The 2019 economic outlook is dominated by many of the same themes of a year ago. While fiscal stimulus (tax cuts and government spending) should provide support in the near term, labor market conditions will become more binding, Federal Reserve (Fed) policy is set to become tighter, and trade policy adds uncertainty. There are few signs of a pending economic downturn on the immediate horizon, but economists have raised the odds of a recession beginning in late 2019 or 2020 – still not likely, but also not out of the question.
The Fed has committed to reducing its balance sheet of assets, thus reducing its impact as a buyer. Given that policymakers at the Fed have indicated interest rates are approaching a ‘neutral’ level, monetary policy in 2019 is expected to be softer than previously anticipated. There is little to suggest that interest rates will make any dramatic moves upward over the next 12 months. Fed policy decisions will remain data dependent, meaning how the incoming information affects the outlook for growth and inflation.
Inflation moderated in the second half of 2018 and Fed officials are more concerned with future inflation than past inflation. The low trend heading into the new year should allow the central bank more leeway in deciding how quickly to raise short-term interest rates. Starting in 2019, the Fed chairman will conduct a press conference after every monetary policy meeting (eight times per year), rather than after every other meeting.
Trade policy will be a major uncertainty in early 2019. Tariffs on Chinese goods were set to expand at the start of the year, but that has been postponed, allowing more time for negotiations. It’s unclear whether an agreement will be reached. An escalation of trade tensions would further disrupt supply chains, add to inflationary pressures, and dampen overall growth through retaliatory efforts abroad.
All else being equal, a strong economy, the Fed’s unwinding of its balance sheet, and the increase in government borrowing should put upward pressure on bond yields, yet long-term interest rates have remained moderate, due in part to global rate disparity and demand. We could see an inversion of the yield curve in 2019, which has historically signaled that a recession is on the way. Some economists, and even a few Fed officials, have suggested that “this time is different,” as there are a variety of factors keeping U.S. bond yields low, including the fact that long-term interest rates remain low outside of the U.S.
Economic growth was strong in 2018, but beyond a sustainable pace. We know this because the unemployment rate fell, which clearly can’t go on forever. The transition to a slower, more sustainable pace of growth may be a challenge for investors, as such transitions are rarely smooth. However, the economic expansion should continue
Recent data suggest that the economic expansion continued at a moderately strong pace in 4Q18, with low and stable inflation. Trade tariffs initially had a significant impact on some sectors, but only a modest impact on overall economic growth and inflation. However, the impact is broadening and there are risks of a further escalation of trade tensions in 2019. Fiscal stimulus (deficit spending) should continue to provide support in early 2019, but the impact will fade. Federal Reserve (Fed) officials expect that some further increases in short-term interest rates will be warranted, but the pace of tightening should slow.