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Strategic Global Intelligence Brief for February 19, 2020

By Chris Kuehl, Ph.D., NACM Economist—

Short Items of Interest—US Economy

Trump Reversal?

If you are having a hard time figuring out the Trump approach to China trade, you are not alone. In the last couple of years, it has been a mix of tactics without a discernible pattern. In many respects, it seems to reflect an internal battle between advisors, as there are extreme hard liners such as Peter Navarro and moderates such as Larry Kudlow. The latest confusing move is the decision by Trump to overturn the ban on selling high tech goods to China. The Navarro position was these are too sensitive to sell to China and could compromise national security, while others assert cutting off the China market would hurt U.S. companies. Trump has sided with those who want to sell to China—sensitive material or not.

Apple Likely to be First of Many

Apple has become the first major company to alert investors the coronavirus is going to hurt business, but they will not be the last. The statement from Apple explained the double whammy. In the first place, the Chinese manufacturers produce a great many of Apple's products and components (a percentage as high as 85%). The second problem is China is a major market for the products and spending in China has collapsed in the last few weeks. The sense is many other companies will be following suit in the days to come as the impact of China's isolation becomes more and more obvious.

Opportunity for Trade Deal with India?

It has been hard to determine what the relationship between the U.S. and India has become. In the early days of the U.S. trade war with China, it was assumed India would be a big winner, but Trump has been critical of India's trade barriers against U.S. goods and accused them of the same patterns China has employed. On the other hand, the relationship between Narendra Modi and Trump has improved as Modi has become more autocratic and more hostile towards China. The trade deal under consideration doesn't appear to be large or comprehensive, but it is a start.

Short Items of Interest—Global Economy

China Starts to Shut Down Critics

The fear that has gripped the medical community is tied to the fact that very little is really understood in regards to the coronavirus. Many remain convinced the data from China is incomplete at best and an outright lie at worst. The Chinese have taken to expelling critical foreign reporters, and the health groups such as the World Health Organization and the Center for Disease Control are still not allowed to visit facilities in Wuhan. The virus could be more widespread and faster than currently assumed.

French President Attacks Militant Islam

Local elections are coming up in France and Emmanuel Macron is worrying about losing support from the right. His contests with the unions have alienated the left and he can ill afford to lose the other side, so he has launched largely symbolic attacks on Islamic leaders that have been deemed to be radical or disruptive. This is popular with the right-wing followers of the National Front, but it is not clear if it will be enough to peel them away from Marine Le Pen and towards Macron.

Cruise Industry Slammed by Virus Outbreak

Cruise ships have always been vulnerable to disease outbreaks and for the most basic of reasons. Passengers are in close quarters for an extended period of time and the ships visit places that are not always as protected as would be preferred. The latest threat has shaken the industry and caused over 50 cruises to cancel. These have all been in Asia, thus far, but there are worries about what happens in other parts of the world. An outbreak in Europe or Latin America would damage the sector severely.

What is Driving Economic Mood This Week

What follows is a part of a monthly summary we do for the American Supply Association. This is the executive summary and is accompanied by much more detail relevant to those that provide a host of items used by the industrial sector as a whole. I am running this piece to show some of our capacity to provide data organizations can share with their members.

The GDP numbers at the end of last year were nothing to write home about, but they were slightly better than had been predicted at 2.1%. The better performance was attributed to the actions of the consumer as business spending and investment fell in the last quarter. Going into 2020, there will continue to be dependence on the consumer as manufacturing remains in a slump. The trade issues have taken a back seat for the moment, but there has not been much that has been settled. The dominant concerns for the industrial sector remain labor shortages and the impact that the coronavirus will have on global supply chains.

Total Industrial Production (IP) deteriorated again this month (another decline of 0.3%), but the impact was spread across all three sectors this time, with manufacturing taking the biggest hit. Warm weather affected the utilities and lack of demand affected the oil and gas sectors. The Purchasing Managers' Index (PMI) finally escaped contraction territory after five months with a reading of 50.9. The better news is there was a 4.4% increase in the new orders index—the forward-looking part of the PMI. Growth in durables manufacturing improved despite declines in aerospace and defense goods. The automotive sector and appliances carried the day. Factory orders also improved but not as dramatically as durables. The levels of capacity utilization had started to trend back towards normal but continue to weaken and remain in the upper 70s—just short of what would be considered acceptable. This means that investment in new machines and people will continue to be limited.

Among key sub-sectors, motor vehicles and parts showed a little bit of growth. The dramatically lower price for oil has meant low prices at the pump, encouraging more interest in trucks, SUVs and CUVs. Primary metals have continued to trend down, despite producers trying to limit output. Steel prices have continued to fall due to a reduction in demand, and consumption numbers had started to improve but have since flattened again. Capex in the machinery sector continues to as capacity utilization numbers are still tracking in a slightly negative direction, but there has been some improvement in the durable goods numbers. Machine tool makers still have a book of business, but with delayed deliveries, they are worried about cash flow.

U.S. rig counts continue to decline and energy production remains down as demand has reduced. The interruption in trade due to the coronavirus has reduced demand even further. The oil producers are making adjustments to per barrel oil prices that could fall to the $40 level and perhaps lower. The dollar has not weakened, which continues to affect the level of exports in general.

Housing starts have suddenly recovered, despite the higher price of homes. The single-family home is now seeing expanded demand. The permit numbers have recovered a little as well. Millennial demand has finally started to be a factor. The overall market performance has contributed to higher levels of consumer confidence. Both the Conference Board and University of Michigan surveys are trending back up, despite some additional worry about the coronavirus and the political future. Retail numbers were stronger than expected, but the deep discounts have come back to haunt retailers as their revenues are up while profit numbers have been down.

Analysis: The long and the short of this is there continues to be good news as far as the economy is concerned, but there are also some cracks appearing. These might become more serious issues as the year progresses or they could fade as the consumer continues to barrel along.

Examining the Fed Minutes

Along with everyone else in the country, we perused the Fed minutes on Feb. 19. This document is in many ways more influential than the actions the Fed takes. When the Fed changes the Fed Funds rate or alters any of its other policies, there will be plenty of advance warning as the central bankers do not want to spring anything on the financial community. In the minutes, there is a chance to see the members of the FOMC in a more candid role. They discuss events and future plans amongst themselves and it is possible to understand where they are in agreement and where there is dissent.

Analysis: There will be several topics that deserve attention in this month's iteration. At the top of the list will be the potential impact from the coronavirus. This has already served to isolate China, altering a great many supply chains. The business community has started to talk about what this will do to them in the next few months and it is not good. There will have been conversation about inflation as the target of 2% seems as distant as ever. The slight hike in wages has not been enough to trigger price hikes and the costs of commodities have not added much pressure either.

There will have been discussion of the reserve balances. The Fed has long promoted the idea of keeping a small asset portfolio, but at the same time, there is a strong desire to keep banks stable. Powell has indicated the bank wants to keep the reserves above $1.5 trillion, which means continued involvement in the money markets. The other topic of interest will be the impact of these moves on financial stability. The Fed has argued that it is no longer engaged in stimulus activity, but comments suggest their actions of late have been similar to the steps taken as part of the quantitative easing strategy of a few years ago.

Demographic Crisis in the Middle East and Africa

It seems that the old adage holds truer than ever: "No good deed goes unpunished." Over the last several decades, the development strategy for the Middle East and Africa (as well as the rest of the world) had been simple enough and seemingly logical. In order for these nations to progress economically, they had to come to grips with the health of their population and radically improve the education of their youth, which is exactly what these nations set out to accomplish with the assistance of dozens of international organizations. If one wanted to get funding for some project, all one had to do was tie it to health and education. The good news is all this effort paid off. The rate on infant mortality plummeted and millions of kids started to get access to education. That access continued and those millions soon began to get access to higher education. This region has never had more healthy young people with education. The majority of the population in the Middle East and much of Africa is under 30 and most have some education—many thousands have degrees from universities. There is just one thing this young population lacks: employment.

Analysis: The vast majority of those who have become formally educated have no opportunity to use those skills and that education. They are working in menial jobs or unrelated fields with virtually no hope of ever progressing. The frustration level is high and getting higher. All of the development effort has been directed at preparing people for careers that do not exist and that leaves very few options. The young and educated can scramble to find the few local jobs available but that very competition ensures that wages remain very low—far less than they were led to expect. People with advanced degrees are barely making more than a day laborer. The second option is to give up that search for a good job and take whatever can be found at whatever wage and wonder why they wasted their time getting an education they can't use. The third option has been to migrate somewhere else and that usually means Europe. The myth is that these migrants are the poor and uneducated when the reality is that most of the migrants (aside from the refugees fleeing war) are young and educated. It doesn't seem to strike people as odd that these migrants are speaking English and German and French when they arrive.

In many of the nations of the region, there has been considerable political unrest and demonstrations made up of that young and angry population. These are the educated young who feel betrayed and exploited and become candidates for all manner of protest movements. They are engaged with the Islamic militants, the nationalists and populists and the radical left—any group that seems to promise their future can and will change.

What is needed is business and lots of it. The only way out of this crisis is the development of viable and vibrant economies that can employ tens of thousands of people in high level tasks. This means massive levels of development and investment via active engagement of the private sector. This is not going to be an easy task in any sense.

Brexit Creates Budget Crisis

The withdrawal of the U.K. has left a 60-billion-euro gap in the EU budget and there has been a scramble to figure out a way to fill it. The suggestion has been to increase the commitment from the richer states so that the poorer states in the south can continue to keep their own budgets intact. Needless to say, this has not been a popular idea with the wealthier nations who argue they already contribute far more than the others. If these assessments are not increased, the poor states will be forced to reduce their spending and engage in tighter austerity measures. These moves have resulted in mass protests in the past, something the EU would like to avoid.

Analysis: There is simply no easy way out of this mess. The richer states have never been enthusiastic about their level of commitment, but today, they are suffering from their own economic malaise and can ill afford more. The German economy is teetering on the edge of recession, France is locked in bitter economic reform battles and the Scandinavian states have financial issues of their own. The populist parties in these nations have taken a very hostile position towards assisting the southern tier and that resonates with the population as they worry about their own economic future. The states that need the assistance are fragile in their own right—chaos in Italy as the coalition splinters, a minority government in Spain, continued issues of high unemployment in Greece and Portugal, and the central European states are pulling away from the EU over politics and could well stage their own exit if they start to see less financial incentive to stay engaged.

Healing Properties of a Good Walk

This is the time of year that tantalizes. In the last couple of weeks, we have been treated to the usual pre-spring tease. One day, it is near 70 degrees and the next day, it plunges to 20 and snows. On those balmy days, the desire is strong to get out and enjoy the opportunity and then, we have to retreat and wait for another one. On those nice days, Gay and I have gone out to the many walking trails in the area, which has been a revelation in many ways.

The first thing one notices is several months of planting one's butt in a chair does nothing for one's leg muscles. Those initial walks featured everything from sore hamstrings to shin splints and calf pulls. After a few days of this, other observations started. My sleeping improved from all that fresh air and sunshine. I got some flexibility back. I also slowed my pace down enough to enjoy the world. We saw a pair of bald eagles on one jaunt, enjoyed the sound of the stream, and observed the return of those migrating birds. People we encountered on the trail smiled and nodded hello and more than a few actually greeted with a verbal salutation. Gay and I talked about all kinds of stuff on the walk—just idle conversation rather than duty oriented. It was a great opportunity for escape and I can hardly wait for more of those balmy days and the end of the cold and snow!

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Monday, 30 March 2020