The U.S. economy is now in its longest but also its slowest expansion on record. While it has been growing for 123 months since June 2009, the pace of GDP growth has averaged only 2.3 percent — well below the 2.9 percent pace of the 2000s, 3.6 percent in the 1990s and 4.3 percent in the 1980s.
Combined, these “longest” and “slowest” factors have brought back misguided fears that expansions “die of old age.” But while slow growth certainly exposes an economy to potential adverse shocks, long expansions are not more strongly correlated with recessions than shorter ones. Yes, the economy is facing an increased number of headwinds, but none seems life-threatening. Here are eight of them.
1) One of the most visible catalysts for increased recession fears over the past few months is the yield curve inversion. The three-month/10-year spread turned negative in May, and the two-year/10-year spread inverted in late August. But while yield curve inversions remain reliable recession predictors, the current inversions come amid a global flight to safety (pushing down yields for safe-haven assets) and central banks easing globally. Further, the recession signal from yield curve inversions is long and variable, with recessions following inversions by 10 months to three years.
2) One of the most commonly cited headwinds is that of rising trade tensions. Over the past two years, the Trump administration has gradually increased tariffs on China and other trading partners, prompting multilateral retaliation. But while trade policy developments have dominated headlines since early 2018, the damage to the economy has so far been modest. Oxford Economics estimates that the hit from the 25 percent tariffs on $250 billion of imports from China will be limited to only 0.3 percent of GDP over 2018-2020.
Thus, while protectionism is often cited as the main culprit for the ongoing economic slowdown, it’s likely responsible for only 25 percent of the 2018-2019 cooling. Even factoring the newly announced September 1 and October 1 tranches of China tariffs, and larger financial market and confidence spillovers, Oxford Economics expects the cumulative hit to US GDP to be limited to 0.6 percent, before policy offsets.
3) Slower global growth is also an oft-cited threat to the U.S. economy. With global GDP growth dropping from 3.5 percent year-to-year in the fourth quarter of 2017 to 2.6 percent in the second quarter of 2019, the external environment has weakened markedly. U.S. exports have cooled significantly since 2017, with real merchandise exports down 0.7 percent year-to-year through July after 1.4 percent decline in 2018
But while trade’s net contribution to GDP growth has clearly faltered, it’s not big enough to represent a recession threat. Over the last year, the drag on growth from slower real exports rose to 0.9 percentage points, but less import growth meant a much smaller net trade drag of 0.4 points.
4) The stall in manufacturing activity is also commonly referred to as a recessionary signal. Indeed, both industrial production and manufacturing have entered a technical recession as of the second quarter. More recent data point to ongoing weakness, with manufacturing output contracting 0.5 percent year-to-year in July and the ISM manufacturing index – a leading indicator for the sector – falling into contraction territory in August for the first time since 2016.
But while the weakness appears broadly diffused across manufacturing sectors – 53 percent of subsectors are contracting – the diffusion and magnitude of the decline remain well shy of the 2015-2016 slowdown and the financial crisis of 2007-08. Further, the sector represents only about 10 percent of the economy, so even a prolonged contraction in industrial activity wouldn’t necessarily lead to an economy-wide recession. In fact, since 1960 there have been 12 industrial production recessions versus 7 economy-wide recessions.
5) The broader corporate sector is also displaying worrisome symptoms. Business investment contracted 0.6 percent in the second quarter – the first since 2016 – and preliminary data point to ongoing softness in the third quarter. With energy investment contracting and equipment spending pulling back, it appears business investment growth will slow to 2.6 percent in 2019 and 0.8 percent in 2020, down from 6.4 percent in 2018. This will certainly impose a notable drag on the economy, but it’s unlikely enough to push the U.S. into a recession.
6) At the same time, profits posted their first back-to-back quarterly decline in two years – down 3.5 percent in the fourth quarter of 2018 and 14.2 percent of the first quarter of 2019. In addition, profit margins are enduring their longest late-cycle contraction in post-war history. But while declining profit margins are a reliable recession indicator, lead times in the post-war era have varied greatly — from 12 months to four years. Further, prolonged margin contractions have typically accompanied extended economic expansions, as in the late 1990s.
7) Meanwhile, the consumer sector – the main engine of U.S. economic growth – remains in healthy shape as retail topped expectations in July and August. In fact, the 4.7 percent surge in consumer outlays in the second quarter was the biggest since late-2014.
The strength in spending appears well supported by income growth, itself driven by a balanced combination of steady employment growth and moderate wage increases around 3 percent. With the personal saving rate approaching 8 percent, household leverage historically low and confidence remaining generally elevated, fundamentals point to a resilient recession buffer from U.S. households. And while some commentators argue that consumer spending is generally the last to fall during recession, that shouldn’t mean we ignore the current resilience entirely.
Instead, over the next year a gradual moderation of real disposable income growth, in line with a cooling labor market and easing wage growth, should lead to a progressive slowdown in consumer outlays growth. Consumer spending will cool from 2.6 percent year-to-year growth at the end of this year to around two percent at the end of 2020. That’s still enough to support an ongoing economic expansion
8.Finally, despite the Federal Reserve’s cacophony, the Federal Reserve will deliver a 25 basis points (bps) rate cut at its next meeting, followed by another two cuts before year-end. All told, the 100 basis points of policy easing in the second half of 2019 should provide for looser financial conditions and a gradual boost to real activity in the medium term.
Gregory Daco is the chief U.S. economist at Oxford Economics.