ECONOMIC UPDATE
- 2019 was a great year for U.S. financial markets
- The U.S. economy performed above expectations for the year, boosted by strong personal consumption
- U.S./China trade negotiations should remain a sensitive topic for financial markets, and the Fed appears content to allow labor markets to tighten further and inflation pressures to emerge
It was a good year for the U.S. economy and broad financial markets in 2019. The S&P 500 generated a 31.5% return, second only to 2013 (32.4%) over the last 20 years. Making the year more unique was the fact that broad fixed income also performed well on both a gross and net basis (i.e., non-directional trading). The ICE BofAML US Broad Market Index posted an 8.9% gross return for 2019, the highest since 2002, and the index bested duration-matched Treasuries by 1.98%, the third best year in the post-crisis era. We’ll take a deeper look at fixed income in the Performance Update below.
The current economic expansion currently stands at 10.5 years, and consumption remains healthy amid relatively tight labor markets. GDP growth in 2019 was better than expected and above trend despite a weaker global economy and heightened uncertainty surrounding trade policy. As we head into 2020, many economists are more cautious on growth. The tailwind of fiscal stimulus has largely faded, and the Fed appears content to stay on the sidelines for the foreseeable future (if, of course, you ignore the current Treasury purchase program). With trade and election uncertainty still looming, businesses are more likely to remain cautious in 2020 as it relates to new investment. The economy was able to more than overcome relatively weak business investment in 2019 with robust personal consumption.
Perhaps more importantly, stronger personal consumption hasn’t come at the expense of depleted savings or increased leverage at an aggregate level. Personal savings as a percentage of disposable income averaged 8.1% in 2019 (through November), two percentage points above the 20-year average. Further, the Fed’s household debt service ratio fell to a series low of 9.69% at the end of Q3 (records began Q1 1980). The ratio divides total disposable income by required household debt service payments, which can be seen in Exhibit 1. The total ratio can be broken down into mortgage debt service payments and all other consumer debt. The sharp decline in the ratio since the financial crisis is clearly attributable to deleveraging in the housing sector, but the consumer DSR has been essentially flat for the last 3 years.
Looking Ahead
The headline unemployment rate currently sits at a 50-year low of 3.5%. If labor markets continue to tighten in 2020 and the unemployment rate falls another 20 bps to 3.3%, it would be the lowest reading during peacetime since the 1920s. The other occasions when the unemployment rate has dipped below 3.5% were during wartime (WWII, Korean War, and Vietnam War). If labor markets do follow the recent tightening trend and push the unemployment rate below 3.5%, will price inflation finally move notably higher toward and above the Fed’s 2% target? That’s the question on the minds of many policymakers and economists at this point and, with the recent decision to put rate policy on hold, it appears that Fed leaders are eager to find out.
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