Paul Single
Managing Director
(415) 576-2531

Steven Denike
Portfolio Strategy Analyst
(212) 702-3500


Most of the weakness in recent U.S. data has been centered in the industrial sector where declines in production have been broad-based and difficult. Mining output has been falling since the start of last year, along with global energy prices and the manufacturing sector, which is still struggling with the dollar’s strength. While these drags are expected to dissipate somewhat later this year (given the weak global backdrop) they will likely remain headwinds for the economy.Slowing U.S. economic momentum over the fourth quarter, along with the continued slide in oil prices, and worries over China has the stock market off to its worst yearly start ever and has sparked renewed recession speculation. Investor fears are understandable; there are plenty of things to worry about in the world, however, we do not believe the overall health and ongoing strength of the U.S. economy is one of them.

Yet, weakness in industrial production alone is not enough to support fears of a more serious downturn for the broader economy. As the massive gains in employment over the final three months of last year illustrate, overall domestic demand remains strong. Indeed, the other indicators used to determine official turning points in the economic cycle are still growing at a healthy pace (Figure 1).

While the case is often made that a dip below 1% means the economy has fallen below “stall speed” and a recession becomes inevitable, the experience of the past few years clearly suggests that this view is wrong. As we have argued before, economic expansions do not die without reason, at least not when there is still plenty of slack in the economy.

Quarterly GDP is by nature volatile and we have already seen a number of temporary dips, or even outright quarterly declines during this expansion. However, in each instance, GDP growth rebounded the following quarter, and we have no reason to believe that this time will be any different. The unfortunate fact is that in an economy where potential GDP growth is close to 2%, rather than the 3% post-war average, there will likely be more times when GDP growth drops below 1%.

Yes, mature expansions often fall under their own weight, but there are normally obvious signs of bloating in the economy, such as tight labor markets stimulating high wage growth and price inflation. Critically, the latter forces the central bank to push real interest rates up sharply, which hits rate-sensitive spending. While we have reached the point where the U.S. economy is close to full employment, the important difference in this business cycle is that we have not yet seen any significant acceleration in price and wage growth.

As a result, monetary policy has remained unusually accommodative and that will not change any time soon. The Fed has stressed repeatedly that it intends to raise interest rates very gradually. Even when it has met its full employment and price stability goals, it anticipates that the fed funds rate will still be well below its long-run equilibrium level. In real terms, the fed funds rate is still deep in negative territory. In contrast, every post-war recession has been preceded by a rise in the real interest rate of at least 2%.

Of course, economic expansions can still be derailed if there is a sufficiently big enough external shock. However, to sink the world’s largest economy (which is relatively closed and service-based) it would have to be a very big shock. We do not think China falls into this category. For a start, the latest data suggest China’s economic growth has stabilized, and there is little evidence of any collapse in activity. Moreover, even if we are wrong about the extent of China’s troubles, its trade and financial links with the U.S. are relatively modest. Exports to China, for example, account for only 1% of U.S. GDP.

Indeed, recent market fears about China or other emerging markets seem to be overdone.
Advanced economies have a much greater impact on prospects for global growth. The IMF estimates that the spillover effect of a 1% change in U.S. GDP has nearly six times more impact on the global economy than a similar change in China’s GDP. Slowing growth in China and other emerging markets will likely continue to weigh on the overall global economy in the year ahead. However, as long as conditions in advanced economies remain reasonably strong, a severe downturn in the global or U.S. economy remains unlikely.


The Federal Open Market Committee (FOMC), the monetary policy arm of the Fed, met at the end of January. It was their first meeting since initiating a rate hike back in December. Since that previous meeting, global market turmoil has left some individuals thinking that the Fed will need to slow down its expected pace of “normalizing” interest rates, which the Fed projects to increase by 100 bps in 2016 (Figure 2). Despite that outlook, the Fed stated that it is “...closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook.” This signals that the Fed is not ready to make significant changes to its planned interest rate increases based upon the events of January.

The FOMC will meet again in mid-March. By then, hopefully, the global markets will calm down. Also, there will be a number of economic releases, including two employment reports that will help the Fed assess the strength of the U.S. economy. From that, the Fed will be able to determine the best path of future interest rate increases.


While the monthly change of inflation fell last month (-0.1%), the yearly change has been moving up for the past three months. The Consumer Price Index (CPI), which now stands at 0.7% for the past year, has had the largest increase in over a year. Core CPI (equal to CPI minus food and energy prices) has been on a stronger relative trend as of late. The yearly change is now 2.1%, the largest gain in about 3.5 years.

Inflation has been held down by falling commodity prices, which began dropping from a post-recession peak back in April 2011 (Figure 3). However, recently, the rate of decreases has been fading. This should help push the inflation rate up over the next few months as the large drop in prices from last year roll off the yearly calculation. For example, a year ago, the year-over-year drop in gasoline prices was down 33.5%, but now it is down just 17%. That being said, the latest drop in gasoline prices (4% of CPI) will extend the downward pressure a little longer.

The firmer annual change to CPI, which has been up—at least fractionally—for seven consecutive months, should help the Fed’s view that inflation will trend back toward its target of 2%.


The robust December employment report does not signal any slowdown in job creation despite the current volatility that is present throughout the global financial markets.
Nonfarm payrolls jumped 292,000, and job growth continues. For 2015, there was a gain of 2.7 million new jobs, which is in addition to the increase of 3.1 million in 2014. The unemployment rate held steady at 5% (a year ago it was at 5.6%).

The labor market is clearly strong, but this strength has not been reflected with sustained increases in wages. The average hourly rate is $25.24, which is up 2.5% in the past year, and in the range of just 2% to 2.5% since early 2013 (Figure 4). During past business cycles, wage gains have tended to increase significantly as demand for qualified workers increased due to an ever shrinking pool of available workers. As past expansions matured, the yearly change in wages trended up to 4% (we have not seen that in this cycle). Part of the reason may be that wages were kept down to help offset the ever-increasing cost of benefits. This metric does not include the cost of benefits, which is part of an employee’s total compensation level.



Whenever the Fed initiates a round of interest rate increases, the housing market tends to cringe. This sector of the economy is more dependent on the level of interest rates than perhaps any other sector. Combine that with the extremely weak recovery that housing has experienced since the recession ended 6.5 years ago, and there may be a double cringe.

That being said, the recent increase in the federal funds rate and planned future increases will probably not have an immediate impact on the housing market. Specifically, over the past couple of years, housing has enjoyed a sustained—yet muted—increase in demand (Figure 5). This will probably not change despite the rate increase for numerous reasons, including: the absolute level of mortgage rates are still very low on a historical basis, the credit requirements of lenders has fallen in the past couple of years, housing affordability (which has fallen in the past few years with the increase in home prices) is still very high on a historical basis; and finally, the supply of new homes has been limited.

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Index Definitions

The Bloomberg Commodity Index is calculated on an excess return basis and reflects commodity futures price movements. The index rebalances annually weighted 2/3 by trading volume and 1/3 by world production and weight-caps are applied at the commodity, sector, and group level for diversification. Roll period typically occurs from sixth-to tenth business day based on the roll schedule.

Consumer Price Index (CPI) measures changes in the price level of a market basket of consumer goods and services purchased by households.

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