The business cycle

Business cycle – US: The hottest country in the world.

By February 7, 2019February 21st, 2019No Comments

In his state of the nation speech delivered last tuesday, President Trump made the point that the US economy is strong – it is “ considered far and away the hottest economy anywhere in the world”. Is he correct and how long could this last for?

According to the official real GDP data, 3Q18 was a robust 3% yoy (saar) – above our best guess for the potential growth rate of the economy, which is around 2%, in our view.In 4Q18, we expect to see a slowdown, due partly to the shutdown effect, which will carry on into 1Q19. In our year ahead projections, we downgraded US GDP growth to 1.8% this year, and we expect a further deceleration to 0.4% next year.

Three key factors influence the outlook for the economy going forward.First, the monetary policyoutlook. Any more rate increases will weigh on consumption, in our view, translating into slower GDP growth within two quarters. We assume that the Fed will raise the policy rate in March and probably again before the summer, then pause thereafter. Secondly, Congress is still working on the infrastructure spending bill, which may unlock as much as USD 1.5trn of spending over 10 years. If this happens, it would lift GDP growth by up to 1ppt per year, assuming that the money is disbursed evenly (which is probably not realistic for the first two years of the project; the impact would be significant in any case). Thirdly, how global tradewill fare, which depends on the deal with China and the UK’s departure from the EU, among other things.

The recovery in market sentiment seen in the past month, particularly the drop in the 10-year Treasury yield, has improved the outlook for US growth.However, we believe that it is still too soon to change our central projections as three big events still need to unfold: Brexit; the negotiations with China; and the resolution of the dispute between the Republicans and the Democrats, which resulted in a very long government shutdown last year. The US is indeed “hot” right now, but things could turn around materially this year and history suggests that they are more likely to go sour first, than to improve steadily from here.