Are we slowing down but? | USAEMALL.com

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Slowdown watch

Unhedged’s base case is that the US economy is strong at present — with a real rate of growth of 2-3 per cent — and that this strength will decline only gradually toward the long-term trend. That’s why our guess is that inflation will move only gradually to 2 per cent, leaving the Fed little room to cut this year. 

But economic predictions, while a useful mental discipline, are generally wrong to the degree they are specific. So we’re alert to indications that our view requires revision. High valuations across risk assets mean that a supportive economic backdrop is important for continued high returns. All the more so after markets digested the Fed’s hawkish message last month, driving yields higher and taking cyclically sensitive small-cap stocks down a peg.

Might there be a not-so-gradual slowdown afoot? Well, have a look at the Citi US economic surprise index, which rises and falls as economic data beats or misses expectations. It appears to have turned over in mid-November: 

This might indicate a change in the economic momentum but (as you can see) the series is noisy. Confirmation is needed. 

Bob Elliott of Unlimited funds, writing in his 2025 outlook, thinks that high rates have been “slowly eroding the momentum in the economy, driving some expansion indicators towards a renewed softening in recent months”. He sees softening in construction in particular. The number of housing units under construction have been falling steadily for months; investment in non-residential buildings has been slowing, too. To this one could add a very recent rapid drop in mortgage applications.

All of this is fair enough, but rates have been relatively high for several years. We know that construction and housing, the most rate-sensitive sector of the economy, has felt the pain. But what has been remarkable about this economic cycle (if it is a cycle) is how well the rest of the economy has done despite this. Consumption has been robust and investment has been overall OK. It is a change in this pattern that we need to be vigilant for. 

US purchasing managers surveys from the Institute for Supply Management show little if any change in the general trend in the past year or so. In the latest reading, the sluggish manufacturing component ticked up (but remained in contraction) and the resilient services component ticked down (but remained in expansion). But if there has been a trend break since the start of 2023, it’s hard to make out. ISM’s Chicago business survey does seem to have broken down. Whether that is an omen for the rest of the country remains to be seen. 

(It should be noted, at least in passing, that growth outside of the US is weakening — from China to the Eurozone to emerging markets. But, as we have written, unless this translates to unsustainable deficits or a resurgence of inflation in the US, slower global growth is not an imminent threat to US expansion.)

Don Rissmiller of Strategas sees weakening momentum in key employment indicators, in particular continuing jobless claims — a timely indicator that shows workers staying unemployed for longer. Continuing claims picked up through the autumn, and this is indeed worrisome, but the upward trend reversed in December. Like the low-but-rising unemployment rate and the soft pace of hirings, this is one to watch, but not a red flag yet. 

On the credit side of the ledger, sentiment among small businesses, which have a higher exposure to the domestic economy and do most of the hiring, jumped after the election in November to the highest level since 2021. Morgan Stanley’s Business Conditions Monitor, which gauges its analysts’ assessments of business conditions in the industries they cover, rose to a two-year high in November, too. Perhaps the honeymoon between business and the Trump administration will not last, but it’s a plus for now. 

The economy rarely sends an unambiguous batch of signals, and there is always plenty of noise, too. But for now, despite a few indicators turning south, we think the broad picture remains unchanged.

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