A funny thing has happened to the U.S. economy on the way to a feared recession. It has suddenly shown signs of life – more life than most observers anticipated.
A recent string of better-than-expected economic data suggests the prevailing view of a sinking U.S. economy that took hold over the summer may have been overly pessimistic – or at least premature. While the recent numbers still show that U.S. growth has slowed and may continue to do so, there is a sense among some economists that the dark recession clouds may be lifting.
“The U.S. economy, though down, is far from out,” said Bank of Montreal senior economist Sal Guatieri, who wrote last week about the emerging potential for the U.S. economy to surprise to the upside – especially if the uncertainty surrounding the U.S.-China trade dispute is lifted.
“If the trade war ends, the economy should enjoy a bit of a renaissance.”
Evidence of a turning point in sentiment emerged at the beginning of September, as a list of economic indicators came in better than anticipated. That momentum continued last week, as August home sales (up 1.3 per cent month over month) underscored the strength of the consumer, while industrial production (up 0.6 per cent) gave hope that the battered manufacturing sector may be healing.
The Citi Economic Surprise Index, which compares how well recent economic data have done relative to market expectations, turned positive in the first week of September after nearly seven months in negative territory – reflecting a long period of decay in the economy and lowering of expectations. Last week, the index hit its highest reading in more than 16 months.
That’s a sign that the prevailing mood had gone about as low as it could go – even mediocre economic indicators are beating deeply depressed estimates. But it also suggests that the data aren’t pointing to the severe downturn that many people fear.
“When people start talking about recession, you know expectations are set pretty low,” Mr. Guatieri said. The recent data, he suggested, may be evidence that the U.S. economy has weathered the storm from the escalating tariffs between the United States and China, and is starting to emerge on the other side of that shock.
“We may have seen the worst of it,” he said. “Perhaps companies have made their adjustments.”
Even with the improving economic tone, growth will likely be tepid over the next year, held back by the impact of the trade war, increasingly sluggish global demand and high levels of uncertainty (especially on the trade front) that are constraining business investment.
Last week, the Organization for Economic Co-operation and Development lowered its growth projections for the United States to 2.4 per cent this year and 2 per cent next year. Other forecasters have been even more pessimistic; Toronto-Dominion Bank last week forecast U.S. growth next year at just 1.7 per cent.
The biggest concerns are about manufacturing and business investment, which have stalled in much of the world, including the United States, as the impact and uncertainty of the trade war have deepened. Despite August’s rebound, U.S. manufacturing output was still down 0.4 per cent year over year.
Meanwhile, the key sentiment indicator for the manufacturing sector – the Institute for Supply Management’s manufacturing purchasing managers’ index (PMI) – slipped below its 50 midpoint for the first time in three years last month, signalling a contraction in industrial activity. Historically, an ISM manufacturing reading below 50 is a strong indicator of a potential U.S. recession.
But the manufacturing PMI is at odds with the ISM’s services-sector PMI, which actually rose in August, to a healthy 56.4. Jonathan Golub, chief U.S. equity strategist at Credit Suisse Securities, argued that manufacturing is not the driving force of U.S. economic fortunes that it once was. The sector accounts for about 11 per cent of U.S. gross domestic product; the services sector, meanwhile, makes up more than three-quarters of GDP. So the still-strong ISM services index may be a more representative reading of U.S. business sentiment than the slumping manufacturing index.
“The small weight of manufacturing in the economy also means that it must contract viciously to precipitate a broad-based recession,” he wrote in a recent report, arguing that, at least so far, the degree of slowing in U.S. manufacturing “would be insufficient to cause a broad-based economic downturn.”
Meanwhile, the consumer side of the U.S. economy continues to look remarkably healthy. Retail sales have been on a six-month tear, and rose again in August by a healthy 0.4 per cent month over month.
The interest rate cuts by the U.S. Federal Reserve – first in July and again last week – should help sustain consumer-led growth, economists said. The summer rate cuts are almost certainly already contributing to consumer confidence, although it’s too early for those lower rates to have had a substantial direct effect on consumption.
Nevertheless, forward-looking economic indicators suggest that a slower growth pace in the U.S. economy is coming. The Conference Board’s U.S. Leading Index – a composite of 10 economic indicators that correlate highly with future economic activity – showed no growth in August, and its year-over-year growth pace of 1.1 per cent was the slowest in almost three years.
Many economists worry that the longer the U.S.-China trade dispute festers, the more likely its effects will spread more broadly through the U.S. economy, rekindling recession fears along the way.
“We remain on the lookout for broadening signs that cautious business behaviour is spilling into hiring decisions. Should this occur, it would risk kicking the legs out from under the expansion,” Toronto-Dominion Bank’s economics department said in a new economic outlook report.
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David Parkinson