This expansion is in the latter innings, and late cycle concerns are emerging
We expect the Fed to begin to ease in the second half of 2019, increasing the odds that the market extends its run
Markets are pricing in a near perfect policy performance, tempering our enthusiasm
Strong labor markets and a near record expansion are facing off against persistently weak inflation, decelerating growth and a possible earnings recession. Despite the economy’s stronger than expected 3.1% growth in the first quarter, macro-economic data have been mostly disappointing. Late cycle concerns have emerged as estimates for GDP growth in the second quarter of 2019 have come down from 2.4% at year-end to 1.7% today as cost pressures, trade tensions and global uncertainty take their toll. These factors are pressuring corporate earnings, making a year-over-year decline likely for the second quarter in a row. On a brighter note, the labor picture remains exceptionally strong with unemployment of only 3.6% at nearly a 50-year low.
While The Federal Reserve’s (Fed) base case calls for growth trending to a slower but more sustainable level, rate cuts are likely if the economy softens more than expected. Interest rates – here and abroad – are signaling that investors are worried about a slowdown. Investors are betting heavily that the Fed is entering an easing cycle, pricing in four or more cuts over the next year. Worried investors are accepting a lower yield on 10 year treasuries than 90 day bills. A curve inversion is a “no confidence” vote in the Fed’s ability to stem a slowdown. It’s unusual to see such strong market conviction about the need for easier policy while the Fed continues to temper expectations, guiding to only modest easing this year.