Underlying Demand Weakened in 4Q

Real GDP growth came in at a 2.1% in the fourth quarter of 2019, the same as the pace of the third quarter. Growth slowed slightly in 2019 from the pace of 2018. Rate cuts by the Federal Reserve helped to offset losses in manufacturing with a turnaround in the housing sector. Residential investment was one of the few sectors to experience an acceleration in the fourth quarter.

Consumer spending, which typically gets a boost from housing, slowed fairly significantly over the period. The bulk of that slowdown was in goods purchases. Spending on services held up better over the quarter. The slowdown in consumer spending is exacerbating retail restructuring tied to the shift from in-store to online shopping. Store closures have already picked up in the wake of the holiday season.

Business investment declined for the third consecutive quarter as weak growth abroad and tariffs took a toll on business planning. The phase 1 trade deal only reversed a portion of the most recent tariffs. Manufacturers are still struggling with margin compression. In fact, orders for new equipment contracted again in December, suggesting that weakness will continue.

That is all before businesses have to deal with blows associated with a sharp cut in production of the Boeing 737 Max and disruptions to demand and supply chains associated with the coronavirus in 2020. Factories and businesses across China have already extended Lunar New Year closings until we can get a handle on the spread of the coronavirus.

The trade deficit narrowed but for the wrong reasons. Imports fell more rapidly than exports; much of the drop in imports reflected the unwinding of hedges against additional tariffs. Companies had bought ahead of tariffs that were scheduled to hit in the fourth quarter; that borrowed from imports in the fourth quarter and helped to reduce bloated inventories. The drop in inventories alone accounted for nearly 80% of the decline in imports over the fourth quarter.

Separately, government spending picked up slightly. Gains in defense and a pickup in spending at the state and local levels accounted for the bulk of those increases. Congress passed the budget for fiscal 2020 late in the quarter. Federal spending will add less to the economy in 2020 than it did in 2019, but will continue to outpace revenues. Recent estimates by the nonpartisan Congressional Budget Office shows trillion dollar deficits for the next decade, without any changes in laws or a recession.

Bottom Line
Rate cuts by the Federal Reserve helped to blunt the effects of weaker growth abroad and trade wars in 2019. We were expecting the Fed to cut again before the onset of the coronavirus in 2020. The Fed has come to the conclusion it can do more to sustain the expansion than right the ship once it capsizes.

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