U.S. economy: Steady growth following a soft landingContributor Dr. David Kelly
In 2020, the U.S. economic expansion should enter its 12th year, having successfully downshifted from 3% growth to 2% growth without falling into recession. The remarkable longevity of the expansion and a continuation of low inflation and unemployment are all significant positives. However, from an investment perspective, the outlook is far from ideal. Slow economic growth and rising wages will put pressure on margins while steady inflation should preclude a significant bond market rally. In addition, long-term returns will be challenged by the implications of a growing budget deficit and political risks of greater protectionism or higher taxation will continue to give investors plenty to worry about.
The longest U.S. economic expansion should continue in 2020
EXHIBIT 1: Length of expansions and recessions in months
Source: National Bureau of Economic Research, J.P. Morgan Asset Management. *Chart assumes current expansion started in July 2009 and continued through November 2019, lasting 125 months so far. Data are as of November 26, 2019.
The strongest part of the U.S. economy should continue to be consumer spending. Even as the lift from the 2017 tax cuts fades, household spending will be supported by good gains in wages. Over the course of 2020, we expect real disposable income to climb by roughly 2.0%, as wages continue to outpace inflation and payrolls gradually expand. Investment spending, however, will remain sluggish as businesses deal with uncertainty from ongoing trade tensions and a slow-growing global economy. In addition, inventories should grow more slowly, dragging on GDP growth, while trade and government spending should have more neutral effects.
On balance, we believe the U.S. economy will avoid recession in 2020. The greatest risk of a downturn centers around the possibility that businesses might collectively freeze or reduce hiring, given trade uncertainty and a slow-growth outlook.
However, this is probably not quite enough to cause a recession and the historically most potent recession triggers appear less dangerous at this time.
First, long-term interest rates are unusually low for this late in an expansion. This means that neither businesses nor consumers are getting boxed out of big-ticket spending decisions because of high financing costs.
Second, the most cyclical sectors of the economy are subdued with no boom in housing, autos or capital spending. This reduces the risk of a “boom-bust” cycle pushing the economy into recession.
That being said, slow economic growth should translate into slow employment growth, with monthly job gains of roughly 130,000 in 2020 compared to 170,000 in 2019 and over 220,000 in 2018. Very low labor force growth implies that even this reduced pace of job growth should be consistent with a gradual tightening of the labor market, with the unemployment rate falling to 3.3% in the fourth quarter of 2020 from 3.5% a year earlier. Despite this, wage growth will likely remain steady at between 3.0% and 3.5% year-over-year, as the pressure of tightening labor markets meets a concerted corporate effort to maintain margins.
Both the unemployment rate and wage growth should be steady in 2020
EXHIBIT 2: Civilian unemployment rate and year-over-year growth in average hourly earnings, percent
Source: Bureau of Labor Statistics, J.P. Morgan Asset Management. Data are as of November 26, 2019.
All of this should result in low and steady inflation, with the core consumption deflator gradually moving up to a 2.0% year-over-year gain from its recent pace of 1.7%. Profits should also grow at only a low single-digit pace from a very elevated level, as corporations get squeezed by a steady rise in compensation and sluggish markets.
Finally, Washington will both impact and be impacted by the economy in 2020. Despite signs of de-escalation in the trade war, the threat of tariff hikes will likely remain through 2020, reducing exports, imports and investment spending. With regard to the 2020 U.S. elections, because of the early stacking of primaries, it should be easy to predict the Democratic nominee for president by March 17. Investors will be interested in this candidate’s proposals on corporate taxation, regulation and health care.
Much of the year will be spent handicapping the November election both with regard to the race for the presidency and control of Congress. A divided government is the most likely outcome. However, one party controlling the White House, the House of Representatives and the Senate could bring more radical policy change. Finally, fiscal 2020 will see the budget deficit exceed $1 trillion for the first time since 2012, and financing this deficit may put some extra strain on the bond market.