U.S. economic growth outperformed expectations early in 2019 but risks loom
On June 17, TD Economics published its Quarterly Economics Forecast, entitled "Tariffs Impart a Chill Wind on Green Shoots." Below is a summary of the U.S. portion of that report.
U.S. economy: Outperformance, but risks loom
U.S. economic growth outperformed expectations early in 2019. Real GDP advanced at a 3.1% (annualized) pace in the first quarter, boosted by temporary factors including a significant inventory build. With some reversal, growth is expected to slow to 1.9% in Q2. Still, the first half of the year is tracking 2.5%, roughly a half a percentage point above our prior expectation.
This places the 2019 annual average at 2.5% (previously 2.4%). Economic growth is expected to slow to 1.8% in 2020, as capacity constraints bind.
The White House has raised its tariff rate from 10% to 25% on the second tranche of Chinese imports subject to tariffs. Taken by itself, the impact is likely to be relatively small (we estimate a little over 0.1 percentage points), but much will depend on how spending and investment reacts to the continued ratcheting up of trade conflicts. Manufacturing sentiment has already begun to converge to lower levels seen abroad. This raises the prospect that another round of tariff action could have a larger impact on economic growth and sentiment relative to last year when both were at higher starting points.
Markets are pricing as much as four rate cuts between now and the end of 2020. This aggressive positioning reflects worries of further tariff escalation alongside low inflation and slowing economic growth (both globally and domestic). We believe the market has over-priced the extent of accommodation the Fed will ultimately need or be willing to provide absent a significant deterioration in the economic data. However, the persistent elevated risk environment opens the door for the central bank to take a risk management approach and provide a modest accommodation (50 basis points in cuts) later this year as “insurance."
We expect some semblance of a deal with China to occur this year. Critical to this outcome will be developments that occur from discussions between President Trump and President Xi at the G-20 meeting at the end of June. However, even in the event of a trade deal, it’s unclear at this stage whether the weight on the economy and market sentiment would fully lift. Importantly for the former, a deal would need to unwind the 25% tariffs placed on China in May. In addition, global trade concerns may quickly return to the spotlight with Trump having already signaled a desire to quickly pivot to Europe (a larger export market for the U.S.).