Strategic Global Intelligence Brief for January 11, 2019
Short Items of Interest—U.S. Economy
Shutdown and Unemployment
The government shutdown has now lasted longer than any of the previous episodes. With both sides as dug in as they ever were, there is no end in sight. The impact on the 800,000 employees has started to become severe. There have been significant problems for those who once relied on various government services. It is also starting to have an impact on various economic issues. For example, there has been a surge in claims for unemployment by the furloughed federal workers. The very long string of positive job numbers will likely come to an end this month, as well. Another impact is that much of the data traditionally collected by the government is not being collected. That will rob analysts of the information they need to understand what is happening in the economy right now.
More Voices of Caution at the Fed
If there is one message coming from the Federal Reserve at the moment it is that there is no need to rush. The latest minutes and Jerome Powell's comments before Congress have been reiterated by statements from several of the regional heads of the 12 Fed banks. It is a call for something of a time out—a period of introspection before taking any further action. The current shutdown crisis only complicates things. The sense is that further interest rate hikes should be put on hold for a while—at least until there is a more secure impression of where the economy is headed for the remainder of the year.
The Attack of the Inverted Yield Curve
The several trillion-dollar question is whether an inverted yield curve signals a recession, causes a recession or really doesn't have much to do with a recession. The inverted yield curve is when long-term yields drop below short-term yields. Each of the last five recessions was preceded by this inversion. The long-term yields are set by the bond market and the short-term yields are set by the Fed. Right now, the bond market has come to the conclusion that the Fed is driving rates up too far and too fast. The worry is that this will set up a recession along the lines of the one triggered by Paul Volcker's Fed in the 1980s. Those who question the connection between the yield curve and recession point out that many things are different this time around—most notably the impact of the Fed buying six trillion worth of bonds and the fact that many of the traditional buyers (China, Japan, Middle East) are not buying as much.
Short Items of Interest—Global Economy
Confusion in Syria
Nobody seems to have a clue what the U.S. policy in the Middle East is these days—despite the lengthy speech made by Secretary of State Mike Pompeo in Egypt. President Trump has indicated twice before that he would pull troops out of Syria and neither time saw a troop withdrawal. This latest assertion caused Defense Secretary Jim Mattis to resign and sparked contradictory comments from National Security Advisor John Bolton. Now it seems that some of the 2500 troops are heading home, but nobody knows if there will be more. None of the analysts agree with Trump's assertion that ISIS has been defeated and none of the regional leaders are of that opinion. The Kurds in Syria are feeling betrayed. That has affected the extent of Kurdish support for the U.S. in Iraq. The U.S. has utterly confused ally and enemy alike.
Brexit Chaos Builds
Supporters of a definitive break from the EU have been handing Prime Minister Theresa May one defeat after another on the issue. She has become increasingly desperate to find a way to salvage a deal. Nothing is working and the U.K. seems destined to hurtle towards a "no deal" Brexit that leaves the country completely cut off from Europe. There is no appetite at all for a changed deal on the part of the Europeans as they believe the British will suffer far more than any nation in Europe will. Analysts universally agree—even those who support Brexit. They acknowledge the pain Britain will feel, but they still think gaining that sense of sovereignty is worth whatever price.
December's Credit Manager's Index Dips a Little
It can be tempting to read too much into the monthly changes that take place in the Credit Managers' Index (CMI). Not that these fluctuations are unimportant, but longer-term trends tend to be more informative when it comes to the status of the overall economy. December saw the combined score fall back to levels seen in October. On one level, this is disappointing. It would have been nice to see the index continue tracking upwards, but it is important to remember that any reading over 50 suggests growth, so a reading of 54.2 is certainly respectable. There is a lot that seems to signal changes are coming, and one could reasonably add the CMI data as another indicator. As we leave the last of 2018 behind, there are growing concerns over everything from trade to the specter of inflation; all against a backdrop of labor shortage and possible government engagement, including regulation and future stimulus.
The overall score for the December CMI fell to 54.2 from the previous month's 55.8. This is certainly not a major drop, but it is not the trend that had been hoped for. The last time the overall score was this low was in April when it fell to 53.7. Over the last several months, the reading has been very close to 55 or 56. The favorable factors also trended down in December. In fact, this was the movement that pulled the overall numbers down. The reading in December went from 63.2 to 59.4—the first time the data has been under 60 since December 2017 (also at 59.4). There was, however, only a slight movement in the unfavorable factors (50.9 to 50.8).
As usual, the details paint a clearer picture. The dip in the favorable factors may be the most important development for December. All of the favorable subcategories also fell out of the 60s, except for amount of credit extended, which tracked at a lower level than the month prior. The sales reading went from 64.5 to 59, a mark not seen since December 2017 when it hit 59.2. The new credit applications number fell from 62.2 to 57.5. It was last at that level in December 2017 (57.3). The dollar collections number dropped from 60.9 to 59.3—not quite as dramatic as some of the other readings, though. The amount of credit extended stayed in the 60s, but went from 65.3 to 61.9. The slide in all these factors suggests there has been a slowdown, which is consistent with some of the other data that has been seen in the Purchasing Managers' Index (PMI), durable goods orders and capacity utilization.
The combined score for the unfavorable factors was a little less threatening, but the numbers are still not good. The score went from 50.9 to 50.8—virtually no change. There was similar activity in the sub-index readings. The rejections of credit applications stayed exactly where it was in November with a reading of 51.4. This is especially good news given that new applications are generally down. The accounts placed for collection actually improved a little, but still fell short of escaping the contraction zone. It was at 48.2 and is now at 49.7. The disputes numbers fell a little and dropped out of the expansion zone with a reading of 49.6 after one of 50.1 in November. The dollar amount beyond terms also slipped from 52.3 to 49.3. This drop is more worrisome, as this is often the first sign of impending credit issues. The dollar amount of customer deductions stayed very close to November's number, but improved slightly with a reading of 49.7 compared to 49.6. The filings for bankruptcies improved quite a bit with a reading of 55 after one of 53.6. Overall, the nonfavorables are stable enough, but they are still very close to contraction territory.
The manufacturing sector was been a subject of intense interest for most of 2018. The U.S. economy is still very dependent on its service sector for jobs and the total GDP. All by itself, the GDP of manufacturing in the U.S. is as large as the eighth-biggest country in the world. The sector is often seen as a kind of symbol for the overall success of the U.S. economy. The numbers look a bit weaker in December, which is a bit worrying for 2019.
The combined score for the whole index slipped from 55.6 to 54, taking the reading back to where it was in October. The index of favorable factors fell out of the 60s for the first time since December 2017. It is now at 58.9; whereas it was 63.2 the month before. The sub-index numbers showed the same kind of retreat. The sales numbers went from 64.2 to 59, while the new credit applications data shifted from 61.7 to 56.8—a number that has not been seen since December 2017. The dollar collections number fell from 61.6 to 59 and the amount of credit extended remained in the 60s, but only by a hair as it went from 65.4 to 60.9. The general sense is there was a slowdown in the manufacturing sector at the end of 2018, but as these numbers are similar to what they were in 2017, this is also a seasonal reaction. The retail community may come to life at the end of the year, but the manufacturing community slows as the holidays tend to chew into productivity.
The combined score for the nonfavorables improved very slightly from what it had been the month before, moving from 50.5 to 50.7. The sub-index numbers showed a bit more variety. The rejections of credit applications slipped from 53.1 to 51.6, but at least managed to stay in the expansion zone. The accounts placed for collection improved and entered expansion territory by a small margin, going from 49.2 to 50.3. The disputes category sagged a little, with a reading of 48.6 compared to the 49.6 reading in November. The dollar amount beyond terms stayed very close to what it had been the month prior with a reading of 50 compared to 50.3. The best news here is the category stayed out of the contraction zone, albeit by the slightest margin. The dollar amount of customer deductions improved a bit, but remained in contraction territory with a reading of 49.1 compared to 48.6. The filings for bankruptcies reading improved slightly, as it went from 52.2 to 54.4.
As with the combined CMI and the manufacturing sector, there was a decline in the numbers in the service sector. There is always a bit of a challenge at the end of the year. The two biggest components of the sector are retail and construction, and these go in opposite directions. It is a big moment for retail, obviously, but a very slow period for construction. The upshot is some confusing readings from time to time.
In December, the combined score behaved similarly to manufacturing with a reading of 54.5 compared to 56 the month before. This is a number seen in October. The index of favorable factors fell a bit from 63.2 to 59.9, while the index of unfavorable factors fell, yet remained in expansion territory as it moved from 51.2 to 50.9.
The sales category slipped from 64.9 to 59; it has been a year since this number was that low. Given that it was retail season, a trend like this is not welcoming. The new credit applications segment also fell (62.7 to 58.2). The dollar collections data didn't fall all that drastically, but dropped out of the 60s by moving from 60.1 to 59.6. The amount of credit extended stayed in the 60s, but was reduced from what it had been, going from 65.2 to 63.
The variability was less pronounced in the nonfavorable categories. The rejections of credit applications actually improved a little as it went from 49.7 to 51.2. Given that new applications were down, this is good news indeed because it suggests the applications that are being submitted are better than has been the case in the past. Either that or standards are being lowered. The accounts placed for collection also improved, but remained stuck in contraction territory at 49.1 from 47.2 in November. The disputes category stayed almost exactly where it had been with a reading of 50.5 compared to 50.6. The dollar amount beyond terms took a real tumble, which is concerning. It was in expansion territory at 54.3 just a month before and now it has fallen into contraction territory with a reading of 48.5. This is not good since this is often the precursor to deeper issues down the road. The dollar amount of customer deductions remained stable as it only shifted from 50.7 to 50.3 and remained in expansion territory by the skin of its teeth. The filings for bankruptcies went from 54.9 to 55.6, back to the numbers seen earlier this summer.
There are some early warnings starting to show up as the favorables are sagging for the first time in a year. At this point, the reason could be seasonal, but if the trend extends to January, there will be more concerns about 2019.
Chances of Recession
There are not many areas of economics more likely to make a fool out of forecasters than predicting a recession. It is akin to forecasting a rainy day in April. It is inevitable that the economy will stutter and experience a down period just as it is inevitable that the economy will experience some high points. Exactly when these periods develop is the challenge. The economy has been on a very long and productive run for nearly a decade; an unusually long string. That very success tends to bring the reversal as there will be pressure on commodity supply and wages in addition to productivity and capacity issues. The consumer starts to become wary and so do investors. There is an expectation of slower growth that becomes something of a self-fulfilling prophecy.
Analysis: At the moment, about half the economists polled by the Wall Street Journal are expecting a recession of some kind by the end of this year or early in 2020. Most are not expecting a major downturn—nothing like the Great Recession that marked 2008 and 2009. This is likely to be one of those "V" or "U" recessions that feature a sharp decline and then a pretty rapid recovery. The speed of that rebound will depend on the willingness and ability of the government to act appropriately. When there is a recession, the expectation is that Congress will accelerate spending at the same time it cuts taxes. This is designed to stimulate the economy through consumer activity so the spending and tax cuts have to find their way to the wallets of the consumer as opposed to business. At the same time, the Federal Reserve lowers interest rates so business can borrow more cheaply and consumer loans such as mortgages, car loans and credit card rates are lowered. This is what worries analysts right now. Congress does not seem inclined to do the kind of spending that would be required and Fed rates are not high enough for a reduction to mean much.
The factors that are causing economists to think recession include the ongoing trade disputes between the U.S. and China, the impact of the government shutdown, the volatility of the stock market and the potential for an incredibly nasty presidential campaign that will pit the extreme right against the extreme left and leave the majority of consumers uneasy and confused.
The Political Disconnect
I had another opportunity to spend some time with the group of local business people that refer to themselves as the Heartland Heroes. This is always a very instructive session for me as it is an intimate group of successful business people who do far more than just listen to my blathering—it is very interactive with lots of questions and commentary. I get a chance to hear what is really on their minds and, not surprisingly, their concerns are not the same as the breathless media and the politicians would have us believe. It is also astonishing that their issues are so similar to each other despite the very wide variety of businesses represented—major construction groups, oil, health care, marketing, plumbing and heating and so on.
I know this will come as a shock, but these people are not obsessed with a border wall or government shutdowns or whether the U.S. has defeated ISIS or whether Russia worked to undermine the election in 2016. They all have their own opinions on these and other subjects. Some of these opinions are passionate enough, but these are not what keep them awake at night as business owners. The top of the list of things that really matter is whether they will be able to find the workers they need. Not one of them was confident they would be able to do that. This has been a chronic problem for decades in the U.S. and yet almost nothing has been done to address it—not at a national level. If all those politicians rattling around in Washington really wanted to see the U.S. grow and prosper into the next century, the only thing they would be thinking about would be the training and educating of the future workforce.
U.S. Business Cycle Expansion
The current business cycle expansion is the second longest the U.S. has experienced since the end of the Second World War. Granted, this has often been an anemic growth period with very modest gains in some years, but it is still an expansion that is pretty long in the tooth. That fuels the prediction that it will have to come to an end sooner than later. Not all of these expansion periods end in a recession—some just quietly fizzle out. Then, a new cycle starts to develop. The one we are in at the moment is likely to end with a recession period of some kind.