By Chris Kuehl, Ph.D., NACM Economist—
Change in Nomenclature—
For several months, it has been hard to define just what kind of conflict the U.S. and China were engaged in. There was always an assumption that much of the confrontation was essentially political theater. At some point, both Presidents Trump and Xi would see that escalating the conflict would do damage to both countries. Most analysts resisted the terminology used by the media as unnecessarily provocative. Those days seem to be over as the majority of economists are now calling this a real trade war and asserting that Trump and Xi now have a personal stake in the contest. This is a confrontation that will not end anytime soon unless one or the other of these leaders capitulates.
Much has changed in the last few days—at least for economic analysts. The consensus view now is that the Fed will execute its next rate cut in September as opposed to later in the year. The view is based on heightened tensions between the U.S. and China and the assumption that this will further affect global growth negatively. There are also more analysts asserting that a global recession is likely by the end of the year. They are still in the minority, as the U.S. doesn't seem on that path. It is very possible, however, that Europe and the U.K. will slide into formal recession and China's growth would be at a point where it would be considered recessionary.
Yield Curve Watch
It is important to point out that an inverted yield curve does not cause a recession. It is an indication that recessionary pressures are building. The situation is as bad as it has been in some time. The yield on three-month treasuries is trading above the 10-year treasury and the spread is as wide as it has been since 2007. There are now models for recession giving a 55% chance of a recession in the U.S. within the next year. This is as high a probability seen since 2007. Just as a reminder for those who have forgotten—2008 was the year of the recession. At that time, the inverted yield curve model hit it right on the nose.
Short Items of Interest—Global Economy
Fiscal Pressure on Germany
The German economy is in real distress. All the indicators are pointing to a recession, and soon. Industrial activity has fallen off, the latest PMI is in the low 40s and the yields on German bonds have never been lower. If ever there was a case to be made for fiscal stimulus, this would be it. The Germans are not enthusiastic about these moves and there is still considerable resistance as such a policy could lead to inflation. The frustration is that Germany's problem is mostly external. The consumer in Germany is still spending, albeit more cautiously. However, the export sector has all but collapsed as the country has been affected by both the Brexit mess and the U.S.-China trade war. Those who oppose the stimulus point out that both of these issues could be settled and the German move would be rendered unnecessary.
Corruption in Poland
The Law and Justice Party is an anti-elite populist group that swept to power on the basis of its anti-corruption pledge, but it seems that temptation has been hard for the leaders to resist. Speaker of the Parliament Marek Kuchcinski has been forced to resign when it was discovered that he had been flying relatives on government planes to holiday destinations. He is not the only member of the ruling party to have been accused of abuse of power. This might start affecting the popularity of the government.
The former leader of Kyrgyzstan tried to depose the man who replaced him, but has been arrested and charged with plotting a coup. He had assumed the military and police would back him, but most stayed loyal to Sooronbai Jeenbekov who had been the prime minister in the former regime. Almazbek Atambayev had been accused of massive corruption and was deposed with little violence.
Oil Market Reaction
There has been immense volatility in the oil market of late. Concerns regarding global trade and the potential for a global recession has driven the price per barrel towards lows in the 50s and some have predicted prices will fall into the 40s. The sense is that much of this concern is overblown as the oil fundamentals are still solid. Demand in the U.S. has held steady, but it has dipped in Europe and Japan. There are still significant supply issues in the Middle East and North Africa with output lower in Iraq, Libya, Algeria and Nigeria. Russia and OPEC are still committed to reduced output. Even the production in Canada and the U.S. has slowed a little.
Analysis: The market analysts assert that prices have reached bottom and will start heading back up sooner than later. The expectation is the per barrel price will hit around $65 by the middle of October unless there is some dramatic event that worries the market on the demand side. The Iranian sanctions are driving that oil off the market and Venezuela is all but cut off. This is also the start of the hurricane season, which could disrupt production in the Gulf of Mexico. The sense is that investors are overly concerned with the trade dispute but will calm down soon.
Redefining Climate Change
Over the last few years, there have been a number of semantic changes relating to the issue of climate. The term "global warming" has faded from use as it was not that descriptive when it came to all the reactions that have taken place in the last decade or so. The term of preference became "climate change." Now, there is a new moniker making the rounds—"climate emergency." At this juncture, there is no doubt whatsoever that there has been climate change and that this change has created major issues all over the world—from agricultural crises to increased storm activity, shrinking ice sheets, heat waves and so on. The arguments have centered on culpability as opposed to solutions. It is as if the fire department shows up at the site of a burning 10-story apartment building and proceeds to sit around a table debating what started the fire. It would seem to make sense to deal with the fire and the rescues needed before addressing the why. The reasons for the heating of the planet are many and varied—from human contribution to greenhouse gas to increased solar activity to natural cycles. The point is steps can be taken to ameliorate the impact of this change and even to reduce it without having to establish a culprit to blame.
Analysis: In general, there appear to be three approaches to addressing climate issues. The first is to take steps to slow down or eliminate the factors that have contributed to the accumulation of the greenhouse gas figured so prominently in the warming of the atmosphere. The major areas of concern have been power production (especially coal-fired plants), transportation (ships, cars, trucks, planes, etc.) and industrial activity. These efforts focus on eliminating fuels that contribute the most to pollution and gaining greater efficiency in the systems that persist. The second approach has been to capture or sequester the carbon dioxide and other pollutants that are creating the problem. There have been many developments ranging from iron filings dumped into the Antarctic to storing the carbon dioxide in caves. The plan is to use nature as well—planting millions and millions of trees and other plants that absorb the offending gasses. The third approach has been to adjust to the new reality of a warmer planet. This means shifting farm sectors, restricting development along seashores, preparing for storms and other weather-related events and building protections for vulnerable areas.
None of these approaches will be cheap and all will be controversial to a degree. It is also unlikely that any one of them will impact the problem sufficiently, they will all need to come into play. The fact is climate impact has already been expensive and will become more so over time. It is essentially a matter of "pay for it now or pay for it later." This kind of three-pronged approach will test the limits of government due to the complexity of the challenge as well as the expense. Ideally, this is a set of campaigns that will draw on the private sector and the individual as much or more than the government. Lifestyle changes by the population will affect the pollution levels as people opt for fuel-efficient transportation and electric vehicles, the use of solar panels on their homes, cultivation of green space and the avoidance of products that contribute to pollution levels. It will also involve decisions to change where people live and work.
The most significant hurdle is that addressing this issue requires international cooperation and there has been precious little of this in evidence. If the U.S. or Europe acts and China or India doesn't, there will be very little to gain. If the U.S. does not engage, it will matter little that others choose to.
What Happens as Interest Rates Fall?
It is an old and still accurate Scottish saying, as appropriate now as ever—"It is an ill wind that blows nobody good." In the world of economics, it is very rare that anything is universally good or bad—there are always going to be winners and losers. The trade turmoil is a classic example. Those who have been buying stuff from China are facing steep tariffs. That will force them to find other sources or absorb that cost. The countries competing with China to be that source will benefit as will companies in the U.S. that compete against that Chinese company. U.S. consumers will lose as they will see higher prices and reduced variety. In the larger context, there will be reactions that will carry their own global implications. In response to the disruption of a trade war, there has been an effort on the part of many central banks to reduce their interest rates as a hedge against slower growth. In addition to these lower rates, there have been dramatic reductions in bond yields as the equity investors get nervous. Long-term interest rates have been falling fast and the tumble doesn't seem to be ending anytime soon. This is certainly not making bond investors very happy, but it thrills the nations issuing these bonds as they will face reduced debt service on those they sell. Investors are moving towards these bonds simply because they are fearful regarding the state of the equity market. Who benefits from these low, long-term rates?
Analysis: One of the most obvious reactions will be in the mortgage market as mortgages are tied to the yield on the 10-year treasury bond—a yield that has been falling rather dramatically. Currently, the 30-year fixed mortgage rate is at 3.75, as low as it has been since 2016. This will certainly jump start the refinancing market as there are still plenty of homeowners saddled with far higher rates. The low rates will also make it easier for people to buy new homes. The rates are only one factor though and there will likely be continued issues of higher cost homes, lenders that are more cautious and areas where housing stock is still in short supply. Also, the new home market has been stagnant for the last year or so. These lower mortgage rates might be a bit of a boost as long as the prospective homeowner stays engaged.
Another reaction to the lower long-term rates may be seen as far as credit cards, but don't expect anything dramatic. The average rate for a credit card is now at 19.29%, higher than it has been in several years. It is conceivable that lower prime rates will see a drop in these rates as credit card issuers generally respond to the prime, which is pegged more closely to the Federal Funds rate. Relief for the consumer will be minor, however. That is an important consideration given that the reluctance to go into debt has all but vanished. The U.S. consumer is solidly back to using the credit card, and for everyday purchases. The frugality that manifested after the recession of 2008-2009 has vanished as people are as exposed as they were before.
There may be changes as far as student loans are concerned, but these will be minor and will not kick in for a while. The student loans handled by the government (as most are) have their interest rates set once a year in May. The terms are then set for the life of the loan. The rate at the moment is 4.53%. These rates are pegged to the 10-year treasury so it is possible that loans for next year might be set at a lower rate provided the bonds are still seeing low yields. For those who already have student loans, there will be no change at all. There could be changes for those who have private sector loans, but these will be minor as well.
Car loans are generally fixed-rate loans and are pegged to the Fed rate, but not directly. The car dealers can do what they want with rates. That has always been obvious as sales are near constant. The average car loan now is 4.67% for a five-year loan, but there has always been a lot of wiggle room for the right buyer. Banks got very interested in making car loans when the mortgage market started to dry up; they are dealing with a lot more default activity than in the past. This makes them eager to see better consumers with better credit.
Those that have high yield savings accounts and/or CDs are going to see their rates go down. That reduction activity has already started with many institutions. This reduction in interest rates has been a concern for many in the banking system as it reduces the incentive for people to save and use the banks for deposits. The Fed officials opposing lowering rates have cited this impact as the bigger issue even though they acknowledge inflation is not as bad as they thought it would be by this time.
As If There Was Not Enough to Worry About
Have you grown weary of the political turmoil and the vagaries of the economy? Are you fed up with stories of social unrest and culture wars? Do you crave something else to worry over? How about a hurricane forecast that is worse than had been originally expected? The latest report from the Hurricane Forecast Center asserts that conditions are setting up for a bad year. The factor that has changed the assessment is the earlier than expected departure of the El Nino pattern in the Pacific.
Analysis: The rise in Pacific Ocean temperatures creates a pattern of high-level winds that stretch across the United States and into the south Atlantic. This creates wind shear that tears the tops off the storms that come marching across the Atlantic from the coast of Africa. These are nascent hurricanes that are prohibited from growing in intensity. Now the expectation is these storms will be able to fully develop and make it into the Caribbean, Gulf of Mexico and along the Eastern seaboard. The previous prediction was for between four and six named storms with only one or two reaching full-blown hurricane status. Now, the prediction is for between six and eight with three likely to be major. There is no sense yet as to where they would go.
It is not altogether clear who or what is to blame for the unfortunate situation we find ourselves in. We are daily fed a steady diet of incomplete sound bites that obscure all nuance and avoid detail like the plague. As we enter yet another protracted political year, we will soon be inundated with half-truths, propaganda and outright lies. Immensely complex issues will be reduced to nostrums and simplistic interpretations as they all compete for the attention of a disinterested and often uninformed population.
Let's review. A fact is a verifiable observation. A fact is a statement that is known to be consistent with objective reality and can be proven to be true with evidence. There is ample opportunity for analysis and interpretation as to the implications of that fact, but the fact itself is unassailable. It is a fact that the top 10% of income earners in the U.S. pays 70% of all the income taxes and the top 1% pays 37.3% of all income tax. It is also a fact that the bottom 50% of income earners pays 3% of all income tax collected. One can argue that one group or another should be taxed more or less, but it is important to understand the basic fact that half of the public are not—in fact—taxpayers as far as income taxes are concerned. That fact should frame the debate over taxation, but it rarely does.
Expected Annual Economic Losses from Weather Events
These estimates keep rising as far as storm damage is concerned. The latest numbers assert that annual costs will be in excess of $50 billion and will only increase over the next few years. The impact of climate change has been intensely debated, but the fact is the U.S. has been subject to storms for many decades. The one factor responsible for the increased toll is that more people and businesses are now vulnerable to everything from flooding to hurricanes to tornadoes.