By Chris Kuehl, NACM Economist—
Short Items of Interest—U.S. Economy—
Consumer Slowdown
The latest data on consumers is not exactly bad, but it isn't all that good either. For the last few years, it has been the consumer driving the economic progress in the U.S. Anything that suggests this run could be coming to an end will worry the manufacturers, the market, the retailers and most everybody else. The growth in consumer spending was lower than it has been, but at least there is still growth, albeit at just 0.3%. A bigger worry is that income only grew by 0.2%. In all of 2019, the rate of consumer spending was at the lowest pace seen in years. There is still growth, but it has become anemic.
Coronavirus Impact
The virus will obviously have a far greater impact on China than the rest of the world as the nation will have to spend billions to contain and deal with the outbreak. Assuming the virus does not spread rapidly outside the Chinese border, the impact on the rest of the world will be in terms of travel and the supply chain. There are many nations that are now banning travel into China and restricting arrivals from China as well. That will make managing business relationships very hard. The other and perhaps more serious issue is that supply chains are disrupted as China works to contain the outbreak and many of the parts and assemblies affected are not going to be readily replaced. There is expected to be a major shortage.
Return of the Inverted Yield Curve
The curve inverted a few months ago and the markets swooned a little in response. The inversion of the yield curve has been considered a signal of an impending recession as it means investors are getting very uneasy. It was a good sign when the relationship between the long-term and short-term bonds returned to normal, but now, they are inverting again as the investment community frets about the coronavirus and the potential for a global recession.
Short Items of Interest—Global Economy
Progress on a Digital Tax
For the last several months, there has been a stalemate over the issue of a digital tax that would be imposed globally on the big tech multinationals such as Alphabet, Apple, Facebook and the like. The Organization for Economic Cooperation and Development (OECD) has been trying to hammer out an agreement, but there have been few issues more contentious. The U.S. and France have been threatening a tariff war over the issue, which has made progress hard. There now seems to be a deal in place that will allow some movement towards a system that would be multinational rather than a fractured approach leading to more of these one-on-one confrontations.
India Struggles to Regain Momentum
Just a few years ago, many thought India was poised to overtake China as the economic engine of Asia. Few would assert that now as the country is in the grips of a recession with six-straight quarters of slowdown. There is widespread unemployment among the young and educated, and that was not expected. The government is now outlining what it plans to do about this, but the options are limited. There will be calls for more stimulus from the central bank, lower taxes and more spending, but it is not clear the government can engage in this. The country is already dealing with stagflation; this will only make that issue worse. There is very little that can be done quickly. It turns out the trade war between the U.S. and China has hurt India more than it has helped.
Avocado Gangs
Forget cocaine, meth and oxy and all those other drugs that traditionally fund the gangs in Mexico. The real money is in satisfying the avocado junkies in the U.S. The gangs in Mexico are taking a stake in this lucrative export market. The trucks loaded to the gills with "green gold" are getting hijacked unless the growers pay protection money. The U.S. demand is insatiable. That has led many growers to create their own private armies to protect their business.
Brexit Day Has Dawned
Just over three years ago, the British went to the polls and decided to exit the European Union—an organization they had been a key part of since 1973. This means leaving a trading bloc of 27 nations and 450 million people. The issues that prompted the decision to depart are complex, but for the majority of Brexit supporters, it came down to three broad categories. At the top of the list was immigration—the British wanted an end to the influx of migrants from Eastern Europe as well as from the Middle East and North Africa. The second issue was chafing at the regulations imposed by bureaucrats in Brussels. The third motivation was a desire to free the U.K. from its dependence on what Germany and France decided.
Analysis: As momentous as this day is, the changes will not be immediate. This really means the negotiations now start in earnest. The possibility that the U.K. would change its mind and remain in the EU is off the table. The sticky issues will now have to be dealt with. There will be a year or more of talks, but this time, there will be no avoiding the decisions that will have to be made. Most everything will remain as it is for the next year—deadline is now Dec. 31 of this year. Trade will continue and free movement of people will continue throughout the talking phase.
The desire on the part of the British is to work out a new trade deal with Europe. They are also interested in getting a deal with the U.S. Neither of these will be easy. There is great confidence expressed by British Prime Minister Boris Johnson, but that is what one would expect from someone who wanted this exit so badly. The EU is not in a mood to give the U.K. a break after three years of acrimony, but the fact is the U.K. is the fifth-largest economy in the world. Only Germany is bigger as far as Europe is concerned and the U.K. market will be missed by the other Europeans. The U.K. also needs that market of 450 million people. There is precedent for what the British would like to see, but there is a question of whether Europe wants to offer them the same deal they offered Norway years ago.
A trade deal with the U.S. is also a tricky proposition. The British economy is much like the U.S. economy in terms of what it makes and what it wants to sell in the world. The U.S. is a manufactured product exporter and so is the U.K. American manufacturers will not be eager to see competitive products from the U.K. and vice versa. The U.S. wants to sell farm output to the U.K., but the British want to keep protecting their smaller farms. The two nations are really not natural trade partners and any deal struck will fall short of providing what the British got from trading with Europe.
One of the biggest issues will be internal. Britain has deep divisions of its own; Brexit makes these more problematic. Scottish voters overwhelmingly supported staying in the EU as they have often relied on European rules to offset the demands made from England. The Brexit decision has reignited the movement for Scottish independence. The Northern Ireland situation will be extremely complex as there will now be a hard border between the two Irelands—one that will cut homes, farms and villages in half. The fear is that demand for Irish unification will ramp up.
Drastic Slowdown in Eurozone Manufacturing
The eurozone manufacturers had a rough year in 2019 and the expectation is not great for 2020. The major problem has been the decline in the automotive sector. That will be the issue that keeps the coming year uncomfortable. The market for cars has cooled in Europe as the consumer has become more cautious and there have been some significant changes in the demand for cars. The consumer wants more electric options, while the carmakers have struggled to keep pace. There have also been issues as far as quality with some of the largest makers running into major recalls issued along with the problems of scandal over cheating. To make matters even worse, it has been the vehicle sector that Trump has targeted as he tries to pressure the Europeans on a wide variety of issues.
Analysis: The automotive sector is not the only problem of course. The struggles in the southern tier states continue to drag the entire region down. There have also been issues that range from labor strife to political ferment. The bigger, long-term concerns include the age of the working population and the failure of the system to recruit enough people to fill the posts of retired workers. The whole region has been slow to react to technological innovation as Europe has nothing to compete with what comes from the U.S. and China. The entrepreneurial culture remains stunted in Europe and keeps many companies from competing on a global scale. That is compounded by a reluctance to deal with immigration. The region needs the new arrivals, but as with every other set of nations, they need certain people and not others.
Pretty Good—Not Great—Better than Expected
Given that football is all that is on the minds of those of us who live in Kansas City, I feel compelled to use a sports metaphor here. The latest GDP data release is somewhat akin to winning a very sloppy football game—one where the quarterback threw an interception or two, the defense cracked and the victory depended on the other team muffing a punt. The bottom line is there was a win, but there are real concerns about the team going forward.
The GDP numbers for the fourth quarter came in at 2.1%. That means the annual growth rate was 2.3%. This is OK growth and better than many had expected to see given the extent of economic turmoil that has been roiling the globe. The somewhat concerning point is there was growth of 3.1% in the first quarter—a full point faster than Q4. In 2018, there was growth of 3.5% in Q3. The current pace is not bad, but it is what I have been referring to as "unforgiving growth."
Analysis: When the growth rate is close to or above 3%, there is more incentive to take a risk. A company can elect to expand territories, acquire new machinery or hire people with some assurance that overall growth will justify these moves. When the growth rate is more anemic, there is less of that confidence and more overall caution. This new pattern has been manifesting for several months now and that will have an impact on the coming year. At a recent major trade show, I heard the same comments over and again. "We have a good book of business, but everybody is delaying delivery and now we have cash flow issues." Many companies are postponing those expansion plans until they can get a better handle on the coming year. They seem worried about a renewed trade war, political wrangles intensifying in the U.S., consumers losing their enthusiasm and, now, new fears stemming from disease outbreaks in China. None of this suggests a reversal is imminent, but the betting now is that GDP growth will stay at this 2% level—OK but not exciting—more games where victory is not at all assured.
What Drove GDP Growth Last Quarter?
The expectation for Q4 growth was a lot lower a few months ago as most analysts assumed the headwinds such as the trade war, the conflict in the Middle East, Brexit, politics and fickle consumers would combine to drop growth below 2%. That has not happened (as yet anyway). Why not?
Analysis: There are always many factors that combine to drive the economy from one day or quarter to the next, but there are a few that really stand out and seem most responsible for the current pace. The consumer is in a good mood and therefore feels like spending money on a wide variety of desires. This is due to the fact that unemployment rates are still very low and wages are starting to come up in reaction to a shortage of labor. The lack of inflation has helped a lot as consumers are now seeing price hikes in the most sensitive of areas. The price of health care and education keeps rising, but gas prices have stayed low. Generally speaking, there has been stability in food prices as well.
The growth in the U.S. economy is due to consumer spending. That has offset the decline in business investment and spending. The manufacturing sector is in recession because of that reduction in business activity, but the service sector continues to boom as the consumer is attracted more to services these days than to goods. That is going to be both a strength and weakness in the year to come. The service sector provides lots of jobs, but they are generally low-paid jobs, which don't provide the fuel for robust economic growth.
Fed Tracks Global Growth
The message has been reiterated every time the Fed meets. There have been dozens of variations on the theme of "we follow the data." In other words, the decisions on whether to lower or raise the Federal Funds rate will be made according to what the inflation and employment numbers are. That will mean a close look at the economic data that spews from various sources in the U.S. After the last meeting of the Fed, there was another factor introduced as the most salient. If there is a change in the interest rate in the coming months, it will be due to the changes in the global economy rather than any changes expected in the U.S. economy.
Analysis: The Fed statement made two things clear. The first is what happens around the world has an impact on the U.S. This has been apparent for years of course. The U.S. depends on exports for over 15% of its GDP. Last year, the level of export activity increased despite a strong dollar and various trade disputes. The second point the Fed statement made clear was that global economic activity is in a state of real turmoil right now; it has become very hard to predict outcomes. The big concerns now include older issues such as Brexit and the U.S.-China trade war as well as new threats such as the coronavirus, civil conflict in Libya and Iraq, recession in Mexico and stagflation in India.
If the global slowdown accelerates, the drag on the U.S. economy will likewise intensify and the Fed will have to do what it can to shield the U.S. from that impact. The question is whether the Fed has the ammunition to accomplish this. Most analysts doubt the Fed can accomplish much with lowering rates from its already very low level.
Another Useless Shout into the Wind
Those who read this newsletter are by definition fine upstanding folks possessed of all the manners and behaviors expected in the civilized world, so pointing out the need for airplane etiquette is certainly preaching to the choir. Let's start with the placement of one's luggage. There are always those who insist on grabbing those front seats despite having bags that will not fit. These compartments are smaller than the rest and were designed for small bags, but this fact escapes many. They then have to place their bag several rows back and somehow swim back upstream to the seat they covet. Rule No. 1 should be—don't take the front seat when you are toting a bag big enough to hide a body in.
If you do have to place your bag in a distant bin, the next iron clad rule comes into play when the plane lands. DO NOT rush back to grab your bag and then force your way back to the front with bag in hand. One jerk of a woman did precisely this and in her best imitation of a bulldozer managed to slam half a dozen people in the effort. Her assault culminated with her bag hitting an elderly woman. If you do have to position that bag in the rear, the proper approach is to simply ask one's fellow travelers to hand it up to you. Simple! We are a cooperative lot as a rule—we are all in this together. This technique eliminates the possibility of bodily harm. The idiot that smashed the woman ignored the damage she had done, but the airline did not and neither did the woman's grandson. As I left the plane, it was obvious she was going to face a conversation with the police as the young man was planning assault charges. One of the morals of this story is "never hit a grandmother in the face—especially when the grandson is around 6' 4" and sports biceps the envy of a linebacker."