Page 10 - ISQ UK_October 2017

INVESTMENT STRATEGY QUARTERLY
The Economic Outlook:
Slower, With Downside Risks

As delayed economic data releases arrive and fresh figures pour in, the 2019 growth outlook has appeared
somewhat softer than anticipated a few months ago. Fiscal stimulus (tax cuts and increased government
spending) was a major force propelling overall growth in 2018. However, the impact was expected to fade in
2019, with GDP growth slowing to a more sustainable pace (one driven by the natural growth in the working-age
population).

Consumer spending slumped in December, with only a partial recovery in January, when confidence was rattled
by the partial government shutdown. Still, the fundamentals of the household sector remain in good shape. Mild
weather helped boost job gains in January, while poor weather dampened job growth in February – the
underlying trend remains moderately strong. Wage growth has continued to pick up and lower gasoline prices
have added to consumer purchasing power. Consumer sentiment rebounded following the end of the
government shutdown.
Slower global growth and trade policy uncertainty appear to have dampened business fixed investment in early
2019. Orders and shipments of non-defence capital goods are on a softer track. Residential homebuilding
weakened over the course of 2018, but a sharp drop in mortgage rates should help in 2019.

“ If we could first know where we are and
MONETARY POLICY: MINOR SHIFTS ARE
A MAJOR DEAL FOR THE MARKETS whither we are trending, we could better
The partial government shutdown delayed a number of important judge what to do and how to do it. ”
economic data releases in early 2019, but the shift in the Fed – A. Lincoln
policy outlook from mid-December to late-January was driven by
other factors. Fed Chairman Jerome Powell noted the economic
outlook hadn’t changed much since the 18-19 December policy expected. The unwinding of the balance sheet was meant to be
meeting. However, the downside risks and uncertainties had background, not active, monetary policy. Fed officials do not
increased substantially. These “cross-currents,” noted Powell, believe it was the catalyst for the stock market weakness last year.
included the partial government shutdown, trade policy However, many market participants believe otherwise. The Fed
uncertainty, Brexit, and evidence of slower economic growth based its decision to end its balance sheet unwinding on
outside the United States, “especially in China and Europe.” considerations of bank reserves.
The Federal Open Market Committee had a mild tightening bias in
December, with market participants generally anticipating a rate THE JOB MARKET IS A FOCUS
increase in June 2019 and perhaps another in December. In Which data releases does the Fed consider in setting monetary
January, the Fed moved to a more neutral stance, indicating it policy? Basically, all of them. The Fed also pays a lot of attention
could be “patient” in deciding its next move. For seasoned Fed to the anecdotal evidence. However, its main focus is on the job
watchers, this was a relatively modest shift, but it proved to be a market and inflation. Based on the demographics, job growth in
much more important development for the financial markets. recent years has been well beyond a long-term sustainable pace.
That’s not a problem in the short term. In his monetary policy
During the financial crisis, the Fed conducted three large-scale testimony to Congress in February, Chairman Powell said there is
asset purchase programs (quantitative easing or QE), adding more likely more slack in the labour market than what is suggested by
than $3.5 trillion to its balance sheet. As part of monetary policy the unemployment rate. Firms continue to report difficulty in
normalisation, the Fed has been allowing some of these securities finding qualified workers, but they remain reluctant to raise
to roll off the balance sheet as they matured. The Fed now expects wages enough to attract those workers. In addition, firms
to end the unwinding of the balance sheet later this year, sooner generally appear to have a limited ability to pass higher costs
and with the balance sheet at a higher level than previously along.

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