The U.S. economy since the 1940’s has spent a total of roughly 130 months in recession, which is barely longer in duration than just the current expansion. Further, over the past century the economy has been growing about 80 percent of the time, meaning that although many pundits would like to go on TV and correctly predict the next recession, betting against America has historically been a losing trade. However, just because the economy has spent most of its time expanding that does not mean the current good times will last forever. The Federal Reserve Bank of New York even estimates that the likelihood of a recession has risen considerably over the past year.
This particular projection, though, is based only on the yield curve, and we have repeatedly cautioned that inversions are less an indication of an impending recession and instead simply a sign that the economy will be more sensitive to negative shocks. One of our own models also signals an uptick in recessionary risk, but less so than the NY Fed as we consider multiple economic indicators, and over the past few months the NY Fed projection has already fallen sharply to be more in line with our outlook. Moreover, while both models suggest that the risk of a downturn has increased markedly compared to earlier this cycle, the probabilities still imply that a recession beginning during the next twelve months is “unlikely” (worse than a coin flip). However, just because we do not see at least two consecutive quarters of negative gross domestic product (GDP) growth occurring anytime soon, that does not necessarily mean the expansion is about to accelerate. In fact, we see GDP rising at a slightly slower rate of 1.7 percent in 2020, with a likely range of 1.2 to 2.2 percent based in part on recent seasonal patterns, what has occurred during the past few election cycles, and prevailing headline risks.
One of the reasons for the moderation in growth is policy incertitude, i.e. trade, taxes, and regulation. With respect to trade, the tariffs (and uncertainty about future levies) created direct and indirect economic headwinds in 2019 that largely eroded any follow-through benefit from the earlier Tax Cuts and Jobs Act. Fortunately, the new “Phase One” deal between the United States and China at the very least will serve as a welcome détente in the trade war, and when combined with the possibility of a Phase Two deal could even provide a temporary boost to GDP in 2020. However, the closer we get to the November elections without a substantive resolution the less of a stimulus positive trade news will likely be because any businesses that put capital expenditure plans on hold because of policy uncertainty may continue to do so because of the election’s potential effect on future tax rates and regulatory burdens. Also of note, inventory builds ahead of expected tariff increases helped prop up GDP growth recently, and some additional giveback could therefore occur if progress with the trade negotiations continues.
Regardless, our base case for the next twelve months remains slower but still positive GDP growth as the Goldilocks expansion lives on for an 11th year. Downside risks to these forecasts include a re-escalation in trade tensions, election uncertainty, and related stock market volatility spilling over into business and consumer confidence, as well as the usual exogenous shocks. Upside risks are primarily related to the global reflation trade gaining momentum and resulting in a greater resurgence in manufacturing activity, business cap-ex, and interest-rate sensitive sectors. As for employment in America, we see monthly payrolls gains averaging 151K in 2020. That would be a decline from the 2019-to-date average of 180K, but in line with the gradual, healthy moderation in job growth that one would expect in a tightening labor market. This pace of job creation is also more than enough to keep up with U.S. population growth, which could allow for further declines in the rate of joblessness in this country. However, the favorable employment conditions should attract more people back into the workforce, e.g. those who had given up on finding a job.
This continuation of 2019’s uptick in labor force participation could therefore put a floor on how low unemployment can fall in 2020, and even cause it to increase in the near-term. As a result we anticipate the official measure of joblessness (U-3) in this country to be contained to a slightly narrower range in 2020 of 3.4-3.8 percent. Seeing the 3-month average unemployment rate exceed the upper-end of this range would be one of the recessionary red flags we look for, but again this is not our base case for 2020. With respect to wage growth, although the tight conditions should keep upward pressure on compensation for most Americans, the official measures may not fully reflect this due to structural reasons. For example, Baby Boomers are retiring in greater number, and since at this stage in life they are typically on the higher end of the earnings curve, their exit from the workforce could be a drag on average pay metrics. Similarly, high-paying manufacturing jobs continue to account for a shrinking share of the monthly payrolls gains (especially with the trade war backdrop), while typically low-paying service sector jobs have seen steady growth, which together can further weigh on average compensation figures.
Continued increases in prime-age participation (a larger labor supply) could also be a headwind for wage gains in the year ahead. Altogether, we see worker compensation rising at an average annual rate of 3.2 to 3.5 percent in 2020, little changed from 2019. With such an outlook we therefore do not expect employment costs to provide a materially different boost to consumer inflation in the year ahead. Healthcare costs, though, have risen at a faster pace recently, and the potential for a stabilization in economic growth abroad, along with some likely weakness in the value of the U.S. dollar, could put upward pressure on various commodity prices. Put simply, a lot of the transitory factors that weighed on inflation measures in 2019 may not be there in 2020. As a result, we see the median core inflation gauge rising by 2.0-2.2 percent next year. Based on recent commentary from Federal Reserve officials, that should not be enough of an increase to warrant the start of another rate hiking cycle. At the same time, the Fed’s preferred inflation measure is currently far enough below this level to give policymakers room to maneuver, although incoming economic data and our relatively bright outlook for 2020 make additional easing seem unlikely at this time.
Further, the Fed may rely more heavily on non-traditional policy tools in 2020 in order to leave itself with a larger rate-cutting buffer should the need to stave off a more severe economic downturn arise. Such measures could include the Fed turning its recent asset purchase program into a somewhat more permanent repo facility in an attempt get ahead of another yield curve inversion. Altogether, we do not anticipate that the federal funds rate will be meaningfully different at the end of 2020 from where it is currently. The potential downside risks to the economy from further trade war escalations and election uncertainty, among other things, make the next rate move by the Fed more likely to be a cut than a hike, but for now we still see the target range for the federal funds rate finishing next year around 150-175 basis points.
Sources: FRBG, FRBNY, BB&D, U.S. DoL, U.S. DoC
Post author: Charles Couch