That big fourth-quarter growth scare looks like it's not happening

Key Points
  • Just a few weeks ago, economists had been expecting near-zero growth for the fourth quarter.
  • Positive surprises in the economic data since then have changed views considerably.
  • Expectations now are for growth in the 1.3% to 2% range.
A General Motors assembly worker works on assembling a V6 engine, used in a variety of GM cars, trucks and crossovers, at the GM Romulus Powertrain plant in Romulus, Michigan, August 21, 2019.
Rebecca Cook | Reuters

What a difference a couple weeks can make: A slowdown in fourth-quarter growth to near-zero that appeared nearly inevitable has disappeared, fading even with manufacturing still stuck in contraction.

A closely watched Federal Reserve gauge that had been pointing to a Q4 flatline in mid-November has reversed course, with Atlanta's GDP Now indicating 1.3% growth, down from a high of 1.7% a week ago. The tracker had risen in recent days following the release of some positive personal income, durable goods and housing data, then came off a bit on Monday's ISM Manufacturing survey that was a bit below expectations.

Overall, though, the picture for Q4 does not look nearly as bleak as it did the previous two months.

Continued pressure from the U.S.-China tariffs, a slowing global economy and low inflation levels had raised fears that a year that started off with a 3.1% GDP gain would end with basically nothing. That no longer appears to be the case.

November ISM manufacturing index, construction spending misses expectations
November ISM manufacturing index, construction spending misses expectations

"We went from a recession scare earlier this summer then to a growth scare to what I would argue is setting ourselves up for a pretty solid 2020, in part because the high-frequency data isn't as bad as people thought," said Joseph LaVorgna, chief economist for the Americas at Natixis. "People were far too pessimistic."

Indeed, the year had seen a steady crescendo of recession fear that climaxed when the yield curve inverted in late-summer, with shorter-term government bond yields turning higher than their longer-duration counterparts.

That phenomenon, however, quickly reversed, and the calls for a 2020 recession have ebbed along with the change.

Manufacturing lags

Monday, however, brought about a fresh reminder that the U.S. economy is far from in the clear.

The ISM Manufacturing Survey, a bellwether for the goods-producing sector, remained in contraction with a 48.1 reading. Anything above 50 represents expansion, and this was the fourth straight month below the break-even line.

Economists saw two primary takeaways — that manufacturing remains a concern, but the recent numbers suggest that maybe the downturn, largely associated with the tariffs, is forming a bottoming that could be reversed in the months ahead both in the U.S. and globally.

"Manufacturing PMIs for November suggest that industrial activity strengthened in most regions," Bethany Beckett, assistant economist at Capital Economics, said in a note. "This provides another welcome sign that the global industrial downturn may be bottoming out."

Economic data in general is on the rise lately, at least compared to expectations.

The Citi Economic Surprise Index, which compares actual readings to Wall Street estimates, is on the uptick thanks to a turn that began around the third week of November. That's generally a sign if not of a robust economy then at least one that is outperforming a lowered outlook.

Federal Reserve officials of late have been giving mostly favorable grades to the U.S. economy while still noting the downside risks and the continued pattern of inflation that has remained troublesomely low. President Donald Trump, in a tweet Monday, repeated his insistence that the Fed should keep cutting. But economists think that's unlikely so long as the growth pattern remains intact.

Concerns about the Fed

"The report should change nothing for Fed officials who are assuming relatively soft manufacturing (but strong consumption) in their baseline economic scenarios," Citigroup economist Andrew Hollenhorst wrote. "Citi's official call remains for the Fed to remain on-hold next week and through 2020."

To be sure, there's still concern that the recent rebound could be a "head fake," as Evercore ISI's Krishna Guha speculated.

While he doesn't hold a downturn steep enough that it would warrant a rate cut as his mostly likely scenario, Guha said central bank officials could be making a mistake in their recent indications that it will take a material change in conditions for them to make any moves on rates.

"Indeed the 'material reassessment' threshold in our view means that the next Fed rate cut, if it turns out to be required, is likely to be a risk-off cut in financial markets rather than a risk-on cut," wrote Guha, Evercore's head of global policy and central bank strategy. "This is because it would likely be late and would signal that the central bank no longer has confidence in its relatively upbeat forecast for 2 per cent type growth with a strong labor market and solid consumer."

Any such situation, though, looks to be in the distance.

CNBC's Rapid Update reading of economist forecasts sees Q4 at 1.6%, while Goldman Sachs said it was cutting its outlook for the quarter, but only by 0.1 percentage point to 1.9%.

"The inevitable recovery in manufacturing, which is highly cyclical, will give the economy the extra thrust going into next year," said LaVorgna, the Natixis economist. "Wouldn't it be great if 2020 turned out to be the best year of the cycle?"

China factory activity sees fastest expansion in three years
China factory activity sees fastest expansion in three years