The recent blip toward economic slowdown — which assured the Federal Reserve doesn’t raise interest rates this week — won’t last. But does that mean the Fed will come off the sidelines later this year, and hurt stock investors the same way it did in late 2018?
Those are the two provocative questions posed by Pantheon Macroeconomics chief U.S. economist Ian Shepherdson, arguing that the stock market is getting too complacent about the idea that the central bank will let the economy run hot because forces pushing the U.S toward a slowdown are so strong.
There really are two questions. First, is the economy running hot, or will it soon? Only then can you answer the second: What should you (the reader) do about it?
“The scene is set for a much more difficult second half of the year for markets, which are very happy with the idea that the Fed is never raising rates again.”
“I’m not sure I buy the idea that the market seems to like,” said Shepherdson, a two-time winner of the Wall Street Journal’s annual forecasting competition. “The scene is set for a much more difficult second half of the year for markets, which are very happy with the idea that the Fed is never raising rates again.”
There’s plenty of dispute — about the markets, the Fed and the economy itself.
75% chance the Fed is on hold
CME FedWatch says futures prices project 75% odds that Fed won’t raise rates through December. Goldman Sachs lowered its estimate of first-quarter economic growth to an annualized rate of 0.4% last week — way below the 2.9% annual rate for 2018 President Donald Trump bragged about on Twitter this weekend, when he wasn’t ranting about 12 “Jexodus” pilgrims, 11 Fox News hosts, 10 General Motors factories, nine climate changes, eight John McCains, seven “emergencies” at the border, six Robert Mueller rumors…
Four union leaders, three states with flooding, two mosques full of Muslims shot dead by a nutcase who, like the president, thinks immigrants are invaders….
And a rerun of Saturday Night Live!
Or something. Whatever. It was Trump, so it didn’t make sense. And it didn’t really matter.
But this is not a column about Trump. It’s about reality, so his name shan’t appear again.
Shaky manufacturing numbers
Goldman’s point was primarily about manufacturing, and was prompted by a weak reading on Empire State manufacturing index — the latest of a series of shaky numbers about manufacturing, accompanied by a handful about consumer spending, including a 1.6% drop in December retail sales that raised some concern that the government shutdown might have broken some of the economy’s momentum.
Pair that with surveys showing a rising share of business economists expect a growth slowdown this year, and many think a 2020 recession is even possible, and you can see why the markets expect the Fed to be out of the business of raising interest rates well beyond the meeting that begins today and wraps up Wednesday with an announcement at 2 p.m. Eastern and a press conference by Fed Chair Jerome Powell at 2:30.
But Shepherdson makes a strong case that the factors behind the slowdown are transitory, and that the consumer part of the economy is still on a trajectory for growth in the 2% to 2.5% range, about a third slower than in mid-2018. Mid-2018’s spending growth was driven by the 2017 tax cut, the effects of which have already faded, and a drop in gasoline prices that have begun to move in the other direction, he argues.
“It’s going to look bad for a while, but it’s dangerous to extrapolate,” Shepherdson said. With incomes growing about 2.5%, that’s a good pace for consumer spending to grow, he says. “The consumer is pretty much back to where they were before the tax cut.”
Similarly, Shepherdson sees manufacturing growth normalizing, if not surging, as the U.S. and China defuse trade tensions and a Chinese stimulus takes root by midyear, stabilizing demand for U.S. exports hurt by both the threat of new tariffs and China’s recent growth slowdown.
With both major forces that have been slowing U.S. growth set to dissipate, Shepherdson reasons, that means tightening labor markets should be forcing wage growth to levels the Fed finds uncomfortable by later this year.
Watch out for the Fed
Does that put everyone back in late-2018’s soup — after a quarter in which the S&P 500 SPX, -0.01% lost 14% of its value?
Maybe, says Shepherdson — it’s a risk big enough to watch out for.
Or, maybe not — if the Fed is steely enough to wait for inflation to begin rising tangibly past the central bank’s 2% annual target before raising rates.
Plenty of big banks’ economists and strategists think Shepherdson is off base.
Credit Suisse just raised its 2019 price target for the S&P to predict a 20% gain this year, saying the risks that tanked the markets are now receding — which is Shepherdson’s point, minus the part about the Fed.
Morgan Stanley said the recent rise in the Dow Jones Industrials DJIA, -0.10% and other averages has markets appropriately valued again. And asset manager BlackRock wants more proof of China’s rebound before endorsing that part of the story.
So if today’s Fed meeting seems boring — they’re not going to raise rates, says nearly everybody — don’t get lulled to sleep.
The stakes will be rising again soon enough.