2018 Closes on a Strong Note…
Last week we laid out all the signs of slower growth in the United States, but we made the point that despite this the odds of recession were still relatively low. Along the same lines, this week we found out that economic growth in the fourth quarter was actually pretty robust.
Real GDP rose by +2.6% in the fourth quarter, well above expectations of +2.2%. While inventories and trade helped boost growth, consumption was also solid, increasing a healthy +2.8%, as strength in autos (+9.2%) and financial services (+4.6%) appeared to offset the impact of the weak December retail sales report.
Business investment was also robust, as you can see below. Unlike the major slowdown in 2015 and 2016 when investment contracted (centered in energy), the numbers have so far held up relatively well.
…But the Momentum Won’t Persist
But growth for the current quarter will be weak – the question is really whether the number will have a plus or minus in front of it. Friday’s manufacturing report, while soft, still points towards growth at least. The manufacturing index fell to 54.2% in February – a 2-year low – but it remains above 50, the threshold between growth and contraction.
Due in part to soft manufacturing, estimates for first quarter growth continue to decline. For example, the New York Fed’s Nowcast estimate has fallen from +2.5% to just +0.88%, as you can see below.
The Fed Grows Ever More Patient
The other major news item this week came from Fed Chairman Powell’s testimony in front of Congress. He basically followed up on the message from the last Fed meeting and the minutes from last week. His key points were:
Inflationary pressures are likely to remain muted.
There could be more slack in the labor market than the low unemployment rate would seem to indicate. If the participation rate continues to creep up this will cap wage gains.
There are economic challenges overseas that gives the Fed pause.
As a result, the Fed can afford to take a patient approach to policy changes.
The Fed’s committee ‘widely favored’ ending quantitative tightening (QT) this year.
We talked a lot about the Fed last week, so we won’t go down that rabbit hole again. Suffice it to say, the Fed is sending a dovish message. Rates aren’t moving any time soon, and we are likely to see a timetable for the end of QT at the next meeting in less than three weeks.
“When the Facts Change I Change My Mind. What do You Do Sir?”
The above quote is attributed to Keynes, although fellow economist Paul Samuelson may have used it as well. Regardless, it could apply just as well to Ray Dalio, founder of Bridgewater Associates, the world’s biggest hedge fund. About 18 months ago he put the odds of a recession by next year’s presidential election at more than 50%, predicting that a short-lived U.S. growth spurt would trigger a harsh Fed response.
However, in a note on Thursday he said there’s less chance of a U.S. recession now that the economy has begun to cool and the Federal Reserve appears less inclined to hit the brakes on growth (See Dalio’s full note here).
“Starting about 18 months ago I assessed the risk of a recession before the next presidential election to be over 50% because we at Bridgewater calculated that a) the growth spurt would be temporary and fade and b) the Fed’s policies in response to the growth spurt would drive asset prices and then the economy down. Because the markets weakened and Fed officials now see that the economy and inflation are weak there has been a shift to an easier stance by the Fed. Similarly, because of weaker markets, economies, and inflation rates in other countries, other central banks have also become more inclined to ease, though they have less room to ease than the Fed. For these reasons, while I still expect that there will be a significant slowing of growth in the US and most other countries, I have lowered my odds of a US recession coming prior to the US presidential election to about 35%. More specifically, the Fed now has both a) the power to lower interest rates by 2+% and to pick up QE and b) the willingness to do that if needed to prevent a recession.”
At first glance the reasoning seems a bit counter-intuitive. Weaker growth will lessen the odds of recession? But Dalio, among others, thinks monetary policy will be the swing factor. Weaker growth means a more dovish Fed, and a dovish Fed is critical if we are to avoid recession. And we shouldn’t discount the fact the Fed could cut rates later this year. As Alpine Macro shows below, every time the yield on the 2-year or 3-year bond falls below the Fed Funds rate the Fed has eased.
We are getting very close. Today the 2-year is at 2.56% while the fed funds range is 2.25% to 2.50%. While only tentative, the yield curve steepening of the last few days hints at possible Fed moderation (or maybe a trough in growth?).
When it comes to Fed policy, this year will differ dramatically to last year.
Why Not Buy the Whole Thing?
We all know bay area real estate prices are nuts. Always have been. But a recent add puts the contrast with the rest of the country in stark contrast. For ‘just’ $1.7MM you can pick up “almost the whole town of Toomsboro” (see: http://www.toomsboroforsale.com/ ).
This small town roughly 20 miles east of Macon, GA is comprised of 40 acres with an opera house, restaurant, Victorian hotel, barber shop (plus chairs), bank, and assorted other buildings.
The video tour is worth a watch if you are in the market.
Perfect opportunity for that special someone looking to set up their first cult. Or a movie studio. Yea, hopefully a movie studio.
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