First Blush 2019 Economic Outlook – Our Core View Growth Softens, But Marches On
Sep. 8, 2018 Commentary

First Blush 2019 Economic Outlook: Our Core View Growth Softens, But Marches On


Our core economic theme for 2018 has been Rounding Third and Heading Home. We’ve been postulating that the United States and world economies have entered the boom phase of the current economic cycle. Typically, economic growth, inflation pressures and interest rates tend to rise during the boom phase of a cycle. So far this year, these characteristics have come to fruition. Will the economic boom turn into a recession bust soon? Our work today represents our core economic outlook for 2019.

Update on Boom Economic Phase

We sense the boom characteristics mentioned above may have further to play out. We’ve been forecasting the U.S. economy should grow by 3 percent this year (“real” gross domestic product (GDP) growth). Growth has risen by 2.9 percent over the last 12 months while economic activity surged by more than 4 percent during the second quarter of 2018. Our expectation of an increase in overall GDP growth has come to fruition.

As economic cycles mature, inflation and growth tend to push upward. This is part of the typical boom phase of the economic cycle. Over the last 12 months, prices for consumer goods/services have risen 2.9 percent, up from an annual rate of 1.7 percent a year ago. We’ve been calling for inflation to rise this year. Our outlook for rising inflation pressure has happened along with inflation, interest rates have risen as the Federal Reserve has increased interest rates seven times over the last 24+ months.

All major economic segments are participating in this expansion in overall economic growth. The drivers behind this ramp-up in economic activity remain in place. However, it appears to us that the “boom” phase, which we have been speaking of over the last year, may start softening as we enter 2019.

Signs of Economic Strength – And Maturity?

A number of economic signs are suggesting the current cycle entered a boom phase late last year. It remains in this phase. Our core economic case for 2019 is that the U.S. economy continues to grow through the boom phase, but the pace of overall growth should slow from the strong pace we are currently witnessing. Consider the following evidence suggesting a maturing economic cycle is at hand.

  • While economic conditions aren’t scheduled, it is interesting to note that the current economic cycle officially started during the second quarter of 2009. Since 1985, we have witnessed three previous business expansions, with the average lasting 95 months. The current expansion is now 111 months in duration. The longest cycle lasted 120 months. By comparison, this cycle is aged (data per NoSpinFORECAST).
  • Unemployment rises during recessions as economic final demand contracts. The opposite occurs during periods of economic growth. Unemployment falls. Currently, the official unemployment rate at 3.9 percent (as of July 2018) is lower than the average low unemployment rate reached over the last three business cycles. The labor market, by past standards, is mature. Many economists agree that the nation has entered a full employment position. Nationally, there are currently as many job openings as people who are officially unemployed, a sure sign of a mature jobs market. It is interesting to note that at its peak, there were 6.6 people unemployed for every job opening (July 2009), per the Bureau of Labor Statistics.
  • Following a long period of caution, consumers are feeling more confident, reflecting a mature jobs market. Consumer discretionary spending growth has doubled since the first of the year. Spending growth rates are exceeding income growth rates. Consumers are increasing the use of revolving credit and lowering savings rates. All historical economic signs of cycle maturity.
  • Interest rates are rising as demand for capital matures and becomes stronger. The Federal Reserve has historically raised interest rates when the economy is headed towards recession. Over the last 24+ months, the Fed has raised short-term interest rates seven times as monetary policy marches towards normalized status.
  • Money supply growth (M2) has risen 4 percent over the last 12 months. During the same period of time, nominal GDP growth (real GDP growth plus inflation) has been 5.8 percent. At its core, demand for capital (nominal GDP growth) is starting to outstrip added supply of capital (M2 growth). When demand exceeds supply for any commodity, prices tend to rise. Of course, the price of money is interest.
  • Short-term interest rates historically rise through long-term rates as the economy matures. Yield curve inversion has occurred prior to the last number of recessions. The yield curve (level of long-term interest rates to short-term rates) has flattened. Treasury notes maturing in two years were yielding a scant .18 percent above 10-year Treasury maturities. A year ago, longer-term rates were .77 percent higher than short rates. The bond market is telling us that the business cycle is maturing.

2019 – Rounding Third and Heading Home Continues 

We believe the U.S. economy will show positive, albeit slowing growth rates for the remainder of this year. Along with slowing growth rates, we suggest the current rise in inflation pressures could eventually subside later in 2019.

Our estimates over the next 3 years.

Let’s step through some of the building blocks that lead us to the estimates noted above…that overall U.S. economic growth should remain positive for 2019 while growth rates decelerate. As noted, inflation pressures will continue to slowly build through next year – typical activity for a late-stage economy. Consider the following points of evidence which lead us to believe there will be continued overall moderate economic growth occurring over the next 12-18-month period.

  • A number of the economic growth benefits accompanying the tax package should lessen as 2019 unfolds, due to calendarization. Comparisons will become tougher throughout 2019 because of the initial benefits which occurred in 2018.
  • In general, we think the stage will be set next year for consumption growth to eventually slow from the 2017 – 2018 rates. Rapid growth in consumption patterns tends to go hand-in-hand with strong improvement in the jobs market. As stated above, the jobs market has reached maturity. We expect consumption activity to be firm next year, but repeating this year’s results may be difficult.
  • Interest rates should continue to rise. As an example, we think 30-year mortgage rates could rise to 5 percent sometime in 2019, up from 4.5 percent currently. But the real fireworks regarding interest rate changes in 2019 may occur in short rates. We suggest the Fed will continue raising interest rates until mid-2019. Fed funds interest rates, currently at 1.9 percent may be in the 3 percent range by mid-2019. Remember, Fed funds traded at .3 percent less than two years ago, per the St. Louis Federal Reserve.
  • Overall, uncertainties accompanying both economic and non-economic events may, on balance, create issues moderating overall U.S. economic growth over the next 12 months.
    • There are concerns accompanying trade policy uncertainties.
    • The full impact of BREXIT policies will start to become clearer as the next 12 months unfold. Will BREXIT actions push the United Kingdom into recession? Perhaps. What type of impact may this activity have on the U.S. economy?
    • China’s overall growth rate, which has slowed this year from last, may see another step downward as uncertainties surrounding trade and BREXIT activities weigh on this part of the world.
    • A U.S. national election may usher changed leadership standing from one party to another. For example, some believe the Democrats will retake control of the House of Representatives.

At the End of the Day 

So, while we expect slower overall growth and continued increases in interest rates, we are forecasting that the U.S. economy stays out of recession in 2019. Our Rounding Third and Heading Home theme should remain in place for at least the next 12-18 months. Following are points of evidence suggesting why we could see a slowing, but still positive economic growth.

  • While the Treasury yield curve has flattened, long rates are still slightly higher than short rates. Typically, when inversion occurs, it is sometime between actual inversion and the onset of a recession.
  • Another yield spread to watch is the Fed funds rate to the 2-year U.S. Treasury yield. Theory holds that this spread – which somewhat closely matches commercial bank’s cost of funds (Fed funds) to rates on loans (2-year U.S. Treasury) gets to the crux of national credit creation. Currently Fed funds are priced at 1.9 percent and the 2-year Treasury is at 2.6 percent. This spread has actually widened over the last year, suggesting bank credit creation should continue to expand.
  • The 6-month rate of change of the Leading Economic Indicators (LEI) is strong. Currently the LEI is 5 percent higher than was the case six months ago, suggesting economic growth should continue for the short/intermediate term. It is interesting to note that over the last 10 business cycles, the economy has only slipped into recession once when the 6-month rate of change of this index wasn’t down by at least 3 percent. The economy hasn’t slipped quickly into recession when the rate of change has been this high since the end of World War II (per Ned Davis Research).
  • While we believe consumption growth may slow somewhat, we expect investment spending to rise nicely over the next 12 months. Two main factors behind business decisions to invest in productivity-enhancing capital projects are interest rates (which are still very low based on historical norms) and tax policies. The recently-passed tax package ushered in an acceleration in depreciation. Businesses are now allowed to write off 100 percent of investment spending the year the spending occurs. The combination of these two factors makes us believe that business spending growth should be strong in 2019.

In the end, we believe our Rounding Third and Heading Home theme remains intact. Interest rate trends may continue to slowly push to the upside. We suspect overall economic growth should decelerate, but remain positive next year. In our view, 2019 will prove to be another year of overall economic growth, extending the current economic growth cycle past its 10-year anniversary. If so, the current cycle would go down in the history books as the longest period of time between recessions our country has witnessed.

Next month we will provide our first-blush 2019 global economic expectations.


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