The Economy Will Slow Over the Course of the Year

By | January 8, 2019

Welcome to FTR’s “Monday Morning Coffee “ blog. The following article is designed to keep busy executives up to date with the latest economic data releases. Released every Monday, this blog promises to keep our clientele updated with the latest weekly economic news and developments, highlighting its impact on the transportation, freight, and equipment markets. Hopefully, this will be an informative addition to the fine body of work associated with FTR.

Overview

Coffee and Economic Review

World stocks rallied on Friday after Beijing announced a new round of trade talks although recession fears still had markets betting the next move in U.S. interest rates might be down. News that the United States and China would hold vice-ministerial talks on Monday and Tuesday to resolve a trade dispute brought some respite to battered markets. Global markets had a rough start to 2019, hurt by a shock revenue warning from Apple and concerns about slowing economic growth. But on Friday, European markets tracked 0.8% higher and Shanghai blue chips rose 2.4%. Markets tumbled on Thursday, as the U.S. ISM manufacturing index fell sharply. The risk of a U.S. economic downturn has caused a tectonic shift in expectations for interest rates, with investors now pricing the possibility of a cut. The Fed is still projecting two more interest rate increases this year, but the futures market implies the next move will be around a 40% probability of cut by year’s end.

Wall Street rebounded on Friday to close at the highest level in two weeks after a strong jobs report and assurances from Federal Reserve Chairman Jerome Powell that the central bank would be patient and flexible in steering the course of interest rates. In a session that reflected the elevated volatility that has gripped markets for weeks, all three major indexes surged more than 3% in one of the broadest advances in years. The gain wiped out Thursday’s losses and were led by the technology sector, which bounced back from its largest one-day decline in more than seven years after Apple Inc. cut its sales outlook. The main catalysts for the surge was the strong U.S. jobs report, at 312,000, that blew away economist’s projections and comments by the Fed’s Powell. In remarks at a recent meeting, Powell soothed markets with assurances that the central bank is sensitive to risks that worry investors and is not on a preset path of interest rate hikes.

Until the recent rebound following the jobs report, equity markets have been on a downward trend. Concerns about the U.S. economy heightened following sharp declines in consumer confidence and manufacturing last month, combined with accumulating evidence of a slowdown in Europe and China, roiled financial markets. Adding to investor’s worries were the continued uncertainty over U.S.-China trade, the Brexit situation and the government shutdown. Markets were starting to price in the possibility of a U.S. recession this year. The markets are righteously concerned about some of their negative apprehensions. China is showing clear evidence of a slowdown. Both the official and private manufacturing PMIs entered negative territory and evidence of consumer spending is also showing a slowdown. Europe is also backtracking on its growth rate. The slowdown overseas seems to have come home to roost with a dramatic fall in the U.S. manufacturing index. Investors and business leaders are also concerned because even the more optimistic economic forecasts for the next two years show a dramatic slowdown in the growth of the U.S. economy. Add to the picture, rising interest rates and the possibility of an inflexible Federal Reserve and the outlook does appear dark.

We think concerns about a near-term recession are misplaced. The upbeat employment report does not show an economy about to enter recession and that economic growth still has considerable forward momentum. Our forecast assumes that real GDP will likely advance between 2.5% and 3% in 2019. There are some basic policy assumptions behind that acceptation. One, is that the federal government goes back to work soon, and that there no further budget disputes that shut down the federal government for a prolonged period. Fueling the almost 3% growth in 2018 was the tax reduction and fiscal stimulus, which added almost a full percent to growth. The tax reduction effect will fade in 2019, but the fiscal boost will add nearly 0.6% to growth in 2019. We need a working government to achieve that goal.

Investors and business leaders also need to know that the Fed will be patient, especially as the international sector appears more precarious with unknown effects to U.S. exports and equity markets. In remarks to the American Economic Association, Powell soothed markets with assurances that the central bank is sensitive to risks that worry investors and is not on a preset path of interest rate hikes. Speaking after months of volatility in the equity and bond markets, Powell told the market the Fed is prepared to shift and that they are listening carefully and that was a good message for a market that was threatening to consume itself with fear.

The American consumer is the backbone to the U.S. economy and with still vibrant job creation and increasingly higher wages, consumption looks good next year. Business confidence and investment could see real gains if some deal is reached with China. Even if trade uncertainty continues for a prolonged period, that does not necessarily mean a steep reduction in business investment, it means more companies will stay on the sidelines for a longer period. Policy missteps and trade disputes, government shutdowns and a potential collapse in key international economic markets could certainly derail the U.S. economy. Barring these geopolitical disasters, the outlook for 2019 looks intact. However, the economy will most likely slow over the course of the year to near 2%. The outlook for 2020 is more problematic. An economy growing near 2%, no stimulus effect, higher interest rates and the uncertainty of the presidential election, would be vulnerable to any outside shock. The recession may not be near, but it could be coming into view.

Next week, we get a look at factory orders, the ISM non-manufacturing index, the NFIB small business optimism index, wholesale trade and the CPI. Currently, the Commerce Department is not funded and reports are being delayed. Reports by the Department of Labor and Federal Reserve are being released on time.

Latest Data

The U.S. Economy:

The ISM manufacturing index fell sharply in December, dropping from 59.3 to 54.1. There was a sizable decline in new orders, which dropped from 62.1 to 51.1. Only six out of 18 industries reported growth. Production fell from 60.6 to 54.3, with 10 industries reporting growth and four reporting a decline. Inventories slipped from 52.9 to 51.2. Supplier deliveries slid from 52.5 to 57.5. Respondents continued to note transportation difficulties and lead-time extensions, but fewer respondents reported slowing deliveries compared with prior months. Employment fell from 58.4 to 56.2. New export orders rose to 52.8 from 52.2. Import orders fell from 53.6 to 52.7. Prices paid fell sharply from 60.7 to 54.9. That index was north of 76 as recently as June. The decline in the index was large in December but it is still just slightly below the average for the cycle and consistent with GDP growth of 3.4%. The anecdotes were a little more pessimistic. A respondent in transportation equipment noted demand continues to decrease because of concerns about the economy and tariffs. The ongoing issues with the U.S. and China are causing concerns about costs and sourcing for the machinery business. We remain upbeat about the economy in 2019, but downside risks have increased as the stock market declines while the government shutdown continues to linger.

Vehicle sales same in at a 17.6 million annual pace in December, up slightly from the 17.5 million pace in November. This gave the auto industry a sales pace of 17.3 million for the year and four straight years of sales above 17.0 million. The auto industry can celebrate 2018 but be mindful of challenges ahead. Average new vehicle interest rates declined slightly to 5.9% in December, down from 6.0% in November. According to Edmunds, zero percent financing deals reached 5.5% in December, the lowest level since 2005. The strong economy continues to drive sales and 2019 looks solid. Interest rates will continue to increase in 2019. Eventually, tighter credit will lower sales volume, but the industry has outperformed expectations the last few months and may continue to surprise the upside.

The labor market delivered a big surprise in December. Payrolls increased by 312,000, well above expectations. In addition, payrolls in October and November were driven higher from 237,000 to 274,000. The fourth quarter had an average of 254,000. Among the industries that drove the December leap were gains in leisure/hospitality, which added 55,000 and education/healthcare, which added 82,000. Overall private sector gains increased by 227,000, up from 146,000 in November. Goods producing industries were led by construction, which added 38,000, after no gain in November. The labor market added 2.64 million jobs in 2018, up from 2.19 million in 2017. The workweek increased to 34.5 hours and average earnings rose by 11 cents, bringing the year-over-year growth to 3.15%, a cyclical high. The labor market ballooned by 419,000, overwhelming the ability of the labor market to absorb the new entrants. This caused the unemployment rate to rise to 3.9% from 3.7%. The strong performance suggests the labor market has room to grow and there is confidence that there are jobs to find by entering the labor market. Although we expect a decent labor market in 2019, the pace of job creation will moderate. Wage gains should reach 3.5%, consistent with very low unemployment.

International:

China’s factory activity contracted for the first time in two years in December highlighting the challenges facing Beijing as it seeks to end a trade war with Washington and reduce the risk of a sharper slowdown in 2019. The official Purchasing Managers’ Index (PMI) fell to 49.4 in December, below the 50-point level that separates growth from contraction. The increasing strain from factories signals a continued loss of momentum in China, adding to worries about softening global growth. Trade frictions are already disrupting global supply chains, fueling concerns of a bigger blow to global trade, investment and increasingly shaky financial markets. December was the first contraction since July 2016 and the weakest reading since February 2016. In November, industrial output saw the weakest output in nearly three years, while earning growth at industrial firms fell for the first time in three years. The PMI for prices fell to 43.3 in December from 46.4, signaling earnings erosion. The gauge on production fell to 50.8, the lowest since February, from 51.9. The new orders index fell to 49.7. New export orders fell to 46.6 from 47.0. The trade war has resulted in billions of dollars of losses for both sides, hitting industries from autos, technology and U.S. agriculture.

There is one bright spot in the Chinese economy in the services sector. The official non-manufacturing PMI rose to 53.8 from 53.4. China’s trade prospects are uncertain. There are many short-term orders from overseas but few long-term orders as caution remains amid the trade uncertainties. The medium to long term export picture is not optimistic. Warehouses n the U.S. are bursting with Chinese goods after retailers stocked up before fresh tariffs. The chances of a near-term rebound in exports is low even if a trade deal could be reached. China’s auto market has been particularly hard hit. Sale n the world’s largest auto market are on track to fall for the first time since 1990. Capacity utilization is estimated in the auto markets to have decreased from 56% in December 2017 to 50% in December 2018. China’s stock market tumbled about 25% in 2018 and the yuan has lost about 5% against the dollar. The World Bank projects real economic growth will slow to 6.2% in 2019, still robust by global standards, but the weakest expansion in 30 years.

Euro-zone manufacturing barely expanded at the end of 2018 in a broad-based slowdown. The euro-zone PMI fell for a fifth month, coming in at 51.4 from November’s 51.8, the lowest reading since February 2016. The index that measures output, that feeds into the composite PMI, did nudge up to 51 from 50.7. Manufacturing growth in Germany was modest, falling to a 33-month low of 51.5 in December, from 51.8 in November, the 11th month in which the manufacturing index declined. Spain’s growth was modest, but Italy and France were in contraction territory. New orders fell to the lowest point in four years in December and backlogs were run down for a fourth month. Continued worries over global trade, ongoing political uncertainties and tightening financial conditions all have served to undermine confidence in December.

Important Data Releases This Week

Factory orders for November will be released on Monday, January 7 at 10:00 AM EST. Advance data from the durables report show factory orders rose 0.8% reflecting a swing in both civilian and defense aircraft. Ex-transportation order fell 0.3% and core capital goods orders were down 0.6%. We see factory orders rising 0.4%. This report will be delayed due to the government shutdown.

The ISM non-manufacturing index for December will be released on Tuesday, January 8 at 10:00 AM EST. A modest but easing rate of growth is forecast for the non-manufacturing index to 58.4 from December’s 60.7. New orders including new export orders were central to November’s strength.

The NFIB small business index for December will be released on Tuesday, January 8 at 10:00 AM EST. The small business index is expected to ease slightly to104 from November’s 104.8. November saw small dips in economic optimism, sales expectations and current jobs openings.

Wholesale trade for November will be released on Thursday, January 10 at 10:00 AM EST. Wholesale inventories are expected to rise 0.4% in November. This report may be delayed due to the government shutdown.

The CPI for December will be released on Friday, January 11 at 8:30 AM EST. Easing pressure on energy costs will cause a contraction of 0.2% for December. The core rate will advance 0.2%, the same rate as in November. Year-over-year rates are seen at 1.9% overall and 2.2% for the core rate.


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About Steve Graham

Steve is one of the premier analysts in the transportation equipment industry. On a monthly basis Steve tracks and analyzes in detail the trailer and heavy-duty truck industry. Aside from following these two sectors he is also instrumental in helping our customers analyze the economy and its impact on transportation and transportation equipment.

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