We think that the US business cycle has transitioned to the late stage. Growth decelerating from its peak toward long-term potential and Fed monetary policy being roughly neutral are the two characteristics typical of a late-cycle economy. The good news is that the economy can be late cycle for a long time. At one point last year the economy had been trending toward overheating, but the more recent data shows that growth is slowing to a more sustainable pace as fiscal and monetary stimulus fades. Subdued inflation has allowed the Fed to send more dovish signals, and risks that excessive monetary policy tightening will cause the cycle to end appear very low.
The meeting between President Trump and President Xi at the G20 summit in Osaka produced an agreement to resume trade talks, but in recent days that agreement has started to look shakier amid complaints from both sides. Recent economic data has been mixed. Purchasing managers indexes (PMIs) have continued to move lower and are now at a level consistent with trend growth. Job growth rebounded strongly in June. Retail sales were better than expected in June and it now appears that 2Q19 was a strong quarter for consumption. We leave our growth indicator just above neutral. Recent inflation data has been stronger, with core personal consumption expenditures (PCE) inflation running at around a 2% pace in 2Q19. Credit spreads on corporate bonds were little changed over the past month. On the back of dovish comments from FOMC members, the market is now pricing in a high probability for the Fed to cut rates by 50 basis points at the next meeting on 31 July.
What are we watching?
It appears that politicians are close to reaching a deal that would set budget caps for the next two years while also suspending the debt ceiling until after the 2020 elections. We await the 31 July FOMC meeting to see what the Fed does and, importantly, how they explain their actions. The drama over Brexit continues, although regardless of the outcome the impact on the US economy should be limited.
What are the investment implications?
While now late cycle, we view the current growth, inflation, and monetary policy environment as still supportive for risk assets. We remain overweight equities in our tactical asset allocation.
Key cycle indicators
The cycle indicators gauge whether the economy is overheating and if financial conditions are restricting growth. These determine our assessment of where we are in the cycle.
Overall: Late cycle
Growth (relative to potential)
Inflation (relative to 2%)
Each indicator is evaluated relative to a neutral level that is sustainable over time in order to determine whether the economy is at risk of overheating or if financial conditions will start to restrict growth.