Economic Data Softening as U.S. Economy Looks Toward Longest Expansion
Two months into the second quarter and the U.S. economy is heading towards its longest expansion since the 10-year expansion from 1991-2001. By July, it will become the longest, even as an escalating trade war between the U.S. and China, that now may include Mexico, has riveted through U.S. and global stock markets, adding to concern for business leaders’ optimism and potentially, consumer sentiment.
As U.S. stock markets posted their worst month since December 2018, market participants began positioning for the likelihood that the Federal Reserve would consider an interest rate cut at some point in 2019. In early June, Federal Reserve officials said they were watching how trade disputes could impact economic growth and indicated they would take steps to keep the U.S. expansion on firm footing in line with the central bank’s full employment and 2.0% inflation objectives. Indications of rate cuts helped stocks rally during the first week of June.
Signs that all is not completely well and that the U.S. economy may limp across that July finish line to a record expansion are partly evident in the slowdown in manufacturing. Both the Institute for Supply Management (ISM) and the IHS Markit reports on purchasing managers activity pointed to declining activity in May.
The ISM reported that its purchasing managers index (PMI) for May fell by 0.7 of a percentage point to 52.1, its lowest level since October 2016. While index readings above 50 indicate that the manufacturing economy continues to grow, consensus forecasts had called for a reading of 53.0. In addition, while new orders, production and employment indicators within the report all rose, order backlogs fell 6.7 points to 47.2 – a contracting direction for the first time since January 2017.1
Another gauge of manufacturing activity from IHS Markit hit its lowest level since 2009, with sentiment also deteriorating. The IHS Markit’s PMI fell to 50.5 in May, down from 52.6 in April. Weighing on the headline index reading was the softest expansion in output since June 2016, IHS Markit said, noting that May data signaled only a “marginal rise” in production that was often linked to clearing backlogs of orders.2
While new orders barely declined for the first time since August 2009, manufacturers surveyed said the fall was driven by weak client demand. Some firms also said customers were postponing orders because of growing uncertainty about the outlook. New business from abroad also contracted, though marginally, for the first time since July 2018.
These factors, then, led to manufacturers exhibiting a lower degree of confidence towards output over the coming year. Expectations for growth dipped to their joint-lowest since the series began in July 2012, IHS Markit said.
In terms of the manufacturing sector’s link to economic growth, ISM’s chair, Timothy Fiore, said the past relationship between the PMI and the overall economy indicates that May’s activity corresponds to 2.7% increase in annual gross domestic product (GDP). The so-called “second” estimate from the Bureau of Economic Analysis released on May 30 showed the economy grew at an annual rate of 3.1% in the first quarter, down from the first reading of 3.2% issued in April.3
Economists have been tapering their expectations for second-quarter GDP, particularly given the recent trends in manufacturing. In addition, both manufacturing surveys were released prior to President Trump’s announcement that the U.S. was considering increasing tariffs on Mexican imports unless Mexico takes action to stem the tide of migration flows into the country.
The stakes of increasing tariffs from a 5% start up to 25% by October are high for U.S. manufacturers, particularly automakers, which have made Mexico a key manufacturing center for their products. Just under 2.7 million vehicles sold in the U.S. last year were assembled in Mexico, according to International Trade Administration figures, cited in this CNBC report.4
Whether or not tariffs on Mexican imports actually materialize, other signs of growing weakness in industrial activity emerged in late May. The Commerce Department reported May 24 that new orders for U.S.-made durable goods declined 2.1% in April compared to the previous month. The closely watched gauge of business spending, orders for non-defense capital goods excluding aircraft, fell 0.9%. Data for the previous month was also revised.5
With the growing downside risks to the economy, particularly tied to trade, forecasts for second quarter GDP are well below the first quarter’s pace. As of early June, the forecast from the Atlanta Federal Reserve’s GDPNow model was at 1.3% for GDP growth, based on recent U.S. data, up from below 1.2% on May 31. As of its May 31 update, the New York Federal Reserve’s Nowcast GDP was forecasting 1.5% growth. Each model is updated as new economic data flows in and the forecasts tend to fluctuate.
Activity in the futures markets as of late May suggested a nearly two-thirds probability that the Federal Reserve will cut interest rates this year and again in 2020. As mentioned previously, Federal Reserve officials, including Fed chair Jerome Powell said during the first week of June that the central bank was watching how trade negotiations could affect the economy and would act, if needed, to sustain the economic expansion.
“We do not know how or when these issues will be resolved. We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2 percent objective,” Powell said in a speech on June 4 in Chicago.6
Expectations for a rate cut may have been buoyed by the ADP employment survey report which showed that 27,000 jobs were added last month, well below forecasts and April’s figure of 275,000 jobs.7 On the other hand, the latest ISM non-manufacturing reading on the service sector for May came in at 56.9, a growing and faster rate of change compared to the previous month, though below 2018’s annual average pace of 58.9.8
Real Estate: Housing Still in Decline, Though Low Rates Could Spur Activity for Rest of 2019
Despite lower mortgage rates and what has been, to this point, steady job creation, home sales continued to show some weakness in April (most recent figures available). Existing home sales fell 0.4% compared to March to a seasonally adjusted annual rate of 5.19 million, according to the National Association of Realtors (NAR).9
Compared to a year ago, sales fell 4.4%, marking the 14th straight month in which existing home sales have declined year-over-year. Despite the persistent weakness which has been the backdrop for housing for nearly two years, low mortgage rates, the current state of the job market, and low unemployment are expected to form a firm foundation for the rest of 2019.
Lawrence Yun, NAR’s chief economist, expects moderate growth for existing home sales soon. “First, we are seeing historically low mortgage rates combined with a pent-up demand to buy, so buyers will look to take advantage of these conditions,” he said. “Also, job creation is improving, causing wage growth to align with home price growth, which helps affordability and will help spur more home sales.”
Freddie Mac’s latest forecast released in mid-May calls for home sales to regain momentum, as sales are showing signs of recovery. It forecasts 5.98 million of total home sales in 2019, up marginally from 5.96 million in 2018. Existing home sales, Freddie Mac said, have benefited from low mortgage rates and a healthy job market. “We expect stronger home sales and housing starts in the coming months. This will bring full-year housing starts and sales in 2019 back to around the same level we saw in 2018,” Freddie Mac said in its forecast.10
Markets: Stocks Fell Broadly in May as Trade Tensions Weigh on Sentiment
Reversing course, global equity markets had their worst month of the year in May. Escalating trade tensions led to a broad rotation out of equities into safer government debt as market participants questioned the implications of the impact of a mounting trade war on global economic growth.
In the U.S., the Treasury yield curve flashed a warning sign for the economy with an inversion by which 10-year note yields were several basis points below those of 3-month Treasury bill rates. While curve inversions are broadly seen as leading indicators of recessions, it’s important to consider other evidence, Benjamin Bimson, BCJ’s chief investment officer, wrote in a recent BCJ Insights post.
The U.S. Treasury 10-year note closed out the month by nearly 38 basis points lower than April, yielding 2.31% as of May 31. The 10-year German bund fell into negative territory, yielding -0.207% as of May 31, after ending April at a yield of 0.013%.
For stocks, it was a far different story. After hitting record territory in April, the S&P 500 posted four consecutive weeks of declines during May, a dubious feat that hasn’t occurred since October 2014, according to S&P Dow Jones Indices.11 Overall, U.S. benchmark stock indexes had their worst month since December with the Dow Jones Industrial Average shedding 6.69%, the S&P 500 down by 6.58% and the Nasdaq Composite losing 7.93%.
While trade rhetoric was often to blame for May’s doldrums, market participants have been broadly rotating out of stocks tied to the economy toward other less risky assets like government bonds. Equity exchange-traded funds (ETFs) recorded their largest ever monthly outflows in May, with investors taking out more than $19.9 billion, according to data from State Street Global Advisors, as reported by CNBC.12
Selling was concentrated within the “cyclical, economically sensitive segments of the market,” such as financials, technology, industrial materials and energy, said Matthew Bartolini, head of SPDR Americas research at State Street Global Advisors. Treasury ETFs took in more than $5.6 billion in inflows in May, though high yield ETFs (corporate bonds rated below investment grade by the major rating agencies) had outflows of about $3.0 billion.
Among the S&P 500’s 11 sectors, only real estate (up 0.90%) was able to post a positive price gain during the month. Particularly hard hit was the energy sector, which declined by 11.70% as the price of Brent crude oil fell by nearly 11.05%.
Information technology fell 8.91%, partly on concerns over disruptions due to the U.S. government’s requirement that prevents American suppliers from providing China’s Huawei Technologies Co. with U.S.-origin technology without government approval.
Prior to gaining back some ground in early June, technology shares fell further as antitrust officials in the Justice Department and Federal Trade Commission are expected to begin investigating the practices of Alphabet Inc. (Google’s parent), Facebook Inc., Amazon.com Inc. and Apple Inc. Congress also appears to be in the initial stages of a broader investigation into competition within digital markets.
In addition to China, where the CSI 300 Index fell 7.24%, trade sensitive markets elsewhere in Asia, including Korea and Taiwan experienced sharp selloffs. Korea’s Kospi Composite was down 7.34%, while in Taiwan, the FTSE TWSE Taiwan 50 Index declined by 5.33%.
In Europe, declining government bond yields pressured stocks, particularly interest-rate sensitive and tariff-related sectors. The Stoxx 600 declined by 5.69% during May, but is still up by 9.30% for the year through May 31. After a recent high during the third week of April, the banking sector within the index fell 14.06% (in euro terms) through the end of May. Similarly, the Stoxx 600 Automobiles & Parts index declined by 13.51% during the same time period.
Commodities: Prices Fall on Global Growth Concerns; Gold Rallying
U.S. crude oil markets hit bear territory briefly in early June on higher supplies and concerns over global growth prospects. Signifying the volatility that oil prices in the U.S. have experienced in recent years, the price of crude futures entering a bear market on June 5 represented the third time that prices have declined by at least 20% from their peaks since January 2017.
Global oil prices sold off significantly during the fourth quarter of 2018, followed by a rally in the first quarter of this year along with other commodities and stocks. The latest decline in West Texas Intermediate crude prices (down by more than 22.00% since late April) comes as data for the week of May 31 showed that inventories of crude oil are about 6.0% above the five-year average for this time of year, according to the U.S. Energy Information Administration’s weekly petroleum status report.13 For the year through early June, U.S. crude oil is still up by nearly 14.00%.
Brent crude, the global benchmark for oil has also given back some of the gains it made in price terms through April, declining by nearly 19.00% from recent highs in late April. Year-to-date through early June, Brent prices remain higher, though, up by 12.70%.
Copper, another commodity tied to the fortunes of the global economy, fell by more than 10.00% in May compared to the previous month. With concerns that the U.S. and China might be moving toward a technology Cold War and escalating tariffs potentially limiting economic growth, the metal which is heavily used in construction and manufacturing, has entered correction territory. Since mid-April, copper prices have declined by nearly 12.00%.
Meanwhile, gold prices moved past a three-month high during the first week of June. The precious metal’s appeal as a safe haven when so-called “risk off” sentiment arises in the market, along with growing expectations of potential interest rate cuts from the Federal Reserve, have led to significant price gains in the past two weeks. A lower federal funds rate helps reduce the opportunity cost of owning gold – as it is a non interest bearing asset – as well as the carrying cost, or rate on loans, for those investors funding gold purchases through borrowing.
- Institute for Supply Management. (2019, June 3). May 2019 Manufacturing ISM® Report On Business® [Press Release]. Retrieved from: https://www.instituteforsupplymanagement.org/ISMReport/MfgROB.cfm?navItemNumber=31135
- IHS Markit. (2019, June 3). IHS Markit US Manufacturing PMI™: PMI drops to lowest since September 2009 [Press Release]. Retrieved from: https://www.markiteconomics.com/Public/Home/PressRelease/21f2aabb766f4eb2b9b7560336d053e8
- Bureau of Economic Analysis (2019, May 30). Gross Domestic Product, 1st quarter 2019 (second estimate); Corporate Profits, 1st quarter 2019 (preliminary estimate) [Press Release]. Retrieved from: https://www.bea.gov/news/2019/gross-domestic-product-1st-quarter-2019-second-estimate-corporate-profits-1st-quarter
- LeBeau, P. (2019, May 31). Trump’s Mexico tariff threat hammers GM, Fiat Chrysler, will raise US auto prices. CNBC. Retrieved from: https://www.cnbc.com/2019/05/31/trumps-mexico-tariff-threat-puts-gm-fiat-chrysler-in-a-bind.html
- U.S. Census Bureau. (2019, May 24). Monthly Advance Report On Manufacturers’ Shipments, Inventories And Orders April 2019. U.S. Department of Commerce [Press Release]. Retrieved from: https://www.census.gov/manufacturing/m3/adv/pdf/durgd.pdf
- The Federal Reserve. (2019, June 4). Opening Remarks: Chair Jerome H. Powell, At the “Conference on Monetary Policy Strategy, Tools, and Communications Practices” sponsored by the Federal Reserve, Federal Reserve Bank of Chicago, Chicago, Illinois. Retrieved from: https://www.federalreserve.gov/newsevents/speech/powell20190604a.htm
- ADP. (2019, June 5). The ADP National Employment Report [Press Release]. Retrieved from: https://www.adpemploymentreport.com/2019/May/NER/docs/ADP-NATIONAL-EMPLOYMENT-REPORT-May2019-Final-Press-Release.pdf
- Institute for Supply Management. (2019, June 5). May 2019 Non-Manufacturing ISM® Report On Business® [Press Release]. Retrieved from: https://www.instituteforsupplymanagement.org/ISMReport/NonMfgROB.cfm?SSO=1
- National Association of Realtors. (2019, May 21). Existing-Home Sales Inch Back 0.4% in April [Press Release]. Retrieved from: https://www.nar.realtor/newsroom/existing-home-sales-inch-back-0-4-in-april
- Freddie Mac. (2019, May 15). A Steadily Growing Housing Market. Retrieved from: https://www.freddiemac.com/research/forecast/20190515_steady_growth.page?
- Silverblatt, H. (2019, June 3). U.S. Equities Market Attributes May 2019. S&P Dow Jones Indices Market Attributes®. Retrieved from: https://us.spindices.com/documents/commentary/market-attributes-us-equities-201905.pdf?force_download=true
- Li, Y. (2019, June 4). Investors dumped a record amount of equity ETFs in May amid the trade war. CNBC. Retrieved from: https://www.cnbc.com/2019/06/04/investors-dumped-a-record-amount-of-equity-etfs-in-may-amid-the-trade-war.html
- U.S. Energy Information Administration. (2019, June 5). Weekly Petroleum Status Report Highlights. Retrieved from: https://www.eia.gov/petroleum/supply/weekly/pdf/highlights.pdf
Sources for Market Data:
Dow Jones Industrial Average:
10-Year U.S. Treasury note:
10-Year German Bund:
Shanghai Shenzhen CSI 300 Index:
FTSE TWSE Taiwan 50 Index:
Euro Stoxx 600 Index:
Euro Stoxx Banks:
Euro Stoxx 600 Automobiles & Parts:
West Texas Intermediate Crude:
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