U.S. Economic Outlook

Will the Fed step in again?

In our last U.S. economic outlook we argued that the pace of job creation might have been overstated in recent years. The annual revision to March 2019, which was released along with the January Current-Employment-Statistics report, makes this abundantly clear.[1]

Annual non-farm-payroll revisions reveal less momentum in job creation

202002 DWS U.S. Economic Outlook NFP Revisions_CHART.png

Sources: Bureau of Economic Analysis, Haver Analytics as of 2/17/20

While the final numbers were in line with what had been forecasted earlier in 2019, the loss of momentum still remains remarkable. Not only was the pace of job growth substantially overstated throughout 2018 but it seems also never to have recovered from the massive hit it took from the 2018/2019 government shutdown. In retrospect the weak pace of job creation during the second and third quarters in 2019 offered an outright justification for the U.S. Federal Reserve (Fed) to cut interest rates several times to protect the economy. The chart also impressively shows the oft-repeated time lag in monetary policy: while the Fed lowered interest rates three times between August and October 2019, job growth picked up just around the time they were almost done.

Moderating wage growth despite record low unemployment

202002 DWS U.S. Economic Outlook Wages RS_CHART.png

Sources: Bureau of Economic Analysis, Haver Analytics as of 2/17/20
* seasonally adjusted, year-over-year, three-month moving average

Most economists have been puzzled about why wage growth actually decelerated through 2019 as depicted in the chart above – despite a historical low unemployment rate and fairly solid job creation. With the revised job data in mind, it now seems that the "job-boom," supported by 2017 tax cuts, was already over by then. But there might also be other, quite structural reasons for muted wage growth. A recent Brookings Institute study shows that about 53 million workers (or 44% of all workers between the ages of 18 and 64) earn a median income of only 18,000 dollars per year, or 10.22 dollars per hour.[2] Digging deeper into their findings, they show that 64% of so-called low-wage workers are in their prime age (between the ages of 25 and 54) and about half are the household's primary earner. These low-wage workers are mainly concentrated in retail sales, restaurant services, housekeeping and personal/healthcare jobs – service jobs that have been a major driver of job creation in recent times. Another survey even finds that one in three American workers runs out of cash before payday – even those earning as much as 100,000 dollars per year.[3]

Higher delinquencies in nominal terms can work as long as there are enough good loans

202002 DWS U.S. Economic Outlook Del Rates_CHART.png

Source: U.S. Federal Reserve Board as of 2/17/20
* seasonally adjusted

In light of these findings there is little comfort in observing that delinquencies[4], in nominal terms, for consumer loans have picked up somewhat in recent years (see chart above). For us, however, these developments seem to be symptomatic of a late-cycle economy rather than alarming signs of elevated imbalances that could trigger an imminent recession. The so-called delinquency rate, the number of delinquent loans as a percentage of the total loans, remains low at just above two percent, about half the peak level recorded before the 2008 recession. After all, the U.S. consumer still enjoys a favorable position when measured by overall interest payments and compared to overall disposable income.

However, wage growth remains especially important to those who earn less. Low and middle-income workers, those that depend on income to pay down their debt, represent the majority of consumers in an economy and therefore represent a main engine of economic growth. Therefore not just the number of jobs created or headline income figures are important, but also the distribution of income. Key takeaway, however, should be: as long as labor markets remain in relatively good shape, there generally is no reason for concern. The latest retail sales data for January or details of the fourth quarter 2019 gross-domestic-product (GDP) figures, for instance, already suggest that consumption is cooling. But we believe things may improve. Considering too that monetary policy acts with a lag, the insurance rate cuts made in 2019 could further support job creation and stabilize wage growth at current levels.

The Fed is aware of these issues. Fed Chair Jerome Powell was asked at his Congressional testimony this month why, compared to other nations, the participation rate of American prime-age workers (ages 25 – 54) is so low.[5] For a number of reasons, he said, but key in his view was a falling educational attainment among lower- and middle-income individuals – exactly the same explanation as given by the authors of the Brookings study for the high number of workers receiving lower wages. The implications are that the labor market might indeed be at its structural limit right now: the qualifications employers are looking for are not available among those seeking a new job – or trying to re-enter the labor market. This clearly places a limit on further tightening of the labor market and in turn growth in wages.

Overall, however, it seems that the Fed remains comfortable with current labor market developments, at least looking at the outcome of January's Federal-Open-Market-Committee (FOMC) meeting. What has changed though is the framing of its comments on inflation. Powell explicitly mentioned a symmetric inflation target in the Q&A session; and the statement also now says that the FOMC expects inflation to return to target instead of being close to it. Furthermore, consumption is now judged to be moderate instead of being strong. Lower growth and higher inflation seems to be the message. But we believe room for maneuver still exists: a symmetric target should allow for a credible easing bias if things turn sour – even if inflation trends somewhat higher. Despite the domestic risks to the FOMC's economic outlook (the drag on GDP in the first quarter from halted aerospace production of a major airline; somewhat fading risk from the trade war as the phase-one trade deal was signed) the focus of course was on the coronavirus outbreak and the possible consequences for the United States.

As we recently reported [DWS Chart of the week: "Looks like SARS" as of 2/12/20 and DWS CIO Flash: "Coronavirus - too early to rely on the SARS pattern" as of 1/28/20] it remains too soon to come up with reasonable numbers on how severe the fallout will be – for the Chinese economy as well as other countries. And while financial markets, and equity markets in particular, have appeared so far to simply walk through the crisis, we remain cautious. The recent major revision to infection numbers, for instance, shows that a lot can still happen. To provide some early guidance, however, we expect – if the epidemic remains contained mainly to China and new infections decline sustainably in the coming two to three weeks – the fallout on the U.S. economy should be minor. For now we remain cautiously optimistic for a modest impact of the coronavirus epidemic.

In general, however, we stick to our long standing view of lower growth in the United States in 2020 and 2021. While we share the view of the Fed that inflation could pick up somewhat and consumption is slowing, we are somewhat less optimistic on the labor market. Based on this outlook we could well imagine the Fed considering to further support the economy, just as they did in 2019.

Overview: key economic indicators

 

2019

2020

2021

Q1

Q2

Q3

Q4

Q1F**

Q2F

Q3F

Q4F

Q1F

Q2F

GDP (% qoq, annualized)

3.1

2.0

2.1

2.1

1.2

1.4

2.0

1.8

1.4

1.4

Core inflation (% yoy)*

1.5

1.6

1.7

1.6

1.9

1.9

1.9

1.9

1.9

1.9

Headline inflation (% yoy)*

1.4

1.4

1.3

1.6

1.8

1.9

2.0

1.9

2.0

1.9

Unemployment rate (%)

3.9

3.6

3.6

3.5

3.5

3.6

3.7

3.7

3.8

3.8

Fiscal balance (% of GDP)

-4.1

-4.3

-4.6

-4.6

-4.8

-4.6

-4.8

-4.8

-4.8

-4.8

Federal funds rate (%)

2.25-2.50

2.25-2.50

1.75-2.00

1.50-1.75

1.50-1.75

1.50-1.75

1.25-1.50

1.25-1.50

1.25-1.50

1.25-1.50

* PCE Price Index
** Forecast

 

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