Our Perspective 8/ 5/ 2019

Economic Commentary: Impact of Recent Market-Moving Events

John Beuerlein
John Beuerlein
Chief Economist
Pohlad Companies

The past two weeks have been filled with economic reports and market-moving events that demonstrate how sensitive investors are as they try to understand the ramifications of ongoing trade tensions, slowing economic growth, and central bank policies.

Starting with the first estimate of second quarter U.S. GDP on July 26, the report showed the economy advancing at a 2.1% annualized growth rate, down from the 3.1% rate in 1Q-19.

The year-over-year rate of growth slowed to 2.3% from 2.7% in 1Q-19. Consumer spending was the strongest since 4Q-17, but elevated policy uncertainty and decreased global trade prevented business investment from expanding.

Fed Funds rate cut
Next came the Fed’s Open Market Committee meeting of July 30-31. As widely anticipated, the Fed lowered the upper target of the Fed Funds rate to 2.25% from 2.50%. The Fed also announced the early termination of the balance sheet unwind, which was due to occur at the end of September. The Fed explained the interest rate cut as insurance against signs of slowing global growth and weak inflationary pressures. The move was characterized as a “mid-cycle adjustment,” not the beginning of an extended easing cycle. Equity markets did not expect or appreciate the characterization and sold off.

Trade war with China
August 1 brought the tweet from President Trump that he would impose 10% tariffs on another $300 billion of Chinese goods starting in September. Equity markets dropped 2.25% on the news and the 10-year Treasury, which had been yielding 2.06% the morning of July 31, ended August 1 at 1.89%. Market reaction is an indication that investors are becoming much more concerned about the possibility of a prolonged trade war. China appears ready to play the waiting game as we head into the presidential elections, thus putting pressure on the U.S. strategy, at the risk of causing further deterioration in economic growth in both countries.

July employment was up 164,000; job growth is slowing

Job growth slowing
At face value, the July employment report released on August 2 matched expectations by growing payrolls by 164,000. Looking more closely, there were a number of concerning disappointments, however. Payroll gains in May and June were revised down by 41,000. After the revisions, the average pace of job gains in the past 3 months is 140,000, down from the 174,000 three-month average gain in 1Q-19. Job growth is slowing. The report also showed the average work week becoming shorter, thus impacting aggregate income creation.

Expectations for another Fed cut in interest rates at their September 18 meeting had eased after Fed Chairman Powell’s comments on July 31. Those expectations have moved back to 100% expectation of another rate cut in September, following the escalation of tariff rhetoric and evidence of slowing job growth.

Corporate earnings reports
While the above events were transpiring, corporations have been busy reporting 2Q-19 earnings. With 77% of the S&P companies having reported, expectations are for earnings to be down about 1% from 2Q-18 according to Factset. Earnings growth is trailing sales growth for the first time since the first half of 2016 – margins are being squeezed.

What to watch
All of the above trends, if continued, will be felt by consumers. The importance of the consumer to the U.S. economy cannot be overstated. Slowing job growth is occurring as corporations employ a more cautious hiring stance due to global economic uncertainty. Accounting for nearly 70% of U.S. GDP, any softening of the labor market will quickly reverberate through the economy. Monitoring the ongoing health of the U.S. labor market, then, is critical in assessing potential future economic activity.