Short Items of Interest—U.S. Economy
Industrial Production Remains Constant
The overall industrial production numbers stayed flat, but that was only due to the fact that some sectors went in opposite directions. There was an improvement noted in both manufacturing and in mining, but there was a decline in the utilities sector. The cooler than usual weather meant power use was slacked (something that is not going to last long now that the summer heat is building). The mining sector includes the oil and gas industry and there has been solid movement here as demand ratcheted up with the arrival of the summer driving season. The part that was not expected was the gain in manufacturing. That gain offset the utility slowdown all by itself.
Latest Fed Appointee Runs into New Problems
The latest attempt by the Trump team to flesh out the Fed's Board of Governors has met with slightly more enthusiasm than the previous try, but not as much as suggested last year. In 2018, the two candidates waiting for Senate approval were economist Marvin Goodfriend from Carnegie Mellon and Nellie Liang from the Brookings Institution and formerly of the Fed itself as head of the Office for Financial Stability. They were not re-nominated in 2019 nor was Herman Cain, former CEO of Godfather's Pizza and Stephen Moore, an economic commentator and former head of the Club for Growth. Both of these dropped out after it became clear they lacked support. Now, the nominees are Judi Shelton—an economic commentator and advisor to Trump as well as Chris Waller—the research head for the St. Louis Fed. Shelton is controversial for both her views on the gold standard and her engagement as Trump's advisor, but she is also being criticized for her lack of attendance at meetings of the European Bank for Reconstruction and Development (EBRD). She is the U.S. delegate to the group and has missed 42% of the meetings in her first year.
Rate Cut Watch
There has been no definitive statement as far as when or even if the Fed will cut rates, but some structure to that decision has started to emerge. Fed Chairman Jerome Powell has stated that a slowdown in the global economy would be a trigger and Dallas Fed Chief Kaplan states he will be influenced by what the bond markets are saying. Charles Evans of the Chicago Fed has indicated he thinks that two cuts will be warranted this year—taking the rate from 2.5% to an even 2%. He is the most dovish of the four regional Fed heads that are on the Open Market Committee this year.
Short Items of Interest—Global Economy
Mexico Slides Towards Recession
Traditionally, the Mexican economy follows the U.S. lead. When the U.S. economy is doing well, so is the Mexican economy and vice versa. The connection has been lost and now Mexico is slipping fast even as the U.S. economy holds its own. The problem has been a combination of U.S. trade and tariff pressure, the costs of dealing with the immigration crisis and fallout from the anti-business policies of President Andrés Manuel López Obrador (AMLO). The AMLO that railed against foreign investment and capitalism is in charge and Mexican business is in full retreat. The only option will be big cuts by the central bank and likely a peso devaluation.
EU Puts Pressure on Maduro
For most of this year, the government of Nicolas Maduro has been concerned by the moves under discussion by the U.S., but now it is apparent the European Union (EU) is joining the fray in earnest and will begin to impose heavy sanctions if Maduro doesn't attempt to find some way to leave office peacefully. Europe has been a lifeline for Maduro and he will not survive long without it.
Italy Goes After the Roma
It is always popular with parts of the European population to focus attacks on the Roma (often referred to as the gypsies). They are persecuted everywhere and intensely in Eastern Europe as well as Italy. They are now being targeted again by Deputy Prime Minister Salvini's government.
Very Controversial Choice as European Commission President
The choice of Germany's Ursula von der Leyen was a shock from the start as many within the European Parliament expected the choice would be from among their ranks and would be based on who had done the best in the elections. This alternative was rejected by the most powerful leaders in Europe and they put their own candidate in place. It was more than a little unusual to see von der Leyen getting support from the likes of French President Emmanuel Macron given that she has a reputation as a conservative and a populist. In the end, her narrow victory came due to the support of those populists and right-wing groups. She won almost no support from members of the Parliament, which will make it hard for her to accomplish much. Her opponents assert she will be far too dependent on these big country leaders and those that are pursuing an anti-EU position.
Analysis: Analysts are struggling to figure out where she came from as her name was nowhere in the conversation until the last moment. It is thought by some that this was a deliberate move by Macron and German Chancellor Merkel to weaken the Parliament as they will tie themselves in knots trying to work with her. The power of the European Parliament remains weak, but it has become more influential over the last few years as the radical groups have become engaged. This has limited the activity of the European Commission and that annoys Macron.
Why Have the Trade Threats Not Been an Issue?
The statements from almost every analyst and economist have been consistent—even the White House has been warning there would likely be price hikes, but these would be worth it in the end. The comments from Fed Chair Jerome Powell have been direct enough—the only factor that would persuade the Fed to lower interest rates would be the struggles of the global economy and the impact that a trade war would have on the U.S. economy. The data has been clear enough, or so it would seem. The U.S. depends on exports for around 15% of its GDP. The tariffs that have been leveled have affected billions of dollars of goods. The U.S. has seen a decline in imports from China and other countries and has seen a decline in demand for U.S. goods, but not to the levels that had been anticipated. Why not? Have all these threats been overblown? Have the tariffs really been on anything important? There are three reasons that have been posited for the lack of response.
Analysis: The first is based on the fact that tariff policy has been very uneven and has been far more talk than action. There were threats to end imports of foreign steel, but then the four-largest importing nations were all given exemptions and hundreds of U.S. companies no special exemptions that allowed them to buy that imported steel. Threats were made to place additional tariffs on China, but there was no follow through. The Europeans were threatened with tariffs on cars and car parts, but that never reached implementation either. Tariffs have been threatened against Mexico, but they were not executed. In fact, there have been very few tariffs imposed on anyone although almost every country in the world has been threatened with them. The end result is that consumers have not seen a reduction in the product mix they are accustomed to and have not seen much in the way of higher prices.
The second rationale is companies that have been affected by the tariffs have not passed on the additional costs to the consumer. The tariffs imposed have mostly been on Chinese goods. The expectation was these prices would escalate due to the tariffs. The companies affected have been more concerned with market share and have resisted the price increase that would be triggered by the tariff. This is not a position that can be maintained forever, but given that many of the Chinese companies are state owned, they will have the support of the government to a degree. That allows them to hold the line on pricing longer than would be the case for companies without that backing.
The third reason for the lack of response has been the quick reaction from competitive nations eager to chew into that Chinese market share. Vietnam has seen a 60% increase in exports to the U.S. and India has seen a similar ramp up. Many assumed there would be a reaction from China's competitors, but few assumed it would be this swift. The tariffs that have gone into effect thus far have been targeted at the industrial community and replacing Chinese production has been relatively simple. If the tariffs on consumer goods are imposed, it may be harder for the rival nations to react, but they will certainly try.
The bottom line is that trade wars and tariffs remain a threat, but the uneven execution of the policy combined with the development of alternatives has limited the impact for the moment. That could change quickly should these threats actually become reality. Nobody really knows what would trigger this.
Good and Bad Factors as Far as Q2 Growth
The second quarter numbers will be out soon and the sense is that they will be substantially less impressive than those from Q1. The data collected shows that two of the motivators for the rapid growth in Q1 slowed drastically as the first quarter ended and the second quarter got under way. The biggest decline was in the trade area as both exports and imports dropped. That pattern has only accelerated. The global economy has been affected badly by the trade wars that have involved the U.S. and almost every trade partner. It is not just that the U.S. has severely limited the business done with China, but the slowdown in the Chinese economy has created a ripple effect that has come back to hurt the U.S. Countries that sell to China have been unable to sell as much as they are accustomed to. That means they have been unable to buy as much from the U.S. Therefore, the U.S. is selling less to these nations. The other factor that has been less robust is the decline in investment in new machines and technology. The level of capacity utilization has been tantalizingly close to levels considered ideal (between 80% and 85%), but they have been stuck in the upper 70s for over a year now. That has been an inhibiting factor as far as growth is concerned. To top it all off, there is the fact that business inventories are far higher than they should be. Many companies started accumulating excess inventory earlier in the year as a hedge against the impact of the tariff and trade war. Now they are saddled with too much of that inventory as the tariffs have been exceedingly uneven and unpredictable.
Analysis: The bright spot has been the consumer. Nobody is quite sure how long the sector will continue to hold the economy up. It has been repeated ad nauseum, but it still remains significant that the U.S. economy is over 80% dependent on consumers. Their mood, and most importantly their actions, will drive the pace of growth. For the last several months, they have been active with retail sales growing for five of the last six months. The data released yesterday added to that string. At the same time, there has been consistent optimism coming from the confidence surveys. Another one will be released this week from the University of Michigan,
The mood of the consumer is a very changeable one, it has never taken much to make people uneasy. In past years, the price of gas was a major factor as it only took a few cents to alter people's moods. The rise in the price per gallon of just five or 10 cents would cause considerable angst and send consumers into full retreat, while a drop of five to 10 cents would spur all kinds of additional spending. These days, the biggest motivator for consumer mood remains the rate of unemployment, but there are other factors as well—everything from the stock market to concerns regarding trade. The warning has been sounded all year when it comes to the trade and tariff wars. The consumer keeps being told that prices are going to surge, but thus far, they haven't and many have started to discount the warnings. The fact is that many of the companies dealing with the tariffs have elected to swallow the price hike. They are more worried about loss of market share so they are not passing the costs on to their consumers—at least not yet. There will come a point when they can no longer absorb the additional costs. That is the point at which consumers will face the costs of the trade war.
The jobs motivator is still very positive, but there are some cracks in this edifice as well. The most important is there have not been wage increases as would be expected with rates this low. The demise of the Phillips Curve has been discussed at length here, but it still remains a little baffling. The fact is employment is more puzzling than ever. There are over a million jobs available even if every person seeking work took a job. The jobs that have been filled in the last several months have generally been lower-paid jobs even though high-paid jobs are on offer. There is a severe disconnect between the skills people have and the skills needed. Companies are hiring people who are not qualified in hopes they can be trained, but that process damages productivity as the workers are not contributing fully while they are in training and the experienced workers are not working at full potential either as they are distracted by having to train.
Second Quarter Projections Improving
The data coming in has been more encouraging than had been expected, but there is still consensus that numbers in Q2 will not be as robust as they were in the first quarter. The good news is many are now expecting numbers to avoid the dismal readings that seemed likely as the first quarter came to an end. The predictions had been as low as 1.5% to 1.8%, but now the majority of estimates are tracking between 2% and 2.2%. This is still down from the 3.1% notched in Q1, but more consistent with the longer-term trends of the last couple of decades.
Analysis: The factors that led to this improved outlook include the better than expected level of retail activity and a bigger improvement in manufacturing activity than had been anticipated. Retail sales were up 0.4%. That was driven by a variety of sectors—most notably entertainment spending, but there were also better numbers in the home improvement sector. The wet spring and cooler temperatures played a role and so did the lower than usual gas prices. Sectors that had been expected to fall off—such as automotive—held their own and there was more spent on dining than had been expected. Consumers have been expressing some angst regarding the future, but for now, they trust that jobs will remain stable and the issues they thought would play a role have not been that big a deal. There is still worry about trade, but the threats are still seen as future issues. Many are now skeptical that inflation will be much of a concern anytime soon.
Subtle Differences—Adventures in Customer Service
It is often the little things and the small gestures that mean the most. Just today, I was trying to execute a transaction that was a little out of the norm and had both good and not so good responses. I was trying to pick up a new laptop obtained with reward points from a credit card company. The transaction called for me to pick up the machine at a retailer. An email was sent with instructions to bring that message with me. I did so and went to customer service as my starting point. It seems that the credit card company failed to put all the needed information in the email and they couldn't find me. The kid behind the counter said, "you obviously bought the thing so it has to be in here somewhere—give me a minute and I will track it down some other way." A few minutes later he announced all was well and I could go to store pickup to get it. I duly did so. That clerk looked at the paper and looked at his screen and announced, "You are not in here. I can't help you," as he turned to the next guy in line.
Excuse me kid—I just confirmed that I was in the system with the guy across the store. "Well, that's great, but I don't see you." I asked for a manager and asked him to talk to the first clerk. He comes back and asks the second clerk if he looked the transaction up by my name. "No—I didn't have it by his phone number." Another day, another moron. The first guy assumed the problem was with his system and corrected and the second guy was (and remains) an idiot that likely alienates 75% of the customers with whom he interacts. And this store wonders why its sales are falling. I can give them a clue as far as next steps. Promote the first guy and fire the other one so fast it makes his head spin.
Number of Tariff Investigations, Obama vs. Trump
There is a perception that Trump is the tariff man. There is not much truth in this assessment. Actually, Trump was active in terms of tariff activity in 2017, but fell off the pace in 2018—Obama was more aggressive in 2013 and 2015 and very close to the Trump pace in 2014 and 2016. The factor that has mattered most is that China has been flaunting global trade rules since 2013. These actions triggered a great deal of U.S. response—regardless of who was in the White House.