The Commerce Department delivered a
surprise at the end of April by reporting a very strong annualized 3.2% growth
rate for real GDP in the first quarter.
However after looking under the hood, the core economy was only growing at a
very modest 1.2% rate. (See Table 1)[i]
The difference is a result of a huge inventory build-up, a substantial decline
in imports, surprising strength in exports and a bulge in state and local
spending due road repairs associated with this winter’s storms.
Similarly the recent employment data
does not appear to be as robust as reported. For example as measured by the widely
reported payroll series the U.S. economy added 2.62 million jobs over the year
ending April 2019, while the household survey reported a far low gain of 1.43
million people employed. This nearly 1.2 million difference between the two
series is unusually large. (See Figure 2) Ultimately the gap will close as the
data gets revised. Similarly, fuzzy data appeared in the Consumer Price Index
where declines of 1.9% and 0.8% in apparel prices in March and April
respectively was due to a change in methodology. These price decline are not
sustainable, especially with more tariffs on the way.
Figure 1. Reported vs. Underlying GDP
Growth in 1Q2019
|
Reported Real GDP Change
|
3.2%
|
|
|
|
Less: Inventory Change
|
-0.6%
|
|
Export Increase
|
-0.4%
|
|
Import Decrease
|
-0.6%
|
|
State & Local Increase
|
-0.4%
|
|
|
|
Equals Gross Private Domestic Final
Demand
|
1.2%
|
Source: U.S. Department of Commerce and
UCLA Anderson Forecast
Figure 2. Annual Change in Payroll Employment
vs. Household Employment, April 2014 – April 2019, Monthly Data, In thousands
Sources: U.S. Bureau of Labor Statistics
and UCLA Anderson Forecast
As a result of the data issues mentioned
above we are essentially maintaining our forecast calling for a 3-2-1 economy
where growth on a fourth quarter to fourth quarter basis was reported at 3.1%
in 2018 and is forecast to be 2.1% and 1.4% in 2019 and 2020, respectively. For
2021 we are forecasting a rebound to 2.1%. (See Figure 3) It is important to note that when the economy slows to 1% growth the
risk of a recession become very real with the second half of 2020 being
problematic.
Figure 3. Real GDP Growth, 2010Q1
-2021QF, Quarterly Data, Percent Change, SAAR
Sources: U.S. Department of Commerce and
UCLA Anderson Forecast
In this slowing environment employment
growth will rapidly decelerate from the monthly run rate of 220,000 jobs a
month in the year ending in April to about 130,000 a month in the second half
and about 50,000 a month in 2020. (See Figure 4) Simply put we tend to believe
that the household series mentioned above is telling the right story where over
the past 12 months employment growth averaged 120,000 a month. Given our view
that the economy is slowing it appears that the unemployment rate will bottom
out at April’s 3.6% level and remain there for about a year before rising to 4%
in late 2020 or early 2021. (See Figure 5)
Figure 4. Payroll Employment, 2010Q1
-2021Q4, Quarterly Data, In millions, SAAR
Sources: U.S Bureau of Labor Statistics
and UCLA Anderson Forecast
Figure 5. Unemployment Rate,
2010Q1-2021Q4, Quarterly Data, Percent, SAAR
Sources: U.S. Bureau of Labor Statistics
and UCLA Anderson Forecast
The
Fed, Trump and Interest Rates
With his call for the Fed to lower
interest rates by 100 basis points at a time when the economy is booming,
President Trump declared war on the Fed. President Trump escalated by preparing
to nominate to unqualified nominees, Stephen Moore and Herman Cain, to the
Fed’s board of governors. Fortunately those candidacies failed, but for
personal, not professional reasons. His next choices likely will not have the
personal difficulties of Moore and Cain, but would do his bidding just as well.
This is not to say that the Fed board does not deserve a diversity of opinion,
but its members should largely be independent of the White House as Trump’s
earlier appointees of Jerome Powell and Richard Clarida are.
Nonetheless with inflation remaining
benign, the Fed is on track to keep interest rates where they are and there
seems to be a willingness to let the economy run “hot” for a while. Thus we are
forecasting that the Fed Funds rate will remain at its 2.375% midpoint until
the middle of 2020 with a total 50 basis points of rate cuts will take place as
the central bank responds to a slowing economy. (Figure 6) In the environment
we envision long term interest rates as measured by the 10-Year U.S. Treasury bond
will remain range bound between 2.3% - 2.8% through 2020, a far cry from our
earlier forecasts.
Figure 6. Federal Funds vs. 10-Year U.S.
Treasury Bonds, 2010Q1-2021Q4F, Percent
Sources: Federal Reserve Board and UCLA
Anderson Forecast
Fed policy will be buttressed by
inflation remaining somewhat above two percent as measure by the Consumer Price
Index and at their target 2% for the price indices associated with GDP
accounting. (Figure 7) Although wage compensation gains will rally from the
current 3% to just under 4%, it will not set off inflationary alarms. In fact
those gains will be welcomed. (See Figure 8)
Figure 7. Consumer Price Index, Headline
vs. Core, 2010Q1 -2021Q4, Percent Change Year Ago
Sources: Bureau of Labor Statistics and
UCLA Anderson Forecast
Figure 8. Employee Compensation, 2010Q1-
2021Q4, Percent Change Year Ago
Sources: Bureau of Labor Statistics and
UCLA Anderson Forecast
Trade WAR
With trade tensions with China going up
and down like a yo-yo it is difficult to forecast what form the final policy
will take on. But make no mistake, increasing the tariff from 10% to 25% on
$200 billion worth of Chinese imports is not a policy that will enhance
economic growth. To be sure there are real trade issues with China, but using
artillery instead of a rifle will only make matter worse. Put
simply tariffs act like grains of sand in the gears of commerce. Output is
reduced and prices rise, not a good thing. Remember a tariff is a tax on
American consumers and as such is contractionary. And as China retaliates it
becomes the stuff that global slumps are made of. Moreover adding insult to
injury the successor to NAFTA the U.S.-Canada-Mexico Agreement (USMCA) looks
like it is about to implode.
What the Administration doesn’t seem to
understand that the overall trade deficit is not a matter of the trade balance
with individual countries, but rather reflects the imbalance between domestic
consumption and domestic production. A nation that consumes more than it
produced imports the balance. Hence real net exports will exceed $900 billion
this year and approach a trillion dollars in 2020. (See Figure 9)
Figure 9. Real Net Exports, 2010Q1
-2021Q4, Quarterly Data, In $billion, SAAR
Sources: U.S. Department of Commerce and
UCLA Anderson Forecast
The flip-side of the trade deficit is
the budget deficit. In a sense the U.S. is using the trade deficit to finance
the budget deficit because the offset to a trade deficit is a capital inflow of
which part of it is used to purchase government debt. After reach $873 billion in fiscal 2018, the
budget deficit is forecast to rise to $1.02 trillion, $1.06 trillion and $1.1
trillion in 2019, 2020 and 2021, respectively. (See Figure 10)
Figure 10. Federal Budget Deficit,
FY10-FY21F, In $billions, Annual Data
Sources: Office of Management and Budget
and UCLA Anderson Forecast
The
Housing Conundrum
One of the great conundrums of the long
expansion is the failure of housing activity to launch. This is especially
troubling because the recent 75 basis point decline in mortgage rates has
failed to ignite demand. To be sure housing became way over-built from
2004-2007, but the failure of housing starts after a long expansion to reach
the normalized level of between 1.4-1.5 million starts a year remains a
mystery. Indeed housing starts have been locked in at level of around 1.2
million starts a year since 2016 and will stay at that level through 2020. (See
Figure 11)
There are a host of explanations for
this that involve, lagged effects of the financial crisis, student debt,
delayed family formation, restrictive zoning in the job creating metropolitan
areas and recently the limitation on state and local tax deductions. With
respect to zoning the lack of supply has led to a spike in housing prices and
rents which in turn has triggered demands for self-defeating rent control and
stricter controls where they already exist.
See Figure 11. Housing Starts,
2010Q1-2021Q4F, Quarterly Data, In millions of Units, SAAR
Sources: U.S. Bureau of the Census and
UCLA Anderson Forecast
Conclusion
Don’t be misled by the apparent strength
in the recent jobs and GDP data. Although growing, the economy is weaker than
it looks and has benefited from several one-off factors involving imports and
trade. Thus we are maintaining our 3-2-1 forecast for real GDP growth with a
realized 3.1% in 2018, and a forecast of 2.1% and 1.4% in 2019 and 2020,
respectively. With job growth slowing to a crawl of about 40,000 a month in
2020 the risk of a recession in the latter part of that year is nontrivial.
Inflation is forecast to run somewhat above 2% and the Fed will maintain stable
interest rates until the second half of 2020 where we are forecasting two rate
cuts. The downside risk to the economy comes from increased trade tensions and
the upside risk would come from housing activity rising out of its stupor.
[i]
This data is for the April release and does not reflect the May revision which
was not available when written.
