After another unexpectedly weak first quarter for US GDP (the 4th in a row), the US economy appears to have suddenly hit the nitrous as the unexpectedly strong Friday payrolls report showed, and from one forecast such as the Atlanta Fed which now sees GDP growing at 4.8%…
… to consensus Q2 GDP, which has surged by 50% over the past year, and is now at 3.1%…
… analysts and economists see another period of above-trend growth for the US economy, in large part thanks to the boost from the Trump fiscal stimulus which is slowly finding its way into the broader economy. Not even Goldman could hide its surprise at the strength of recent economic data, writing that the “Friday’s jobs and ISM numbers capped several weeks of firm US numbers that have taken our Q2 GDP tracking estimate to 3.7%… so the economy is back to a very rapid growth rate of roughly twice our 1¾% estimate of the underlying trend.“
However, also according to Goldman, the streak of good news fo the economy is about to end as David Kostin explains below:
The current pace is probably as good as it gets because we expect the impulse from financial conditions to turn gradually more negative, based on the modest tightening in our index that has already occurred and the further likely FCI impact of our above-market funds rate forecast.
Even so, Kostin believes that growth should remain well above trend as the fiscal impulse boosts both personal consumption and business fixed investment. We therefore expect the jobless rate to fall to 3¼% by the end of 2019, 1¼pp below the FOMC’s current estimate of the longer-term sustainable rate. Goldman also notes that the biggest missing variable from the so-called expansion – wage growth – may finally be making a comerback:
our single favorite US wage measure—the employment cost index for private-sector wages and salaries excluding incentive-paid occupations—printed a sturdy 0.9% in Q1 on a seasonally adjusted basis. When translated into annualized terms, both numbers are well above our estimate of the sustainable wage growth rate of 3-3¼%, though these high-frequency signals admittedly await broader confirmation.
However, aside from extrapolating trends, a bigger question in light of ongoing political developments, is how much growth will be impacted by the ongoing trade war. Here is Goldman’s take:
The Trump administration’s recent trade-related announcements have taken us back to the environment of March/April, before Treasury Secretary Mnuchin declared the trade war “on hold.” We wouldn’t take the latest announcements entirely at face value and regard them, in part, as an attempt to carve out a favorable negotiating position. However, the administration is likely to implement at least some of them, as the threats otherwise risk losing credibility. The measures could boost core PCE inflation by between 0.03pp and 0.15pp—depending on the extent to which the administration follows through on its threats of tariffs on China and auto imports— and subtract a similar amount from real GDP growth, assuming US trading partners retaliate as we expect.
But before the ongoing trade war impacts the economy negatively, another potential risk is how the Fed will respond to what now appears to be an economy firing on all cylinders, if only for the time being:
What looms larger in the run-up to the June 12-13 FOMC meeting is how the 0.3pp drop in the unemployment rate since the March meeting will affect the committee’s economic and monetary policy projections. We think the unemployment forecasts of 3.8% for end-2018 and 3.6% for end-2019 will need to come down by at least 0.2pp, despite the understandable reluctance to show labor market overshooting to a degree that has always set the stage for a recession in the past. And, in our view, such a forecast change not only seals the case for another 25bp hike in the funds rate target range (coupled with a 20bp hike in the interest rate on excess reserves) but it also makes an increase in the median number of hikes in 2018 from 3 to 4 quite likely.
Where things get more interesting is Goldman’s forecast of a total of 8 rate hikes in 2017 and 2018 (or another 7), which would send the fed funds rate to 3.5% by the end of 2019, and all else equal, sharply inverting the curve:
we remain comfortable with our baseline forecast of a total of 4 hikes in both 2018 and 2019, and in fact think the risks to our 2019 forecast are skewed to the upside. In the world of projections, the gap between the real funds rate and r* is the key metric by which most FOMC participants judge the stance of monetary policy. But in the world of actual rate decisions, the key issue is the observable behavior of the economy and financial conditions. And we expect that behavior to support rate hikes for longer than many FOMC participants now believe, partly because our estimate of r* is somewhat above the committee’s 0.75-1% estimate and partly because we are more skeptical that there is a mechanical or even close relationship between the funds rate gap and the strength of the economy.
And here is Kostin’s top argument why the Fed will continue to aggressively hike to the point where growth itself will finally stumble:
As a matter of causation, it is the conditions that have historically driven the FOMC to deliver curve-inverting hikes—i.e., economic overheating—that raise recession risk, not the committee’s decision to act on those conditions. In fact the opposite is likely true; if the FOMC decides not to hike when the economy is overheating for fear of inverting the curve, the overheating will tend to get more extreme and recession further down the road will become all the more likely.
Meanwhile, as Bloomberg macro commentator Andrew Cinko wrote this morning, “on the other hand, some prognosticators were caught off guard as this unusual cycle unfolds. It probably pays to be flexible in one’s forecasting rather than getting too comfortable with the idea that the next year will rhyme with some prior period.”
Indeed: as we reported over the weekend, not one but two banks have now called the expansion phase of the global economic cycle, with first Bank of America saying that “The Global Wave Has Just Peaked For Only The Tenth Time In 25 Years…”
But Morgan Stanley went so far as to lay out when the two key asset classes, stocks and bonds will peak (September and December, respectively).
Ultimately, however, it will all depend on the central banks, because while on one hand the habitual gamblers are once again dumping vol as if the February volocaust never happened…
… the biggest risk remains the central banks, whose net liquidity injections will turn into this decade’s first liquidity drain, some time in the 3rd quarter of 2018.
What they do, and how they respond after the market and economy finally in response to this most critical of all inflection points, is the only thing that matters.
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