Shoppers walking in the Herald Square area of New York.
Michael Nagle | Bloomberg | Getty Images
By any number of measures, the U.S. economy is outshining the depressed picture the bond market has been painting of U.S. growth, and a big part of it is the resilient American consumer.
The latest batch of U.S. economic data, released Thursday, shows a strong consumer and a mixed picture for manufacturing, but still better than expected. Based on the data, economists surveyed in the CNBC/Moody’s Analytics Rapid Update raised their forecasts for third quarter GDP by 0.2 to a median 2% pace of growth.
July’s retail sales, which take the pulse of consumer spending, jumped a much stronger than expected 0.7%, and two key business indexes for the New York and Philadelphia area showed continued expansion in August. Productivity in the second quarter grew at a better than expected pace of 2.3%, but industrial production was weaker, declining 0.2% in July after gaining a revised 0.2% in June.
“The U.S. is pretty strong actually. The markets are trading more off the headline risk, particularly around tariffs, than the actual fundamentals, at least from the U.S. data,” said Tony Bedikian, head of global markets at Citizens Bank. “The jury is still out whether the market is going to be correct here, and whether we are going to see a slowdown. We’re not seeing that in the data. Broadly, we’ve seen some slower growth, but it’s still growth. It’s waning a bit but it’s still kind of a Goldilocks scenario.” Bedikian said the Fed is still expected to cut interest rates, which should help the markets and economy, even though the data shows a fairly solid economy.
Another piece of data released Thursday was homebuilders confidence, and it rose as mortgage rates fell sharply this month. Builder confidence for single-family homes hit 66 in August, one point higher than it was in July, according to the latest National Association of Home Builders/Wells Fargo Housing Market Index. Anything above 50 is considered positive.
Yield curve inversion
Markets have been spooked by the steep decline in bond yields since the Federal Reserve’s rate cut July 31, and most recently by the inversion of the 2-year and 10-year Treasury yields. Inversion means the yield on a shorter duration security, in this case the 2-year Treasury note, moved higher than the longer duration note, or the 10-year Treasury. While the spread is no longer inverted, it still could easily move that way once more. The concern is an inverted curve has been a very reliable signal of a recession.
In fairness, U.S. yields have also been moving lower as investors seek better yielding sovereign debt in the Treasury market. Yields move opposite price, and the yields on some sovereign bonds in Japan and Europe are negative. Bond yields have also been moving lower as global data from China and elsewhere has looked weak, and strategists say the bond market is reflecting both a flight to safety and fear the U.S. will fall into the weakening trends in Asia and Europe.
Chris Rupkey, MUFG chief financial economist, said the bond market is not reflecting reality but fear brought on by the trade wars.
“It’s certainly overstated. If you look at retail sales, one of the signs of a recession is three consecutive monthly declines in retail sales, and we’re seeing just the opposite,” said Rupkey, adding the retail sales reports were weak at the end of last year and beginning of this year before recovering.
Michelle Meyer, head of U.S. economics at Bank of America Merrill Lynch, had expected the consumer to look strong in July, and her forecast for 0.6% gain was nearly double the sales increase, expected in the consensus forecast. One of the big drivers of the gain was Amazon’s Prime Day, which triggered lots of promotional activity at other retailers.
“The promotion season was so big, and it was retailers outside of Amazon trying to compete,” said Meyer. She said a weak consumer would not have been lured in by promotions. “It shows the consumer was able to spend.”
Economists say the consumer has been supported by a solid labor market, which is showing some signs of slowing down but still adding jobs at a solid enough pace. Weekly jobless claims is a closely watched indicator because it is the freshest signal on employment, and one of the first pieces of data to show weakness when the employment picture changes.
Weekly jobless claims Thursday rose by 9,000 to 220,000 in the week ended August 10, but one economist notes the number of new claims being filed has been locked in a narrow range between 207,000 to 222,000 in 13 of the last 14 weeks. “Firms are struggling so much with a scarcity of qualified workers that it is hard to imagine layoffs rising much any time soon unless the economy falls off a cliff,” said Stephen Stanley, chief U.S. economist at Pierpont Amherst.
The monthly employment report two weeks ago showed the economy added 164,000 nonfarm payrolls in July, nearly as expected, and also about the average monthly gain for the year. That pace is down from 2018’s strong average monthly job growth of 223,000 payrolls, but economists see the level as still solid, with an unemployment rate at 3.7%.
“Factory output is not out of the woods yet in this latest soft patch caused by trade war uncertainty and slowing exports growth,” notes Rupkey. “Production is down but not out as the trend is largely sideways since the low for the year was made back in April.”
‘Consumer is two-thirds of the economy’
But Rupkey adds that the output from manufacturing is mostly exported so with volumes lower as a result of the trade war, manufacturing is soft.
“The biggest surprise is consumer spending continues at such a rapid rate. There’s still a question mark over the trade war and what that’s doing to manufacturing production in this country,” said Rupkey. “I think the more powerful data is really the consumer. The consumer is two-thirds of the economy. Manufacturing is only 10% of private jobs.”
He noted that manufacturing has fallen more than 1.5% this year, marking the second time in a decade that it has declined outside of a recession. But Rupkey does not believe it will have negative implications for the broader economy. “The health of factories is still an important driver of growth and the soft patch for production remains a factor that is keeping economic growth in the slow lane,” said Rupkey.”
The worry, however, is the weakness in manufacturing and investment spending will spill over to the consumer economy if companies become more negative in their outlook and hold back on hiring or paying wage increases.
But economists said they were encouraged Thursday by better than expected business surveys.
“I was pleasantly surprised by the Empire Manufacturing and Philadelphia Fed. Both came in above expectations and these are August surveys,” said Meyer, adding respondents would have known about the latest escalation in the trade wars and tariffs. “Their sentiment actually improved in the month.”
The Empire State Manufacturing Survey had been expected to show a reading of 0.5 while the Philadelphia Fed Business Outlook Survey was projected at 8, according to economists surveyed by Dow Jones. Both readings were well above those expectations, with the New York gauge posting a 4.8 reading and Philadelphia 16.8.