The United States economy is growing moderately as of August 2019. Bits and pieces of economic information are released over the course of a quarter, and it’s human nature to recall the items that reinforce our prior beliefs, while ignoring those contrary to our preconception. For that reason, I periodically roll through many of the indicators that I track to assess our current condition. Right, now, we’re doing okay. Not exceedingly well, but certainly not in recession.
Real gross domestic product grew by 2.1% in the second quarter, in line with estimates of the growth of potential GDP. Potential is estimated based on the available labor force and productive capital in the economy. It’s a soft number, but worth looking at. To continue growing along with our potential is better than it sounds, because we are now running above potential. We should expect some decline to return to potential. The 2.1% growth figure is less than the historical average, but that average covers a period with population growth much greater than it is today. Our recent number is just fine.
The second-most-popular aggregate statistic for the economy is job growth, which at 164,000 net new jobs is just a little below the recent trend. The percentage gain in employment is well above the growth of population, though, indicating a tightening labor market. The number of job openings edged down recently, as did employee quits, but both are coming off very high levels. Call this area not quite as good as recently.
Starting through the major sectors of the economy, consumer spending has been a solid foundation for our economic growth. Consumer spending has increased by 3.9% over the past 12 months, with the most recent four months even better. Disposable income grew even faster, up 4.7%, bringing the savings rate up. This sets the foundation for solid growth in the future.
Total consumer spending includes retail sales as well as services, with retail being more discretionary and thus volatile. Retail sales increased by only 3.4% over the past 12 months, but a good bit of the gain came in the most recent four months. Car and light truck sales were 17.3 million units last month, a typical level for the last few years. Measures of consumer confidence are high, but I don’t place much stock in them, as they generally reflect underlying fundamentals of the economy, primarily unemployment, inflation and interest rates. I assess the consumer sector as moderate.
Residential construction is light at 1.253 million housing units. We used to think of 1.5 million as normal, but today’s slower population growth has pushed normal downward. Home prices are still rising, though not as fast as last year. If the recent mortgage rate decline stimulates new construction and sales, developers will only be borrowing from the future. This sector is weak.
Non-residential construction is essentially flat over the past year. Gains in manufacturing and office construction were offset by declines in commercial (retail) and power construction. Public construction rose earlier this year, boosted by state and local road building, but the last couple of months saw a decline. Call this sector flat.
Business spending on equipment and software was up just a little last quarter. A more useful measure is orders for non-defense capital equipment. The normal form of this indicator excludes aircraft order, because they are highly volatile and a substantial portion of them are foreign. (Foreign orders are important to American manufacturers, of course, but not indicative of U.S. economic strength.) The usual measure has increased a little over the past year, 2.0%, not adjusted for inflation. With Boeing’s 737MAX troubles, it’s worth looking at the total including aircraft orders: they are down a whopping 6.6% over the past 12 months. The drop in aircraft orders is not an indication of weakness at airlines, but a particular problem of one corporation. Nonetheless, it is a big enough problem that it affects the economy as a whole. Mark the entire business capital goods sector down as negative.
Business inventories can be very destabilizing. Inventories rose relative to total merchandise sales from spring of 2018 through February 2019, pushing the economy forward, but unsustainably. The latest data suggest a retrenchment, which pulled down second quarter GDP. We likely have another quarter of declining inventories ahead of us, after which we will see inventories grow with the overall economy.
Total government spending is increasing significantly, with federal up 7.0% and state plus local government up 3.5%. The federal side is roughly 5/8 of the total. Neither Congress nor the White House has a taste for fiscal discipline, so this spending is likely to continue.
U.S. exports have been roughly flat for the last year, with the latest month at the low end of the range. Imports show the same pattern.
The preceding paragraphs show the major sectors used in the GDP calculation. Consumer spending, which is moderate, comprises 68% of GDP, and government, which is growing strongly, 18%. The weakest sector, residential construction, amounts to only four percent of GDP. Weighting the sectors appropriately, the overall economy is growing moderately well.
There are other ways to split up the economy, such as manufacturing and services. Manufacturing production hit peak output in December 2018, with 1.1% decline since then. The ISM index (formerly called the Purchasing Managers Index) has moved from expansion to roughly flat in the most recent data. The component of supply managers experiencing slow deliveries from vendors has also moved from expansion to neutral, and this is a pretty good leading indicator.
The overall service sector continues to grow its total revenue, up 5.8% over the past four quarters, though the most recent two quarters for which we have data (2018q4 and 2019q1) both showed slower growth.
The economy is growing, with a few weak signals from the data on spending, production and employment.
Flashing bright red, though, are financial markets. In particular the yield curve is signaling recession.
The yield curve reflects interest rates on bonds of different maturities. When short-term interest rates are higher than long-term interest rates, we say the yield curve is inverted. As I write, 3-month treasury bills and 1-year treasuries pay higher interest rates than 10-year treasuries. That’s inverted, and a fairly reliable—but not perfect—indicator of recession.
The challenge is that we don’t have many recessions, so our sample size is small. And a lot is changing in the structure of the economy, so what might have been an informative relationship in the past may now be unimportant. Analysts looking at the yield curve have noted that financial markets are more globalized, and Europe has negative interest rates. Also, the yield on the 30-year treasury remains pretty high, even though the 10-year is low. So we cannot say for sure that we are going to have a recession based on the yield curve.
What’s the action plan based on this information? Don’t assume the doom and gloom side is right. More often it’s wrong. But develop a contingency plan. If we see consumer spending drop off, it will be time to conserve cash and prepare for a downturn.
