2019 was a very unusual year. Domestic growth whipsawed from strong (over 3%) to concerning (just over 1%). This volatility was compounded by both domestic and global headline factors: a very public trade dispute and very weak global growth. Policy was also in play. The Fed rotated from tightening, to neutral, to easing in the first 3-quarters of the year. Nominal rates moved up a little at the start of the year, but then dramatically declined for the first three quarters with the 10-year falling from 2.69% to 1.46% by the start of September. This low in intermediates coincided with a very modest 5 basis point (bps) inversion in the bellwether 2-year to 10-year yield curve measure. Around the same time, a significant repo market disruption occurred that the Fed countered with QE-like intervention. By year-end, the bulk of the economic growth scare had dissipated, the yield curve was more normalized, rates across the curve were lower by 80- 100 bps and risk markets had logged in some of the best returns over the past 10-years.
Chart 1 shows three measure of economic activity: Last twelve months (LTM) of quarterly Gross Domestic Product (GDP), the National Association of Purchasing Managers Purchasing Managers Index (NAPMPMI) and the Conference Board’s Leading Economic Index (LEI). The former tracks trailing domestic growth. The latter two indicators are more forward looking.
All three indicators reflected a slowing domestic economy. The material message from the PMI and LEI, however, is that while decelerating over the bulk of 2019, both indicators suggest that the domestic economy is no longer weakening. Indeed, the current readings are very similar to those we experienced at the bottom of the 2012/13 and 2015/16 growth slump periods. The biggest difference between 2019 and those previous periods is the focus and magnitude of weakness in the industrial and manufacturing sectors, recently amplified by the decline in the Purchasing Managers Index to a “Contracting” 47.2 reading on January 3rd. Comparing the current conditions to the previous two recessions supports our view that the current situation is slowdown, but not evidence of a lead up to recession. In both those cases, the LEI continued to weaken all the way through the point where GDP went negative. This is not the trend we are seeing today. Our view is that the Fed’s forecast of 2% growth in 2020 is potentially a little high in the nearterm, but broadly consistent with our assessment of approximately 2% growth for 2020. Any strength above that number will likely develop in the second half of 2020.
Chart 2 displays two important inflation measures over the past 10-years: Personal Consumption Expenditures (PCE) and Average Hourly Wages (AHW). Since consumer behavior represents roughly 2/3 of GDP in the US, the Fed is especially conscious of trends in personal consumption. This measure remains relatively well behaved under the Fed’s 2% inflation target. Wages, as represented here in AHW are a cause for concern.
Our view is that wage pressure will ultimately put upward pressure on prices, but that its effect will continue to be muted by productivity, global and technological substitution. As such, we regard inflation as a potential problem, but one that will more likely become evident in the face of synchronized global growth and reflation. As we witnessed in 2019, the market will undoubtedly extrapolate any surprises on the inflation side insofar as it might foreshadow a change in Fed behavior.