The U.S. employment situation report for June 2018 showed solid job growth, including a welcome rise in hiring in the manufacturing sector. The unemployment rate rose to 4 percent, for good reasons, as a healthy economy attracted a large number of individuals to re-enter the workforce looking for jobs.
Wage growth continued to be subdued. The pattern suggests the U.S. economy recorded a solid first half in 2018. Indeed, second quarter real GDP may post in the 3.5 to 4 percent range, when released at the end of July 2018.
We expect some deceleration in both job growth and real GDP in the second half of 2018. The first half of 2018 was bumped stronger by the tax cuts enacted in December 2017. The second half of 2018 will be constrained by the huge uncertainties over tariffs which will be negatively impacting corporate investment plans, as spending on new plant and equipment is delayed pending a clearer picture on how the trade war develops. The other constraining factor for the second half of 2018 is the flattening of the yield curve, which suggests less robust economic activity in 2019.
Also, note that this economic expansion is quite long and still going. If it can make it another year it will be longest U.S. economic expansion on record. We do not subscribe to business cycle theories that economic expansions end because of old age.
Instead, our perspective is that economic expansions typically come to an end due to policy mistakes – usually too aggressive hiking of short-term interest rates by the Federal Reserve. With two more rate hikes, the Fed will be in the neutral range in terms of monetary policy as indicated by the yield curve. So far, the yield curve has not inverted (i.e., short rates higher than long-term yields), but the yield curve has gotten appreciably flatter. Indeed, even as the Fed pushes through rate hikes in the second half of 2018, we would not be surprised to see the Fed initiating a debate about when they should stop raising rates.