The bifurcated U.S. economy: soft on the business side but solid growth on the consumer side

December 17, 2019 – Economic data this month continues to reflect a bifurcated economy, with the business side of the economy still showing signs of softness while economic data related to the consumer side of the economy continues to point towards solid growth. As we noted in our Holiday Sales Outlook, the U.S. economy faces some key risks this month. In addition to a possible federal government shutdown, yet-to-be-resolved trade issues have the potential to cause shocks in both the equity markets and business and consumer confidence. Sound familiar? Last year, this exact combination of a government shutdown and trade tension-induced equity market sell-off led to a disappointing end to the 2018 holiday shopping season.

Our forecast (P.2) assumes a government shutdown is avoided but does not assume a complete resolution to ongoing trade issues between the U.S. and China. As such, our fourth quarter gross domestic product (GDP) growth estimate reflects growth of 1.5 percent. Real consumer spending should rise 2.2 percent on an annualized basis in Q4 before accelerating in the first half of 2020. Business investment will remain soft, rising just 0.3 percent for the quarter.

Highlights:

• Slower Q4 GDP growth
• Consumer fundamentals remain solid
• The Fed is likely on hold for a while
• Expect trade issues to weigh on the outlook

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November’s employment report showed an impressive gain of 266,000 jobs for the month and continued growth of 3.1 percent YoY in average hourly earnings. We suspect these job gains and wage growth should help to lift real consumer spending to a 2.4 percent annualized basis in the first and second quarters of 2020 before downshifting to 2.1 percent in the third and fourth quarters of the year. In nominal terms, we expect consumer spending to rise 4.6 percent in 2020, up from 4.1 percent in 2019. Higher inflation readings will be the key factor that helps to lift nominal spending higher for the year. The Fed’s preferred measure of inflation, the personal consumption expenditure (PCE) deflator, is expected to rise 1.9 percent in 2020, up from just 1.4 percent this year.

Following the strong November employment report the Federal Open Market Committee (FOMC) of the Federal Reserve left rates unchanged at its December policy meeting. As we turn the page into 2020, we expect the FOMC to remain on hold for the near future. With inflation edging back towards the Fed’s 2 percent target and modest economic growth continuing, we see little impetus for the Fed to change the stance of monetary policy in 2020.

With few changes to short-term interest rates, we expect the yield curve to continue to steepen. The 10-year Treasury yield should end this year around 1.80 and end 2020 around 1.96. The spread between the 10-year Treasury yield and the 3-month T-bill rate should widen to 36 basis points by the end of 2020. The modestly higher longer term interest rates along with continued global economic uncertainty will both serve to keep business investment modest.

It is still possible that the federal government will shut down this month. Congress kicked the can and funded the government through Dec. 20 in order to buy more time for a larger budget deal. Progress has been slow, but our forecast assumes that Congress will provide at least a short-term funding bill to avoid a shutdown. The second key risk is on the trade front. Starting Dec. 15, tariffs are set to rise on consumer goods imported from China. The U.S. and China have been working towards a phase I agreement, but nothing formal has been announced as of yet. If this next round of tariffs is allowed to go into effect, an equity market sell-off is likely. This would have an adverse effect on consumer confidence in the final weeks of the holiday shopping season.

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