United States / Spotlight Reports
Q4 2018 Macroeconomic Update
by Viraj D'Costa, Senior Technical Analyst; Mario Ismailanji, Lead Technical Analyst; Rachel Hyland, Lead Analyst; Anna Amir, Lead Analyst; Ryan Roth, Lead Analyst
Mar 05 2019

The United States’ inflation-adjusted Gross Domestic Product (GDP) increased at an annualized rate of 2.6% in Q4 2018, down from 3.4% in Q3, according to the Bureau of Economic Analysis (BEA). This growth is primarily a result of positive trends in personal consumption expenditure (PCE), nonresidential fixed investment, private inventory investment, federal government spending and exports. However, poor growth in residential fixed investment and state and local government spending hindered overall growth. The deceleration of GDP growth from Q3 to Q4 is primarily a result of decelerations in private inventory investment, federal government spending, state and local government spending and PCE. Overall, however, real GDP increased 2.9% in 2018, compared with 2.2% growth in 2017. As economic growth accelerated, rising consumer spending exerted inflationary pressure, leading to interest rate hikes in 2018.

macro 1

Consumer spending and labor

The US economy added a total of 304,000 nonfarm jobs in January, according to the Bureau of Labor Statistics, exceeding 2018’s average monthly gain of 223,000 new nonfarm jobs. This job growth coincided with a slight increase in the unemployment rate, which rose from 3.9% to 4.0% in January amid the impact of the partial federal government shutdown. However, the labor force participation rate is expected to remain at 63.2% in January, representing little change. The main sectors that fueled employment growth in January include construction; healthcare; leisure and hospitality; and transportation and warehousing. In January, construction added 52,000 new jobs and healthcare added 42,000.

A rising unemployment rate and relatively stable labor force participation indicate a slight tightening of labor markets. With no sectors declining in employment aside from Utilities and Information, wages grew. With the unemployment rate remaining relatively low, companies had to increase wages to maintain current employee counts. Accordingly, average hourly earnings for nonfarm employees increased $0.23 in December, leading to a year-over-year (YoY) increase of 3.3% from December of last year. Furthermore, the PCE price index increased 2.0% YoY in 2018, or 1.9% YoY when excluding food and energy.

Fixed capital investment and construction trends

Fixed capital investment also exhibited signs of growth during Q4. According to data from the Federal Reserve Bank of St. Louis, total private nonresidential fixed investment increased 1.8% to $2.87 trillion in Q4 (latest data available). This growth is faster than Q3’s 1.0% rise and represents an increase of 8.6% YoY. This significant increase in investment activity over the past year can be attributed in part to booming economic growth.

Construction spending is another method of analyzing nonresidential investment. Businesses often spend on building projects when they believe the revenue generated from new locations will remain profitable; this level of confidence helps to indicate long-term trends for nonresidential markets. In December 2018, nonresidential construction remained stable, increasing slightly to $750.5 billion. Construction spending was somewhat volatile in 2018 due to the implementation of steel and aluminum tariffs that caused input costs for construction projects to increase. Additionally, with inflation on the rise, wage pressures have increased costs for businesses, partially limiting overall construction spending. As a result of these increased costs, contractors and businesses may have decided to delay certain projects. Furthermore, increases in interest rates may be deterring construction projects from coming online. During Q4, the largest decline in nonresidential construction was in the highway and street segment, which decreased 2.4%. Conversely, the communications sector increased 4.4% during Q4.

While nonresidential construction spending increased during Q4, residential construction activity fell. In December, residential construction spending declined 1.4% to reach $542.2 billion. While spending on new single-family housing construction increased in December, these gains were offset by declines in new multifamily construction. Housing starts declined significantly during the quarter, falling 12.9% since September 2018. Furthermore, this represents a 10.9% decline from December 2017. However, housing permits increased during the quarter, rising 4.4% to 1.3 million permits.

Similar to demand for nonresidential construction, raised prices for inputs such as steel and wood contributed to Q4’s general decline in residential construction. Residential construction was also hindered by expensive labor, as a result of relatively low unemployment. Rising interest rates have also exacerbated these issues, as residential investment activity is typically pressured when borrowing costs rise. Accordingly, as the labor market remains tight and inflation is near the 2.0% target set by the US Federal Reserve (the Fed), these factors are expected to continue to weigh negatively on the housing market.

macro 2

Volatility in financial markets 

Financial markets experienced high levels of volatility during Q4 2018, primarily as a result of heightened geopolitical tensions between the United States and China and interest rate increases resulting from the Fed’s fiscal policy. These macroeconomic developments have negatively impacted US financial markets; tight labor conditions and inflationary pressures have led to an increase in interest rates, effectively raising the cost of borrowing for all consumers and businesses. The Fed remained firm on its economic forecast during the period, deciding to raise the Federal Funds Rate by a quarter of a percentage point to a range between 2.25% and 2.5%. The Fed’s rate hikes are an attempt to return the economy to “normal,” while also keeping the economy from expanding too quickly or slowly. The Trump administration has attempted to pressure the Fed to keep interest rates stable, but to no avail. Although Federal Reserve Chairman Jerome Powell reinforced his confidence in the US economy during a Senate Banking Committee hearing in February, he also mentioned negative pressures that could keep the US economy below its recent rate of expansion.

Additionally, a rise in interest rates has affected the yields on many US treasuries and corporate bonds, making the bond market increasingly more attractive to investors. In December 2018, the spread between the 2-Year and 5-Year Treasury notes inverted, leading to financial market worries. When the yield curve inverts, it signals that investors consider short-term debt instruments to be riskier than long-term debts, indicating a more-pessimistic outlook in regard to the shorter-term maturity; often, a yield-curve inversion like this one can signal the potential onset of a recessionary period. Accordingly, investor uncertainty is rising and volatility in US financial markets has increased, causing greater emphasis to be placed on the spread between the 2-Year and 10-Year Treasury notes. Fundamentally, the Fed primarily bases its interest-rate targets on unemployment and inflation. While the Fed’s decision-making process is not directly influenced by the potential of a recession, it acknowledges that these metrics are important when considering potential rate hikes for 2019.

Amid this relatively high volatility, merger and acquisition activity was weaker than average in Q4 2018. In terms of the total number of deals, 2018 exhibited a decline, though this comes after a record year in 2017. However, total deal value did rise in 2018, representing a positive trend for US financial markets. Furthermore, initial public offering (IPO) activity increased in 2018, with the number of IPO filings up 19.0% to reach 190 deals. Despite geopolitical tensions with the United States, Chinese companies have been a main source of these IPOs. Additionally, healthcare and technology companies contributed to overall IPO growth in 2018, with 2019 expected to exhibit a significant increase in IPOs for these sectors.

Edited by Kieran Newton