Once again, and for the nth time this decade, the U.S. economy is slowing.
Don’t get me wrong, we are still growing at a pretty rapid clip, but the acceleration that everyone was expecting is just not materializing.
You can see that in retail sales, in manufacturing indices, and most importantly, in the economic surprise indices. Exhibit 1
Yup, tax cut or no tax cut, budget deal or no budget deal, the U.S. economy is unlikely to grow at a rate north of 2% in 1Q18.
Similarly, the economic commentaries are chock-full of forecasts of the same slowing happening to the global economy.
Normally, I am one of the people who savour this cresting phenomenon by the global economy in general and by the U.S. economy in particular, as my core belief remains that the global economy is still mired in a demographic- and debt-driven, slow-growth environment.
But, in this go around, I believe what appears to be the current cresting of the U.S. economy is a head fake.
Growth Likely to Accelerate in Second Half of 2018
The U.S. economy, and the global economy for that matter, is likely to accelerate again in the second half of this year. The federal tax and budget deals have enough built-in, deficit-driven accelerators that the likelihood is the current pace of growth is very low. For that low growth to continue to be the case, the U.S. would have to believe that fiscal multipliers have basically disappeared, and there are no data to support that.
Growth in the second half of 2018 is going to be materially higher than it was in 1Q18, I have no doubt about that. Therefore, the U.S. Federal Reserve (Fed) policy pressures that we faced in early 2018 are still very much with us. As a result, if you believe that the Fed is on a policy-tightening path for the next few years, there is no reason to change that view.
That being said, I am hoping that the 1Q18 slowdown provides a marker and a data nuance to the policymakers on the Federal Open Market Committee (FOMC): The output gap has disappeared but the underlying structural issues with the economy still persist. Yes, the U.S. fiscal stimulus will accelerate growth in 2018 and 2019, in my view, but it will eventually fade. If the Fed is too aggressive with monetary policy, it would be setting up the economy for the end of the cycle in late 2019 or early 2020. That does not help anyone. Letting the economy run a little hotter through 2019, rather than talk it down, may be the optimum policy.
Bottom line: The U.S. economy seems to be cresting but it may seem like Goldilocks is back. In my view, the markets will likely react more positively than they have since February. However, the economy is likely to reaccelerate in the second half. Therefore, the policy-driven risks for the market are still high until the Fed talks down its 2019 policy forecast.
Enjoy the recovery, but don’t let the U.S. go overboard.