Steady As She Goes
Growth is slowing, even as fears of a recession have dissipated. In their place are concerns that labor scarcity may create some inflation pressures. Nonetheless, many worst-case scenarios now appear far less likely. We can only hope this will result in less Sturm and Drang over the summer, which should be good for equity markets.
Job growth is slowing, with reduced labor availability a key ingredient. The labor force shrank by 695,000 in May, which likely reflects in no small part the decline in legal (and illegal) border crossings. The Fed noted this development, highlighting that it may focus more on the unemployment rate rather than the pace of job growth. Fewer immigrants implies that fewer jobs can be filled, but because of labor scarcity, not because of weak labor demand. So, it is best to review the unemployment rate to anticipate wage inflation pressures. Indeed, the latest wage numbers, a 0.4% rise in May and 3.9% year-over-year indicate that the Fed will have a tough time getting closer to its 2% target, especially with more tariff effects about to materialize.
Even so, economic growth remains solid. As expected, the trade balance improved very sharply in April. Just as the surge in the trade deficit artificially suppressed growth in Q1, so it was barely positive, Q2 GDP will rise sharply due to the plunge in the trade accounts that we already see underway. (NB: we expect a sizable upward revision to Q1 GDP eventually, so the wild swings should be revised lower at some point.) Looking at the first two quarters together, growth is running about 2%, a solid and more accurate image of the economy’s performance.
Looking ahead, much depends on how the tariffs discussions play out. While problematic scenarios are easily envisioned, it is more likely that deals will be cut to avoid really bad outcomes for the U.S. and for its trading partners. Both sides will want to avoid damaging disruptions to trade flows. So, a steady as she goes outlook is the most likely one for the economy and the market. And after all the volatility experienced recently, it sure would be nice if this is how things play out.
What could go wrong? As is always the case, plenty. There are still two wars being fought and talks may soon collapse between the U.S. and Iran over its nuclear enrichment and its support of terrorism around the world. Tariff induced inflation pressures may soon appear domestically. The domestic political scene remains highly contentious. Budget pressures remain an issue, as the proposed budget proposals risk enlarging the budget deficit. Thankfully, there is always something to worry about, or life would become boring. But jokes aside, economic growth is likely to continue even with the many uncertainties that investors must deal with. In some sense, uncertainty is normal, especially with regard to the future. We continue to monitor economic and political developments, but believe the recovery in the stock market after the tariff induced decline makes perfectly good sense and see more upside ahead.
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