A deterioration in consumer spending to warrant additional easing come 2020.
As expected, the FOMC began 2020 as they ended 2019, remaining constructive on the outlook, particularly the US labour market and the support it is providing to household spending.
This can be seen in the decision statement where the labour market was again characterised as “strong”. Job gains were viewed as “solid” and the unemployment rate having “remained low”. Notably, there was no discussion of the recent deceleration in wage growth, nor the loss of support for household disposable income from investment income through the second half of 2020.
Where there was recognition of a slowdown however was for household spending. In December, momentum in household spending was seen as “strong”. A month on, this view has changed modestly, with growth in the sector now regarded as “moderate”.
By itself, this is not a large enough change to challenge the FOMC’s above-trend GDP growth outlook for 2020 and beyond. However, if this downtrend in consumption is sustained and business investment remains weak, as we expect will be the case in 2020, then growth will quickly fall below trend.
With this economic cycle now having run for over a decade and given the Committee’s belief that more economic progress can be won, such an outcome would surely lead to “a material reassessment” of the FOMC’s outlook and a consequent easing in the stance of US monetary policy.
The other major change to the January statement relates to inflation and also points towards additional easing in 2020.
At the time of the December decision, the Committee judged “the current stance of monetary policy [as] appropriate to support… inflation near the Committee’s symmetric 2 percent objective”. In January, this was changed to the current stance being “appropriate to support… inflation returning to the Committee’s symmetric 2 percent objective”.
At face value, this suggests the Committee now has greater confidence in the outlook for inflation. However, it was made clear in the press conference that the change in language was instead intended to highlight the Committee is “not comfortable” with inflation running “persistently below 2.0%yr” (i,e, “near” 2.0%yr) and are determined to avoid it.
Note though, this is exactly the outturn that core PCE inflation (excluding food and energy) and inflation expectations currently imply will occur. If sustained, this trend will soon offer cause for the Committee to cut rates to strengthen inflation to the medium-term target, or indeed above it if the Committee desires inflation to average 2.0%yr over the cycle.
Our base expectation for the US economy is that the first half of 2020 will see GDP growth fall below trend and core inflation hold below the 2.0%yr target. Come June then, the FOMC will be justified in beginning another sequence of three rate cuts.
Following June, September and December is the most likely timing for the second and third cuts. This would see the federal funds rate end 2020 at a mid-point of 0.875% – a policy stance we believe will stabilise GDP growth at trend come 2021.
While our own view is more downbeat than that of the FOMC, we believe the risks to it are actually to the downside.
Key for the US is that the majority of US/China tariffs are set to remain in place indefinitely, even with the stage 1 deal signed. Also, other trade conflicts (such as that with Europe) are currently dormant but unresolved. For US businesses, there is therefore little-to-no reason to upgrade investment and/or employment plans for the foreseeable future.
The risks for household spending are also skewed to the downside following a long period of above-average gains for employment and spending. Any new shock to markets from global tensions and/or the Wuhan Coronavirus outbreak would further reduce consumers’ appetite for discretionary spending as their wealth is seen as at risk. If the Coronavirus outbreak spreads further, then it could also have a more direct impact on spending and hence US economic growth.
