2019 has been a busy year so far. The United States has weathered a 35-day government shutdown, global data have deteriorated further, trade headlines continue to dominate the news, and the Federal Reserve (Fed) has made a significant U-turn in monetary policy plans, all on top of the sharp market selloff in late 2018. In response to the collective impact of these events, we’ve adjusted our 2019 economic forecasts [Figure 1].
In January, policymakers removed language from the Fed’s policy statement that “some further gradual (rate) increases” would be consistent with economic conditions and added language that they would be “patient” when determining future rate adjustments. The Fed has been messaging all along that policy decisions would be data dependent, but markets were becoming increasingly concerned that the Fed was on autopilot despite a slowing global economy and tightening financial conditions. More recently, the Fed demonstrated its commitment to flexibility, and it will likely pause on further rate tightening as the world waits for greater clarity on global conditions.
We’ve long emphasized our faith in the Fed’s commitment to flexibility and said in our Outlook 2019 that policymakers likely would not be as aggressive in 2019 as investors have feared. Based on recent Fed commentary, we expect the Fed’s pause to continue through the end of 2019. The Fed may need to briefly pump the brakes with an additional rate hike, potentially in the second half of this year, if business investment rebounds, the labor market tightens further, and economic growth picks up. To be clear, we think the U.S. economy could digest another rate hike, and it would be prudent to increase rates if there were signs of excesses or overheating. However, the Fed must consider global stability in its monetary policy moves, as an accelerating U.S. dollar could disrupt trade further and curb growth in struggling economies internationally.
Recently, the Fed has also messaged flexibility in the pace of balance sheet runoff, which is likely to calm investors’ nerves. No official changes have been made yet, and we don’t expect any in the near term. Further balance sheet reduction still gives policymakers a more subtle tool to influence interest rates, helping to provide some tightening while hikes remain on hold. Despite continued balance sheet runoff, global liquidity remains more than adequate, and the impact on global markets should be modest.
We see enough evidence to think 2019 gross domestic product (GDP) growth is likely to be closer to the lower end of our original 2019 forecast with risks balanced to the upside and downside. Heightened trade and political uncertainty have clearly weighed on corporate and consumer sentiment, and capital expenditures growth stalled in the second half of 2018 as U.S. corporations waited for greater clarity on trade risk before investing in their businesses. Growth in capital spending, measured by new orders of nondefense capital goods (ex-aircraft) slowed through November, so we wouldn’t be surprised to see tepid business investment weigh on last quarter’s output. December’s historic slide in retail sales points to fourth quarter weakness in consumer spending as well. Control-group retail sales, which are used to calculate GDP, decreased 1.7% in the month, the worst drop since September 2001. Fourth quarter GDP data are scheduled to be released February 28, with the consensus predicting from 1.5% to 2.5% growth.