Continued trade uncertainty weighs on economic growth

June 2019 – Economic data continues to indicate a downshift in the pace of economic growth in the second quarter. Our forecast for business investment now points towards a contraction in the second quarter as ongoing trade-related uncertainty continues to keep a lid on business spending. The key support to growth in Q2 will be consumer spending as a slower pace of inventory building subtracts from growth. Given the tightness of the labor market, employment growth is also set to downshift as the year progresses. May’s employment report affirmed this downshift in job growth. Upside risk remains for inflation if additional tariffs are enacted on Chinese imports. We believe the Fed will likely remain on hold and look past the temporary boost to trade related inflation.

This month’s update includes assumptions about two key factors driving heighted uncertainty around our forecast view. First, we assume that no further tariffs are enacted on China and that tariffs on Mexico are not enacted. Second, we expect Congress to pass a budget that carries over existing funding levels into next fiscal year before September 30th, avoiding another partial government shutdown. In addition to these key risks, we remain concerned about the continued inversion of the yield curve.

Key Takeaways:

Softer economic data suggests a slower Q2
Trade tensions remain a key risk to the outlook
Credit availability concerns are building
Inflation creates a challenge for the Fed

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Consumer spending to support 2019 growth

While a number of risks remain, one bright spot to the outlook is the consumer sector. Real consumer spending is expected to rise 2.7 percent in the second quarter before moderating in the third and fourth quarters of 2019. On a nominal basis, consumer spending is expected to rise 4.2 percent this year. With a downshift in auto sales expected as the year progresses, the primary drivers of consumer spending growth should be services and retail goods. If continued equity market sell-offs persist, consumers may begin to pull back on spending. Additionally, higher prices passed on to consumers from additional tariffs may begin to erode the purchasing power of consumers going into the critical fall holiday season.

Implications of the inverted yield curve

In response to recent equity market sell-offs, global investors have been piling into safe U.S. assets such as 10-year U.S. Treasury Notes. This is resulting in an inverted yield curve—short term interest rates are higher than long-term rates. When such behavior persists, banks become less willing to lend, drying up credit. We remain cautious in our outlook for both business and consumer spending given that the inverted yield curve environment is likely to stick around for a bit longer. It does not signal the end of growth but does add yet another headwind to the economy.

Key risks to the outlook

For the second month in a row we highlight trade tensions as the number one downside risk to our growth outlook. While tariffs on Mexico have been avoided, there remains a risk of further tariffs on imports from China. This would create a challenge for the Fed in trying to balance job growth and keep inflation in check. We suspect the Fed will look past the near-term effects of the tariffs and keep rates unchanged. Manufacturing would likely continue to bear the brunt of any new tariffs and slow the growth of consumer spending on such goods. In the near-term, we would expect higher inflation readings likely beginning in the third quarter of this year. On balance we now see more downside risks to growth than upside over the next two years.

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