JP Morgan Economic Overview
A Look Back at 2019 and the Economy’s New Normal
- The year’s biggest purported hazards turned out to be busts.
- Despite relatively slow growth, the economies of the US, Europe and Japan are operating close to their full potential.
- Equity investors haven’t been discouraged by pessimism; stock prices are rising on a tide of profits.
Looking back: After a year of fruitless economic worries, the expansion still has momentum. If a recession hits in 2020, it will be the result of overheating or asset bubbles rather than the transient—and largely resolved—setbacks that have sparked fears in recent months.
- Tensions with China are finally easing, and the summer’s heated rhetoric had little impact on trade flows.
- The Treasury yield curve inverted steeply before flattening, leaving little discernible impact on the real economy.
- Headwinds slowed the manufacturing sector but barely affected the overall expansion.
The new normal: The top of this business cycle has been confusing. Past expansions saw much faster growth, but the aging workforce has changed the rules of economic prosperity.
- The last recession masked America’s demographic transformation—for a full decade, slack in the labor market hid the impact of baby-boomer retirements.
- But now that the US is back to full employment, the aging workforce may only be able to sustain a 2 percent pace of GDP growth.
- The same is even more true for Europe and Japan, where labor force growth is even slower—unemployment is at a record low and productivity at a record high, but the EU will likely struggle to maintain a real growth rate above 1.1 percent. Japan is expected to average a 0.6 percent pace of expansion.
- Slowing growth isn’t a sign of weakness: What matters more than GDP is how close the economy is to its full potential.
Equities climb on durable profits: Technology has increased both productivity and profits, and equity markets are seeing the benefits.
- The stock market’s capitalization has reached a record-high multiple of 1.5 times GDP. That may seem unsustainable, but equities are climbing in response to record corporate profits.
- As globalization and automation make businesses more efficient, profits have risen from a 6 percent share of GDP in the early 1990s to a 9 percent share today.
- The shift has been underway for decades. Higher profits—and the stock valuations that come with them—are likely a new structural feature of the economy.
The Fed’s path to neutral: With tame inflation, balanced financial risks and a tight labor market, the Fed should be moving interest rates toward their natural equilibrium—but other factors are complicating monetary policy.
- Treasury yields have been distorted by quantitative easing. Today’s flat yield curve likely masks an accommodative monetary stance.
- The federal funds rate is slightly below inflation expectations, and a negative real interest rate raises inflation risks.
- The Fed has signaled it may keep interest rates low and allow inflation to briefly overshoot its 2 percent target, helping balance out years of below-target price growth.
- But aggregate demand is strong at the top of the business cycle; it wouldn’t be surprising if the Fed has to raise interest rates before unsustainable inflationary pressure builds.