The US economy expanded by 2.3% last year, weaker than the figure of 2.9% recorded in 2018. The slowdown was driven primarily by softer investment spending, itself explained by a weak global backdrop and increased uncertainty related to trade. Without the Federal Reserve’s pivot towards easing, last year’s figure may have been even worse. The FOMC’s three rate cuts eased financial conditions, and supported the housing market and private residential investment.
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Looking forward, we see grounds for qualified optimism. Survey data appear to have troughed, perhaps aided by a ‘Phase One’ trade deal between China and the US. After consistently posting readings consistent with contraction through the latter half of 2019, the ISM manufacturing survey rose by 3.1 points to 50.9 in January. Meanwhile, its partner non-manufacturing survey also increased. At the same time, the labour market remains in good health, with the unemployment rate at 3.5%, and non-farm payrolls continuing to increase at an above-trend pace. Finally, with inflation pressures subdued, the Federal Reserve is unlikely to take away the punch bowl. Indeed, their own forward guidance is consistent with the fed funds rate remaining unchanged through the year.
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But it is qualified optimism because this will not be a V-shaped recovery. The previously mentioned Sino-US trade agreement merely prevented a further escalation in trade tensions. Most of the tariffs that have been implemented remain in place, while the signed treaty did not address thornier issues such as subsidies and China’s state-owned enterprises. Trade tensions between the world’s two largest economies therefore risk flaring once again. Meanwhile, the US trade deficit with the EU rose to a record high in 2019, perhaps setting the stage for a new source of global trade friction. Finally, uncertainty around the direction of US economic policy should increase as the presidential election heats up. All told, survey data may struggle to sustain their positive impetus, and that is before even factoring in any fallout from the coronavirus outbreak.
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A look at the US economy’s fundamentals provides further reason for caution. In steady state, an economy’s potential growth rate boils down to two things: people and productivity. On both fronts, the US has been struggling. Demographic changes mean smaller increases in the working-age population moving forward. Meanwhile, productivity growth has been steadily declining for many years. Adding those two figures together, Fathom Consulting estimates that US trend economic growth lies somewhere between 1.0% and 1.5%. Admittedly, US GDP has been expanding at rates above this recently. But it cannot continue to do so indefinitely. Putting the above analysis together, any short-term cyclical boost is unlikely to be maintained, implying a further easing in annual growth rates to a new normal that is closer to 1% than 2%.
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