The consensus in the US is that growth will slow and the economy will enjoy a “soft landing”. This is a comforting term but what does it mean? To us it looks like the slowdown in activity levels may not be comfortable at all.
Our forecast for this year is that the growth rate will reduce to about 2 per cent but the slowdown will not be uniform. Despite recent signs of stability, housing’s contribution will be lower but other parts of the economy will continue to expand at or near trend rate and so slower growth is not likely to be matched by lower inflation.
The problem is with the jobs market, which is tight and likely to tighten further. In the past few years, initial estimates of jobs growth have regularly been revised upward as the surveys have struggled to keep up with what has been going on. The difference between initial and revised totals is about 1.5 million jobs.
Despite growth in the workforce, this trend has meant that unemployment has fallen to around 4 per cent, with skill shortages increasingly a concern. This phenomenon illustrates how mature the productivity cycle is in the US. With capacity utilisation high and multi-shifting in place, companies are meeting increases in demand with new hires, with an obvious implication for wage rates. Higher labour costs have negative implications for bonds and equities because of the implications for interest rates, inflation and profit margins.
Inflation is above the Fed target rate so that upward pressure on wages will be a concern. The scope for falling interest rates against a backcloth where growth is still robust and where inflationary threats are present is low. Why does the Fed need to ease when overall conditions are still buoyant? More likely is that rates stay near current levels for some months ahead. Where this might be positive news is in the currency markets but the dollar is presently subject to different pressures.
The problem is that in order to balance its trade deficit, the US needs huge inflows from external investors – about $800bn a year. Although the US appetite for capital inflows continues, the willingness of others to feed it is diminishing. If demand for dollars falters, new buyers must be found and the way this will be achieved is by making the terms more attractive – cutting the price or, in this particular context, letting the dollar decline.
The US is cheaper than it was but as yet is not cheap enough relative to opportunities available elsewhere.
John Kelly is head of client investment at Abbey.