The U.S. economy extended its record long expansion into the third quarter of 2019 as real GDP increased 1.9 percent and beat market expectations. The increase reflected positive contributions from PCE, government spending, residential fixed investment and exports; negative contributions from nonresidential fixed investment and private inventory investment partially offset those gains.[1]
American consumers continue to drive the economy with robust growth in spending and income.[2] Consumer spending for the year remains solid but slowed ahead of the holiday season, with tempered growth in the services sector and spending on durable goods cut nearly in half. Spending on motor vehicles and parts sharply decelerated and was the primary factor of the pullback in spending on durable goods.[3] Household consumption expenditures for health care and recreation services also decelerated, while food services and accommodations grew for the second straight quarter.
Rattled by the uncertainty of Trump’s trade wars and a global economic slowdown, business investment tumbled the most in nearly four years.[4] Though the Federal Reserve hoped that investment would pick up the pace considering two rate cuts earlier in the year, the slump in gross private fixed investment shows their vision is yet to unfold. The rate of deceleration in investment in structures sped up as the report shows its second-straight double-digit drop. Higher levels of investment in intellectual property products partially offset dwindling demand for information processing equipment, though it did not bring the overall ‘Equipment’ category out of negative territory.
Lower interest rates and lenient mortgages revitalized residential investment growth after seven consecutive quarters of decline.[5] Chief Economist for the National Association of Realtors credits interest rates and increased buying power for the rise in investment even as home prices continue to rise faster than incomes.[6]
Payrolls increased year-to-date by approximately 1,400,000 jobs and the rate of unemployment remains near 50-year lows. Additions to total nonfarm private payrolls averaged 131,700 jobs per month in the third quarter of 2019, slightly slower than the first three months of the year, but still positive. In addition, initial claims for unemployment fell 3.4 percent from the beginning of the year as a shrinking pool of qualified candidates forces employers to focus more on worker retention. The White House reported 75 percent of new hires in the third quarter came from outside the labor force, suggesting there are enough people qualified to work but not actively seeking employment to fill labor market demand.[7] Viewed in conjunction with ADP payroll data suggesting that the labor market is losing momentum, this implies a modest outlook for wage increases.[8]
Inflation data, as measured by the Core Personal Consumption Expenditures (PCE) price index, continues to underperform the Fed’s target of 2.0 percent this year. The Fed’s response to cut rates in July for the first time since 2008 and to further reduce borrowing costs in September has been insufficient thus far in boosting inflation. However, Fed Chair Jerome Powell asserted the economy is reaping dividends from the rate cuts in an October press conference, stating that looser monetary policy is “supporting household spending and home buying by keeping the labor market strong, keeping workers incomes rising, and keeping consumer confidence at high levels.” It is still too early to tell what affect the October rate cut will have on markets, but Powell’s comments suggest interest rates will stay where they’re at until the economy sees a persistent, sharp uptick in inflation.[9]
Bond yields typically correspond to its time until maturity, with yields on long-term bonds typically higher than short-term bonds, all other things being equal. However, when the yield curve inverts, it shows that investors’ short-term outlook is more bearish, and a recession could be imminent. The yield curve for the 3-month and 10-year Treasuries inverted in May, flashing warning signs through the media that the prolonged economic growth will soon come to a creeping halt.
Duke University professor and leading researcher on the yield curve, Dr. Campbell Harvey, found that an inverted yield curve has predated the past seven recessions and believes now is the time to reevaluate asset management strategies before it’s too late.[10] But other leading advisers, including Mohamed A. El-Erian, Chief Economic Adviser at Allianz SE, the parent company of PIMCO, point to cooccurring strong fundamental indicators and suggest unconventional central bank policies have deteriorated traditional recession signals.[11] Research earlier this year from economists Eugene Fama and Kenneth French supports this stance and found no correlation between an inversion and an equity market that underperformed government bonds.[12]
[1] BEA.gov, October 30, 2019, “Gross Domestic Product, Third Quarter 2019 (Advance Estimate)”
[2] Whitehouse.gov, October 30, 2019, “Economy Reaches Longest Expansion”
[3] BEA.gov, October 30, 2019, “Table 2: Contributions to Percent Change in Real Gross Domestic Product”
[4] Economic Times, October 30, 2019, “US Economy Grows 1.9% in Q3”
[5]BEA.gov, October 30, 2019, “Table 1: Real Gross Domestic Product and Related Measures”
[6] CNBC.com, October 29, 2019, “Pending home sales rise 1.5% in September, thanks to lower mortgage rates”
[7]Whitehouse.gov, October 30, 2019, “Economy Reaches Longest Expansion in U.S. History in Third Quarter of 2019, Beats Market Expectations”
[8] Fred.stlouisfed.org, November 3, 2019, Total Nonfarm Private Payroll Employment [NPPTTL]
[9] Federalreserve.gov, October 30, 2019, “FOMC Press Conference”
[10] CNBC.com, October 8, 2019 “Father of the Yield Curve Indicator says now is the time to prepare for a recession”
[11] Bloomberg.com, March 24, 2019, “There’s Danger in Misreading the Inverted Yield Curve”
[12] Fama and French, July 2019, “Inverted Yield Curves and Expected Stock Returns”
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