Economy: Signs of Strong U.S. Economy Clouded by Market Volatility
Economic trends generally improved in December, even amid some of the most significant financial market volatility of the bull market. The Conference Board’s Leading Economic Index (LEI), an aggregate of ten leading indicators, increased 0.2% in November and 5.2% year over year. While LEI growth slowed for a second month, positive momentum signaled low odds of recession in the coming year.
Still, signs of economic strength last month were clouded by U.S. stocks’ worst monthly performance since February 2009. In the month, investors became more anxious about the economic landscape given an ongoing U.S.-China trade dispute, signs of slowing global demand, and the Federal Reserve’s (Fed) monetary policy tightening. Both short term and long-term inflation breakeven rates, or the difference between the yields of nominal Treasuries and those of Treasury Inflation-Protected Securities, dropped significantly in December as investors positioned for the possibility of slowing price and wage growth amid growing uncertainty [Figure 1]. In December, the one-year breakeven rate slid the most since October 2008, while the 10-year breakeven rate fell the most since September 2011.
Still, we saw no indications in economic data that inflationary pressures are slipping significantly. Average hourly earnings grew 3.1% year over year for a second straight month, tying the fastest pace of wage growth since April 2009. The core Consumer Price Index, which excludes food and energy components, rose 2.2% year over year in November, marginally above the 12-month year-over-year growth of 2.1% for the measure. The core Producer Price Index increased 2.4% year over year in November, higher than the 12-month average growth of 2.2%. Core personal consumption expenditures, the Fed’s preferred inflation measure, climbed 1.9% in November, just below the Fed’s 2% target for the gauge. We think current inflation is sustainable and healthy for the U.S. economy, especially given manageable wage growth.
We also remained encouraged by solid data on U.S. consumers and businesses. While the Conference Board’s gauge of consumer confidence fell for a second straight month, it is still just below an 18-year high reached in October, signaling strong consumer demand will likely help boost future output. A continually strong job market aided consumer health towards the end of the year, as nonfarm payrolls grew solidly in November and the unemployment rate stayed at a 48-year low. Personal incomes grew year over year in November near its fastest pace in three years, while personal spending rose near the fastest such pace in four years. In 2019, we expect modestly accelerating wages, continued steady job gains, and fiscal stimulus to lift consumer spending, which should be the primary driver of gross domestic product growth.
Business spending growth rebounded in November, as new orders for nondefense capital goods (excluding aircraft) increased 6.6% year over year. Small business optimism indicators remained solid, and the Institute for Supply Management’s (ISM) gauge of new business orders rebounded sharply from an 18-month low. Overall, Markit and ISM data showed manufacturing activity stalled in November, but both Purchasing Managers Index gauges are still well into expansion territory. Still, we are encouraged by U.S. manufacturing strength relative to global manufacturing, and we expect fiscal tailwinds and economic momentum to fuel further growth in the sector. We see the ongoing trade dispute as the primary obstacle to corporate health. Trade tensions have been difficult to navigate for U.S. corporations, and some have opted to put future expansions on hold until there is more clarity on the tangible and intangible effects of tariffs on demand and profits.
Data released last month showed the U.S. housing market continued to cool in November. While existing home sales grew 1.9% month over month, they fell 7% year over year, the biggest decline since November 2010. Year-over-year growth in housing prices, represented by the S&P CoreLogic Case-Shiller 20-City Composite, slowed for a seventh straight month.
Stocks Slide as Fed Hikes Rates
Fed policymakers reconvened in December and on December 19 announced the central bank’s fourth rate hike of 2018, boosting the fed funds rate to a target range of 2.25–2.5%. More importantly, policymakers lowered their expectations for future interest rate hikes in the new “dot plot” [Figure 2]. However, the dovish context wasn’t enough for markets. That day, the S&P 500 slid 1.5%, closing down for a seventh straight Fed day, after being up as much as 1% before the announcement. Markets were especially jittery around Fed commentary last month, but domestically economic fundamentals generally remained favorable.
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