As the ongoing coronavirus outbreak continues to capture financial markets’ attention, economic indicators released in February highlight at least four overarching themes seen in the U.S. economy in recent months. The first theme highlights the primary strength of the ongoing economic expansion: the resilient U.S. consumer. Retail sales increased for the fourth consecutive month in January as the consumer remained in good shape at the start of the year. Resilient hiring gains and solid wage growth have buoyed consumer sentiment and spending. Consumer resilience should continue, with spending increasing at a healthy pace in the first quarter.
The second theme highlights the ongoing struggles in the industrial sector. Industrial production fell in January, marking the fourth decline over the past five months. Manufacturing output fell largely due to the Boeing 737 MAX production shutdown. Outside of the Boeing impact, solid gains were seen in other sectors. Looking ahead, headwinds should continue to plague the sector in the near term, as concerns now center on supply chain disruptions emanating out of China as a result of the coronavirus outbreak.
The third theme highlights the steady, yet the tame, performance of consumer inflation. On the other hand, U.S. hiring strengthened in January as more Americans joined the labor market. A larger flow of workers into the labor force has kept wages from breaking out. Americans are less likely to feel the pinch from limited pay increases because inflation has been modest.
The fourth theme highlights the ongoing dichotomy between the business and consumer sectors. Consumers in the U.S. remained upbeat as consumer sentiment and retail sales have increased. Going forward, low unemployment and steady wage growth should drive continued consumer spending and confidence. Business investment, on the other hand, declined in three out of four quarters in 2019 and has remained constrained by weak global growth, trade tensions and China’s coronavirus outbreak that threatens to upend global supply chains.
The Federal Reserve left its benchmark interest rate unchanged at its meeting in February, after cutting interest rates three times last year to buffer the economy against slowdowns in trade and manufacturing. January’s employment report and modest inflation have offered Fed officials comfort in their wait-and-see approach to interest-rate moves. Towards the end of 2019, multiple risks that could have had significant impacts on the global economy subsided. A Phase I trade deal between the U.S. and China was secured, while the U.K. was able to exit the European Union with a withdrawal deal in place. While trade tensions have receded markedly in recent months, the coronavirus has taken its place as the latest source of uncertainty plaguing businesses and investors. It has continued to depress China’s economy with large scale factory shutdowns. Global manufacturing supply chains have also begun to feel the effects of the virus.
Headline retail sales were up 0.3% m/m in January. However, the control group, which excluded some of the most volatile categories, was flat in January, while the December gain was revised down. Despite a soft entry into the New Year and the added near-term headwind from reduced tourism as a result of the spread of the coronavirus, consumption should still advance at a decent rate this year. This view has been underpinned by strong consumer fundamentals, including upbeat consumer confidence and stable job and income growth.
Small Business Optimism IndexThe NFIB survey indicated that American small businesses entered 2020 on solid footing. The confidence measure was up 1.6 points in January to 104.3 – a level within the top 10% of historical readings. The most striking improvement was in sales volume expectations. Interestingly, this came alongside a mild pullback in expectations about an improvement in the economy. This suggested that the improved sales view may be partially linked to the signing of the Phase 1 trade deal, with China’s pledge to boost imports from the U.S. having the potential to benefit small firms too, despite their heavier domestic tilt.
HousingThe housing market has shown signs of continued momentum in 2020. Housing starts fell modestly in January, but only because of the incredibly high pace seen in December. Starts in both months were boosted by some of the warmest winter weather on record. Like housing starts, existing home sales also contracted in January, coming off a solid December.
However, the underlying trend has remained very strong—low mortgage rates have improved buying conditions, and consumers have increasingly reported now is a good time to buy. Sensing this, builders have turned very optimistic and builder confidence has remained near a two-decade high. With labor markets healthy, mortgage rates low, and a large number of millennials still to move into homeownership, strength in the housing market could continue this year.
The epidemic, which has curtailed Chinese manufacturing, exports, and consumption, has threatened to dampen global growth as factories worldwide depend on a supply chain connected to China. An extended Chinese shutdown could cripple global manufacturing and cost the world up to $1 trillion in lost output. There could also be supply chain implications for American businesses if Chinese factories shut down for any significant length of time.
The Federal Reserve could respond by cutting interest rates. For now, the FOMC has kept rates unchanged through at least the first half of 2020. Monetary easing works best when interest rates are relatively high and the economy faces a demand shock. Neither is the case here.
But this forecast would rest on the underlying assumption that the coronavirus outbreak would remain more or less manageable. The situation has been very fluid, and recent events have raised credible questions about the validity of this assumption.
Boeing 737 MAX and U.S. GDP
Boeing also faces broader risks. Regulatory approval for the MAX could be delayed again, forcing the company to push production back further. Also, passengers could refuse to fly on the Max, hurting airline profits and potentially exposing Boeing to higher compensation claims.
EurozoneThe eurozone’s economy slowed sharply in 2019 as factories faltered amid weak overseas demand and trouble in the auto industry. The eurozone’s GDP grew 1.2% last year, its weakest expansion since 2013.
The bloc’s economic weakness has also reflected longer-term problems, including an aging and stagnant population, a weakening presence in faster-growing digital sectors and a coordinating problem and other challenges across its’ member countries.
However, there have been some signs of a eurozone revival in early 2020. Manufacturers have been more upbeat about their prospects in response to the trade truce between the U.S. and China. One upside for the eurozone economy has been that a large part of 2019’s slowdown appeared to be due to businesses running down their inventories, a process that has a limit. It is unlikely that inventory drawdowns will be a similar headwind in 2020, and stock building may aid growth.
However, some headwinds will remain and may intensify. One obstacle could be the reluctance of some eurozone governments to stimulate their economies through tax cuts and spending increases, in support of the ECB’s already negative interest rate. The weak performance of the manufacturing sector has been another obstacle that the EU faces. Also, the U.K’s recent departure from the EU leaves the future of trade with one of the eurozone’s main export markets uncertain.
Japan contracted at an annualized rate of 6.3% in the fourth quarter of 2019 due to a sharp drop in private consumption after the national sales tax rose from 8% to 10% in October. The contraction in the October-December quarter was the first in
more than a year and the biggest since the second quarter of 2014, the last time the sales tax was raised.
Japan’s economy has also faced the risk of a recession because the coronavirus outbreak has hurt tourism and production. The virus has hit Chinese tourism in Japan and disrupted some manufacturing in the country that depends on Chinese parts. Consequently, weakness in consumption will likely continue in the January-March period. Exports and production could be impacted as the supply chain is interrupted.
At this point, Japan is fairly constrained in terms of a possible policy response. The Bank of Japan seems to have a limited appetite for further stimulus while the Japanese government already announced a substantial package of easing measures a few weeks ago. The additional stimulus would only further undo some of the fiscal consolidation achieved by the 2019 tax hike. Real GDP is expected to decline by 0.1% in 2020.
OutlookOnly two months into the New Year and so far, there has been a China-U.S. trade deal, the signing of the USMCA, the sudden escalation of U.S. tensions with Iran and, most recently, growing concerns over a coronavirus outbreak. So, what do all these mean for the U.S. outlook?
On balance, The U.S. economy seems to be on a decent footing. That said, GDP growth in Q1 is nonetheless set for a slowdown, to roughly a 1.5% annualized pace, as another sizeable drag from inventories alongside a modest drag from trade could weigh on the pace of overall growth. Until there is a greater understanding of the magnitude of the economic impact, the coronavirus poses a downside risk to the outlook. However, assuming the virus does not become a full-blown pandemic, the short-term U.S. economic impact, while noticeable, is yet manageable. With that idea in mind, the U.S. economy is likely to remain in expansion, with real GDP increasing at a 2.0% pace this year.
RisksThe spread of coronavirus out of China introduces a new uncertainty. The current assumption is that the virus does not become a pandemic and that the economic impact to the U.S. should be fairly minimal and contained. That said, growth in the first quarter in the U.S. is nonetheless set for a slowdown.
The coronavirus, however, is very likely to have a notable impact on China’s growth during the first quarter of this year, and Chinese GDP growth is likely to slow to 5.5% in 2020. Despite the impact on China, the impact on economic growth as a result of the virus in advanced economies is likely to be small. 2020 global economic growth is likely to come in around 2.9%, a bit lower than the 3.0% expected earlier.
Sources: Department of Labor, Department of Commerce, The Conference Board,
National Federation of Independent Business, Bloomberg, Morningstar
This article was produced for Middleburg Financial by Capital Market Consultants, Inc.
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