Hard to see the US economy improving
Headline US GDP declined modestly from +2.0% quarter on quarter in Q2 to +1.9% in Q3. But while the headline GDP number may have looked resilient, it hid a crucial Achilles’ heel: the biggest drop in business investment since Q4 2015 (-3.0%). But the contrast between weak business investment and a strong consumer was evident in the Q3 2019 report. In particular, there was a strong rebound in residential investment thanks to falling mortgage rates. Overall, there is nothing in this data to alter our view that US GDP growth in the second half of this year will average less than 2.0%.
The weakness in business investment does put the spotlight back on recession fears. Yet, while they can be either started or amplified by a downturn in business investment, more than just negative investment is required to trigger a recession. Reassuring news can be found in the labour market, with US employment reaching a new record high in September, according to the Bureau of Labor Statistics. In addition, financing conditions remain loose, especially bond-market conditions. It would take a sharp deterioration in these to make us worried about recession.
At the same time, it is hard to see a rapid improvement in US growth. While some recent surveys, such as those of the Institute of Supply Management, may have painted an unduly dark picture, we remain somewhat anxious about a number of factors. Trade uncertainty may persist; the labour market, while strong, is beginning to show cracks; a sharp drop in oil rigs may contribute to weaken business investment further; and the US election season could bring additional uncertainty. Furthermore, we continue to fear that growth in consumer spending could slow as the labour market loses steam. Meanwhile, we remain concerned about the limited pass-through from lower Federal Reserve rates to the consumer, especially as credit card rates remain high.
We will be watching the labour market as well as banking conditions (loan appetite and financing conditions) very closely in the coming months.