We are entering a new decade in the midst of an old expansion. The length of the expansion does not suggest a recession is imminent, but it does imply that GDP growth will struggle to exceed 2% consistently even as interest rates remain near historic lows. The Federal Reserve is faced with the daunting task of moving interest rates higher without squelching the expansion so it has more firepower to stimulate a recovery when the next recession hits. In this update, we evaluate what current economic trends mean for the future and why, paradoxically, the Fed is more likely to cut interest rates this year than raise them.
In the second quarter, only two sectors of the economy contributed positive growth, and deteriorating trends suggest our “Good but not great” growth outlook for the economy will come under pressure in coming quarters. Slowing growth is one reason the Federal Reserve has shifted toward easier monetary policy, but importantly, U.S. central bankers are also responding more reasonably to slowing global macroeconomic conditions and persistently low inflation. With the Fed actively easing, our baseline forecast does not include an imminent recession, but the call is increasingly difficult to make as slower growth produces a fragile economy more susceptible to shocks.
Following a month-long delay due to the government shutdown, officials confirmed what economists and investors already suspected – the economy is slowing. We expect growth to continue to slow towards the 2.0% – 2.5% pace characterized by the post-Financial Crisis expansion, though we caution the potential for Q1 2019 growth to surprise to the downside. However, as we detail in the letter, the domestic economy is on reasonably sound footing, and the economic expansion has room to run if the Fed sticks to their new narrative of being patient.