In keeping with slowing global economic trends, the United States (US) economy is showing some signs of vulnerability. The Institute for Supply Management’s US manufacturing index has undergone a sharp decline and is currently sitting at a three-year low, with potentially negative implications for labour markets.
While unemployment is currently at its lowest levels since 1969, should manufacturing and other industries continue to come under pressure, demand for workers could fall and wages would stagnate. This, in turn, would see consumer spending run out of steam – a particularly worrying turn of events for the consumer-driven US economy. Already, the latest US job report has revealed that some 10 000 jobs were shed in August, largely as a result of trade pressures.
Concerns over a weakening local and global environment led the US Federal Reserve (Fed) to make its first interest rate cut in July. However, the Fed only lowered the rate by 25 basis points, much to Trump’s disappointment. This provoked the US President to announce higher tariffs on outstanding Chinese goods excluded from tariff adjustments. By creating a more volatile global environment, Trump’s intention is to push the Fed to act more aggressively.
But, in September, the Fed still only cut interest rates by another 25 basis points, demonstrating its independence despite Trump’s thoughts on the subject. So, while the European Central Bank (ECB) pushed interest rates further into negative territory, Powell explicitly stated that the Fed would continue to look at the underlying US economy and would not be participating in a race to the bottom when it came to interest rates.
This more moderate approach is justified given that, despite the aforementioned concerns, US consumers are in a generally healthy financial state. Retail sales rose 4% year-on-year in the third quarter and a tight labour market saw household disposable income growing by more than 4%.
Furthermore, appetite for credit is strong, as average debt servicing costs remain at only 10% of disposable income (the lowest level in 40 years), thereby providing consumers with plenty of room to increase their credit as needed. Lower interest rates saw new housing developments reach their highest point in 12 years in September, while a healthy household savings rate of 8% should provide consumers with a solid buffer against difficult times, further supporting the economy.
The US should, therefore, achieve GDP growth of some 2.8% in 2019 and is unlikely to see an economic collapse over the next year at least.
Even so, consumer sentiment has seen its largest drop since 2012, echoing a decline in business confidence, largely owing to increases in tariffs. Should the global slowdown continue, the US economy will likely cool further and may enter a recession.
RISKS BUILDING FOR EUROPE
The third quarter saw a continuation of the trends witnessed in Europe over the past few months, characterised by geopolitical volatility, social tensions and, of course, Brexit uncertainty. Brexit remains one of the biggest risks to the region as we move into the final quarter of 2019. Without arriving at an exit agreement, Brexit could well derail the support the ECB has been injecting back into the economy.
These issues have seen an economic slowdown across the region, particularly in Germany, which is at real risk of entering a recession. As a result, the ECB’s Mario Draghi has kept interest rates below 0% for the past five years in an attempt to boost spending, investments and consumption. This has had the unfortunate effect of punishing banks and savers’ holding deposits. This quarter the ECB reaffirmed its belief that economic risks in the region remain to the downside, and it remains especially concerned about a potential deflation patch.
But not all central banks in the region have been in full agreement with the ECB’s decision to kickstart quantitative easing, with notable disapproval coming from the French, German and Dutch central banks.
This may put Christine Lagarde in an extremely difficult position as the new ECB President. She will need to decide whether to continue with Draghi’s stimulation policy or pause to take stock of where the European economy is at that stage.
It is clear that monetary policy alone will not save Europe. Already this approach has resulted in a surge of fiscal spending in countries such as France and Italy, and has placed pressure on Germany to follow suit after many years of running a surplus.
This follows a collapse in regional manufacturing production, most acutely felt in Germany, which has dampened the business climate and witnessed confidence fall to levels last seen around the time of the European Union banking crisis in 2012.
As is the case in the US, consumer confidence in the region has also begun to erode amidst slowing growth, although with retail growth of 3% year-on-year consumers are not yet on their knees. This should, to some extent, help to keep the region afloat, but given the many issues weighing upon the region, Europe will struggle to maintain economic growth of above 1.5% this year and next.
Written by Maarten Ackerman, Citadel Chief Economist