Looking Backward, Looking Forward

The game right now is all about tracking the magnitude of the expected slowdown in US economic activity as Federal Reserve policymakers lay down markers about what the outlook means for rate policy. San Francisco Federal Reserve President Mary Daly, for instance, said she is anticipating 2% growth this year, setting the stage for the Fed to stay on the sidelines until 2020. Via the Wall Street Journal:

“If the economy evolves as I just said I expect it to—2% growth, 1.9% inflation, no sense that [price pressures are] going up, no sense that we have any acceleration—then I think the case for a rate increase isn’t there”

The median forecast for longer-term economic growth in the Summary of Economic projections is 1.9%, so 2% growth is pretty much at trend hence no need for hikes absent any inflationary pressures. In contrast, Atlanta Federal Reserve President Raphael Bostic thinks the economy will support another rate hike in 2019 while Philadelphia Federal Reserve President Patrick Harker expects a rate hike in each of 2019 and 2020.

Although on net central bankers thus appear on average to hold neutral to ever so slightly hawkish expectations for rate hikes this year, I imagine at this point this risk is that the outlook could turn darker than officials anticipate and hence the Fed cuts rates before the end of the year. That likely requires the threat of below trend growth. The challenge of course is, as I explained last week, that it is very difficult to identify the extent of a slowdown early in the process.

For example, the industrial production report revealed a sharp decline, placing it at odds with the most recent ISM report (although the situation was reversed in December). The magnitude was non-trivial, but we would be looking for a string of weakness similar to that of 2015-6 to become very concerned that the economy was slowing to something below trend:

The impact was largely attributable to manufacturing:

Which in turn was driven in large part by weakness in the automative sector:

Truck assemblies have been all over the place this year so I am wary of concluding that the industry is at the front end of a 2008 kind of slide. That said, it seems likely that auto sales have peaked for the cycle and are likely to move sideways to modestly down going forward. That though differs from recessionary dynamics. Overall, industrial production still looks solid compared to last year:

A typically good recession indicator, initial unemployment claims, has also been all over the map in recent weeks but still track at very low levels:

The dispersion of claims has picked up a bit, similar to that seen in 2015-16. That should make us a bit cautious about over-interpreting this signal as here again we need to be careful. Initial claims can provide a false recession signal:

A familiar story – the data is moving as one might expect with the economy slowing but as in the past, this is not yet different than other slowdowns that did not evolve into recessions.

Coming up this week we get a few bits of data to chew on. Wednesday the Fed releases the minutes of the January FOMC meeting. Of particular interest will be the discussion on the balance sheet. Last week Federal Reserve Governor Lael Brainard said that she favors ending the balance sheet reduction later this year; my suspicion is that she will find support among her colleagues and that it won’t be long before the Fed signals more clearly that they are getting close to ending quantitative tightening. Thursday promises a flurry of activity with durable goods, Philly Fed, Markit manufacturing and services, initial unemployment claims, and existing home sales set for release. Friday should be fun with Randal Quarles, John Williams, Mary Daly, James Bullard, and Patrick Harker all participating in the University of Chicago 2019 US Monetary Policy Forum. The conference begins with the report Prospects for Inflation with a High-Pressure Economy, which sadly is a topic that may have been overtaken by recent events.

Bottom Line: The economy is set to slow in 2019 and such an outlook is supported by early indicators. Slowing is not recession. While officials have said the next move could be up or down, I tend to think the median FOMC member would still believe flat to up more likely. That said,  I think flat to cut is more likely; the events of December appear to have been a wake up call for central bankers who had fallen too far into love with the idea of hiking rates deeper into the range of estimates of neutral. That change on the part of the Fed will likely prove critical to sustaining the expansion.