The US economy continued to demonstrate resiliency in the 3rd quarter of 2019, clocking in with a 1.9% annualized growth reading. That figure is better than the consensus expectation of 1.6% and in line with the 2nd quarter 2019 reading of 2%. So it begs the question of whether the US economy needs a rate cut at this particular moment in time and, if so, why.
Virtually all of 2Q’s and 3Q’s growth was due to the strength in consumer spending. Business spending, which had been a meaningful contributor in prior quarters, actually detracted from GDP performance in the second and third quarters of 2019. It looks like inventory changes played no role in the 3rd quarter1.
So, while the consumer has always been responsible for about 70% of the economy, we are now in a world where we are almost entirely dependent on the consumer. Business spending is on hold pending trade and political uncertainties whose resolutions are repeatedly moved further in time. Government consumption, while reasonably constant, is a small overall contributor to GDP.
We believe now more than ever, there is a great need to keep the consumer from flagging. Which means that the job creation numbers are relatively more important than ever, and there has been a modest slowing in these figures that we believe would encourage the Fed to be accommodative.
Most forecasters are predicting a 25 bp cut in rates today, with talk of further rate cuts. Expectations are mainly driven by (a) an exceptionally low inflation environment (b) historically low rates of GDP growth, although there is no compelling argument for a recession at this time (c) and a decline in the rate of job creation relative to prior years, although even here the numbers are still reasonably strong. Lastly, we believe the inversion at the shorter end of the Treasury’s yield curve suggests that the Fed Funds rate may be too high for market conditions.
Even with the cut, it is unlikely that longer term rates will rise, so the yield curve should remain flat. If future economic news were to deteriorate, longer rates might fall even lower and we might see further inverting the curve. So, there is some pro-activeness in cutting rates now.
In our view, the economy’s fundamentals in and of themselves, do not demand a cut. What we are talking about is now being referred to as an “insurance cue”, and this raises the question of what steps will be available to the Fed were there to be a significant economic softening in the next year or two.
Joseph A. Abraham, CFA
Senior Vice President, Direct Client Investments
1 Source: US Economy Holds up with 1.9% Growth on Consumer Strength by Jeff Kearns on Bloomberg. October 30, 2019.
