The Fed’s set to cut rates and job growth is expected to decline… and that’s just a few of the highlights hitting the U.S. economy this week.
Cutting rates now takes arrows out of the Fed’s quiver for when it might desperately need them in the future.
A pivotal week for the economy
This week should prove pivotal for the economy. Several noteworthy events will set the stage for the balance of 2019. Foremost among these, the Fed looks set to cut interest rates by 25 basis points (bps) for a third time this year. Overall the last year, the Fed turned an abrupt about face: projections in October 2018 showed the Fed raising rates multiple times in 2019. With the global and domestic economies slowing, the Fed will attempt to prop up the economy. We remain skeptical that the rate cuts will produce the impacts normally seen with rate cuts. Interest rates remain at low levels and very few businesses cite the cost of debt as an impediment to borrowing. And consumers continue using debt, with several categories such as credit card balances (revolving credit), student loan balances, and auto loan balances hovering at or near record-high nominal levels. Debt markets in general seem quite flush. Beyond this, we also remain skeptical that cutting rates will offset the major concern restraining private investment: trade policy uncertainty. Surveys of business leaders continue to cite this uncertainty as the primary reason companies are pulling back on spending and investment. And cutting rates now takes arrows out of the Fed’s quiver for when it might desperately need them in the future. The Fed typically cuts 500-600 bps heading into recessions. Assuming it cuts this week, that leaves the Fed with only 150-175 bps to cut if it cannot raise rates again before a more serious slowdown in economic growth. After this week’s meeting the Fed will likely maintain a flexible policy heading into its last meeting of the year in December.
We expect that economic growth in the third quarter should show a deceleration relative to second quarter, marked by a second consecutive decline in private investment offset by continued consumer spending.
GDP growth likely slowed in the third quarter
After private investment surprisingly contracted in the second quarter, durable goods orders for September signaled that businesses remain concerned about the economic slowdown and policy uncertainty. Headline and core durable goods orders contracted in September, ending the third quarter on a dour note. We expect that economic growth in the third quarter should show a deceleration relative to second quarter, marked by a second consecutive decline in private investment offset by continued consumer spending. That remains a key divergence in the economy – business investment declining while consumers continue spending money – but it also highlights the key risk the economy faces. If businesses move beyond pulling back on spending and reduce hiring, further slowing in economic growth would occur. Consumer confidence remains elevated and we expect a rebound in September’s reading. But we continue to monitor consumer confidence and sentiment for any sign of faltering.
Look for noise in October payrolls data
We expect the employment situation release for October to show tepid job growth, likely below 100,000 net new jobs. Some of this stems from the recent GM strike (which should reverse in November’s data when striking employees return to work), but more generally we see continued declines in job gains as the supply of qualified labor remains limited. The unemployment rate likely changed little and should remain near half-century lows. We look for wages to have ticked up slightly, keeping year-over-year wage growth little changed near 3%.
Manufacturing still contracting?
The ISM manufacturing index for October should come in below 50, even if it rebounds slightly. If so, that would mark the third consecutive month of contraction. Slowing global growth, continued trade policy uncertainty, and the GM strike weighed on the manufacturing sector. Although the manufacturing sectors holds relatively less importance to overall economic health because of its diminished share of output, sustained declines would present greater concern. In 2016, similar declines in manufacturing did not spill over into the services sector. But the risk of contagion still exists if a continued slump in manufacturing reduces demand for labor.
What it means for CRE
For commercial real estate (CRE), the asset class continues to weather the economic headwinds well, so any declines in third quarter growth should not present much trouble. But the employment situation will warrant scrutiny. In recent months net employment growth excluding education and healthcare (two industries that typically use less traditional CRE) has slowed. If that trend persists, it could mean reduced demand for space in future periods, particularly for the office sector if office-using employment continues slowing. For now, demand of office space looks robust, but slowing economic and office-using employment growth could present further headwinds in 2020.
Thought of the week
The federal budget deficit reached nearly $1 trillion, its highest level in seven years.