US economic growth still in the 2ish% channel

In the aftermath of the shale oil bust that sent the US economy to stall speed in 2015, growth has rebounded, but only to a sort of 2%ish level. Continued low inflation insures further low nominal GDP growth aka secular stagnation. But so far, this stagnation has not made the economy more susceptible to recession. Some brief thoughts below

Here’s the right narrative for thinking about the US economy right now:

  • Following a massive bust in the oil sector that began in mid-2014, economic growth in the US was under severe downward pressure. Year-on-year real GDP growth peaked at 3.31% in the first quarter of 2015 and fell to 1.27% by the second quarter of 2016.
  • The Yellen Fed – contrary to the usual anti-Fed narrative – was actually looking for excuses to normalize the Bernanke Fed’s zero rate policy during this period, despite the weakening growth numbers. And eventually it did raise rates in December 2015, predicting an aggressive rate hike campaign of 100 basis points in each calendar year for 2016 and 2017.
  • But the weakening growth was too much for a data dependent Fed to take. And they paused, delaying the rate hike timetable.
  • Meanwhile growth started to perk up in 2016, rising for three quarters to the most recent figure of 2.03% year-on-year – during which time the Fed has raised rates three more times – reinforcing the view it has been looking to raise rates all along.
  • Now we must consider whether this trend of increased real growth will continue – especially in view of lowflation. And if the trend does continue, will the Fed will stick to its current normalization timetable?

Here are the rolling year-on-year real GDP numbers supporting this narrative, by the way.

Now, if you look back to 2016 when the Fed was predicting an aggressive rate hike campaign, there was a lot of incredulity about the fed’s ability to carry out its plan in the face of weakening growth – rightly so, since the Fed changed tack for the balance of the year.

But now that the Fed has resumed hikes on a less aggressive schedule – 3 hikes per year versus 4 – there is again widespread doubt due to the low level of inflation.

One interpretation of inflation below the Fed’s 2% target is that it is temporary. This is the view championed by Janet Yellen and some of her colleagues. And this view – backed by declining unemployment and rising real growth – favours more rate hikes to come.

Minneapolis Fed President Neel Kashkari took the low inflation data to heart in dissenting this month. He reasoned that a faith in traditional models that say inflation would soon rise was outweighed but the data, which pointed to more than temporary aberrations.

My own view is that the US economy remains in the 2%ish real growth channel that it began when the recession ended. 3.31% in 2015 was a high water mark buoyed by capital investment in the shale sector. 1.27% was a low point heavily influenced by the bust in oil capex.

Going forward, I want to highlight four things:

  • Jobs. There are no visible signs of distress in the employment picture. Initial jobless claims are still at multi-decade lows around 240,000.
  • Autos. Distress in the auto sector seems to be picking up a tad, though it has not hit worrying levels. GM, for example, recently lowered its 2017 vehicle sales outlook. The CFO said “The market is definitely slowing … it’s something we are going to monitor month to month.” His comment suggests he hopes the slowdown will pass but is prepared for the opposite to happen.
  • Oil. The recent decline in oil prices is likely to have less effect on capital expenditure because oil majors with better resources have committed to shale and because the decline is less severe than in 2014 and 2015. Nevertheless, not only are we near pain points for many players, but because this oil price drop has persisted, we should also see the decline in prices as applying downward pressure to both broad and core inflation numbers.
  • Credit. Both consumer and commercial credit growth have been declining. And the decline is broad-based. The question is whether this slowdown is a rear-view look or has some forward-looking implications.

Conclusion: The upward trend in US real GDP growth is under threat due to a broad-based array of weakness from oil to autos to credit. Most tellingly, real estate credit growth has slowed, removing a support that could buoy the economy while autos and oil shakeouts occur.

To me, the data speak to this quarter as a high water mark in the rebound from 2015’s mid-cycle pause. 2%ish growth will continue. With lowflation, that increases the likelihood of a Fed pause (and switch to beginning its balance sheet rolloff). The outlook is, therefore, largely supportive of longer-duration US government bonds. Wider implications are not yet clear, but watch the four highlighted items above.

PS – Contrary to what I would have reckoned, low nominal growth has been accompanied by more stability in GDP growth numbers, not less. We are in the midst of a very long expansion. And though I believe the data show weaknesses, there are few signs that the upturn is about to end shortly.

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