The latest GDP report for the US showed their economy in strong form, with a 3.5% annualised gain in the three months to September following the June quarter’s 4.2% rise. For the year to date, growth is currently running at a 3.3% annualised pace, close to twice potential.
In assessing the outlook for the US economy, it is important however to not only consider the headline result, but also the underlying detail. Put simply, we need to assess where growth is showing resilience and also where it is at risk.
The out-and-out positive for the US economy remains household consumption. In the September quarter, growth for this sector printed at 4.0% annualised, a touch stronger than June’s 3.8%. For perspective, growth for the last six months is well in excess of the 3.0% average of the past five years, and the 2.5% seen annually since the beginning of 2010 (post-GFC). Given the strength of employment and accelerating wages growth, this momentum is hardly surprising. Also unsurprising owing to rising interest rates is that in 2019, more of total consumption’s growth has come from services rather than durable goods (principally cars).
In stark contrast to the enduring strength of consumption however stands residential investment. From its most recent peak of 11%yr at September 2015, annual growth first slowed to around 4.0% a year later, and now just 0.4%yr. Indeed, activity in the sector has declined by around 3.0% annualised over the past nine months.
Why is this the case? There are a variety of reasons, but chief among them is likely the income and wealth deficit of younger Americans who have built their careers post-GFC, and the fact that many of these individuals are also struggling to pay back significant student debt liabilities. Also increasingly evident in the data is a pull-back in the institution-led, build-to-let market. For this sub-sector, a significant ramp-up in supply in major cities and rising interest rates warrant investors take a much harder look at new projects.
The status quo for residential investment is interesting, but relatively insignificant for aggregate growth due to its limited share of the economy. Far more important is the trend in business investment.
Here we have also seen a deceleration of late, from an annualised pace of 12% at March to just 1% in September. Note though that this abrupt loss of momentum is as much about the first quarter of 2018 being abnormally strong as the third quarter being weak. The deceleration in annual growth has been much more sedate, having eased from 7.1%yr at June to 6.4%yr in September.
Extrapolating out from the September quarter result, a number of the regional surveys suggest momentum will disappoint hence. Core durable shipments and orders to September tell a similar story, with both broadly showing a flat trend over the quarter.
Coming into 2018, the view of many was that business investment would rise rapidly and then sustain a strong pace of growth as extraordinary tax and fiscal support spurred US businesses to finally make up for years of underinvestment post-GFC.
However, it increasingly seems that the robust uptrend anticipated by others will not be seen, with US corporates instead remaining focused on financial efficiency; M&A; and the considerable uncertainty associated with US trade policy.
On the latter, while most in the market seemingly hold that US tariffs will be a net positive for investment in the US, we believe this is unlikely to be the case. Simply, even if US firms decide to shift production from China, they do not have to move it to the US to escape the imposition of tariffs. Across the world, there are many other nations offering better long-term cost and efficiency opportunities for production than the US.
Omitting the considerable volatility apparent in net exports and inventories of late, given the above, we remain of the view that US GDP growth will remain strong through to mid-2019.
However, from that point, persistent weakness in business investment and a softening consumer pulse (on the back of reduced employment growth; still-moderate wage gains; and higher interest rates) will see annual GDP growth come back to trend.
Amid considerable global uncertainty and in the absence of an inflation threat, these outcomes should be sufficient to see the FOMC go on hold indefinitely after raising the federal funds rate to 2.875% (mid-point of range) at their June 2019 meeting.
That is a solidly argued base case. We still think Trump will fire up more stimulus next year as growth slows which then sets up a 2020 bust as the Fed is forced to tighten further…