Strategic Global Intelligence Brief for March 13, 2018
Short Items of Interest—U.S. Economy
Conference Board Indicators Rise
From time to time, I think we have mentioned that gauging the level of employment is always tricky. This is, at best, a moving target; people somehow refuse to be easily categorized. The Conference Board has put together a more complex index that tries to look at multiple factors to get a better idea what is happening with overall employment trends. The latest version is up over last month—107.74 vs. 106.30. In the release, it was noted that data shows an improving labor market—not the static one that would appear from just the government data. Six of the eight measures trended positive. The result has been a far tighter labor market than many have assumed.
Is Labor Market Going to Force Inflation Reaction?
As the labor market gets tighter, there are all kinds of questions regarding what this means to the economy, but few concerns are greater than what all this will mean to Federal Reserve decisions. In short, does this market mean higher interest rates? The short answer is that it will depend on wage inflation. Thus far, the low rate of unemployment has not pushed wages up that much. In fact, the rise last month was less than the month prior. Unless and until the wages go up, the Fed is not likely to hike rates. There are those strongly suggesting the Fed avoid hiking rates at all this year unless inflation hits at least 2.5% at the core. This is not the message the Fed has been sending, but they have made it clear they are watching these wage rates closely.
U.S. Wants $100 billion in Imports to China
When Liu He, China's top economic adviser, visited the U.S., he asked for a plan. The U.S. wanted to reduce the size of the trade deficit with China. So, how does the U.S. want that to take place? Most of the conversation has revolved around cutting exports from China, but there is also the possibility of hiking the level of exports from the U.S. to China. The emphasis will be on China buying more farm output, more airplanes and more general machinery. China has made some offers as regards investment, but has not talked much about buying more from the U.S. This $100 billion would be roughly a third of the trade deficit notched last year.
Short Items of Interest—Global Economy
OECD Sounds Warning on Tariff Backlash
The imposition of tariffs on steel and aluminum will have a deleterious impact on some 30,000 companies in the U.S. that use these metals. The worst is yet to come as other nations will not sit idly by and watch their economies suffer from the trade barriers. They will impose their own tariffs and barriers. The U.S. has promised to retaliate with even more barriers. This is not going to be good for the U.S. either given that trade accounts for over 15% of the national GDP. The Organization for Economic Cooperation and Development (OECD) now asserts this will mean a significant decline in the rate of global growth.
Who Is the Real AMLO?
Depending on who one talks to, the front runner in the Mexican elections, Andrés Manuel López Obrador (AMLO), is either a committed populist who seeks to overthrow the corrupt status quo in Mexico, or he is a shrewd and canny politician who sees a path to the presidency through pulling a "Lula." Just as the former Brazilian president (Luiz Inácio Lula da Silva), AMLO has begun to sound a moderate tone while still staying connected to his populist origins. He wants to appear less "scary" to the moderates. He seems to be making progress against a very weak set of challengers. He would win the election easily if the polls were held today.
Slovakian Government on Edge of Collapse
The assassination of a young journalist and his fiancé has sparked a major protest in the country. The government is teetering on the edge of collapse as the members of the junior members of the coalition have pulled out. The system has been corrupt for years and tolerance seems at an end now that the thugs have stepped up their activity to murder. The streets are full of tens of thousands of angry protestors. Nothing thus far has been able to calm them down.
What We See in the Indices of Indices
Analysis: There has been a lot going on as far as the economy is concerned. Not that there is ever a time when everything is predictable and calm, but this year has been more volatile than usual—especially of late. We had the big tax cuts at the start of the year and are still waiting for the projected impact. We have seen the return of stock market volatility in part due to the tax changes as there is now a real concern regarding an outbreak of inflation and the Fed's subsequent reaction. Now, we have steel and aluminum tariffs, but still don't quite know who will and will not be affected. The consumer should have reacted strongly to the tax cuts, but they seem to be waiting for those wage hikes they were told to expect.
This month, the index readings split neatly down the middle with five trending in a positive direction and six trending in a negative direction. Some of the movement was slight but significant nonetheless. Among the stronger growth indicators was the new automobile and light truck sales category as it came back after a major decline. The good news is that there has been a recovery, but the bad news is that the pace of selling has been off from what it was through the year. The better news was found in the new home starts data as there was a really appreciable surge taking these readings back to what they were through most of the year. Steel consumption went up slightly, but this is likely to be the calm before the storm as the drama of the steel tariff discussion had not occurred yet. The expectation is that consumption will rise sharply in the short term as buyers try to beat the price hikes, but by the summer months, expect a decline in consumption.
Durable goods shipments were generally up (but just barely). This was in contrast with the decline in factory orders. The surge for durables is attributed to the activity in the industrial machinery sector. There is a lot of anticipatory buying of late (although this slowed a bit this month). The interest in technology and robotics continues to expand. That added to these positive durable goods numbers. There was also positive movement in the Credit Managers' Index (CMI). This also marked the second month in a row for CMI growth. These days that qualifies as a trend.
The negatives are not trending in an awful direction, but there are concerns. The slip in industrial capacity utilization is not huge, but there had been hope that it would keep trending in a generally positive direction and get close to the ideal level between 80% and 85%. The fact that capacity numbers went down is related to the big drop in capital expenditure that always seems to take place at the end of the year. Those tax breaks start to expire and companies make the decision to purchase whether they need to or not. They hope the added capacity will be needed at some point, but in the meantime, they have too much on hand. The prices of metals slipped a little this month as well, but that is also likely to be temporary. The demand for aluminum is still high. The U.S. is just starting to understand that it is going to be dependent on other nations regardless of the tariff—the U.S. doesn't have its own bauxite, which is needed in aluminum.
The Purchasing Managers' Index (PMI) New Orders index fell a little, but given the lofty position held last month, that rise is nearly guaranteed. The fact that the numbers are in the mid-60s is the important point, as anything over 50 is a strong signal of expansion. The overall CMI index is also as high as it has been in years even with a small dip this month. The slip in factory orders was a bit confusing given the rise in durable goods activity, but the downward shift is likely due to consumers that are still not motivated to spend as aggressively as expected. The tax cut boost was nice, but wages are languishing. The transportation index has remained high, but slipped a bit. The issue in transportation is capacity. There is not enough to meet current demand—not enough drivers and not enough trucks and trailers. Yields are up simply because shippers have to pay what the trucking companies demand.
New Automobile/Light Truck Sales
Sales are not back to what they were earlier in the year or even what they were last year, but at least the downward trend has halted to a degree. That bodes well for the coming year if a variety of positive factors hold. The question at this point is whether these can be counted upon. There are mixed opinions. On the positive side, there is the renewed sense of consumer confidence that has been chronicled lately. The consumer also has a little more money to spend on things like cars due to the tax cuts. Also, the latest assessment of household wealth is the highest it has ever been due to the growth in the stock market and the rise in the price of homes. The negatives include the fact that wages are still not going up that much. That leaves the consumer's pocketbook a little light. The wealth effect is important, but this is not necessarily liquid assets available to splash out on a car. The other issue is the impact of the tariffs on imported steel, which will likely manifest soon. The automakers will try to force their suppliers to eat the extra costs, but the sense is that car prices may shift up a little anyway. Thus far, the confidence of the consumer is not reflected in additional retail activity—for cars or much of anything else.
The factory orders numbers were expected to rise—not fall. This is supposedly the consumer-driven activity. The tax windfall was supposed to drive the consumer to the store to buy new and shiny things. Some of that took place, but it has not been as robust as had been assumed. The consumer seems to be saving and deleveraging as much as they are planning to spend additionally. The factory sector has been more responsive to the threat of import restrictions, but these have not been manifesting as was expected earlier in the year.
New Home Starts
The news in the housing sector is very good right now. That is in the face of those headwinds referenced all year. The consumer is shrugging off the higher price of homes as well as the bigger down payments and there has been buying at a variety of levels—from the starter home to the much more expensive "McMansion." The fastest-growing segment is still the multi-family home for which there are still major shortages. The recovery this month, after a down period the month before, is somewhat related to the weather, but not as much as would have been assumed this time of year. There is evidence that housing activity is surging in the jobs data as well—over 60,000 jobs added in construction this month. The majority of these are in the housing sector as there has not been a huge recovery in either commercial construction or in public sector activity.
Down the road, there is concern that interest rate hikes and hikes in the long-term bonds will spill over into mortgage rates. That is expected to put a damper on growth in this sector by the end of the year. A lot is now riding on the decisions the Fed makes regarding interest rates and inflation. The mood seems more hawkish than not. The betting is that interest rates will go up at least three times this year, but a fourth hike is not out of the question.
To note that the steel sector is going to be very interesting in the next several months would be a major understatement. By now, you have been watching the ever-changing story of the steel tariffs closely. The actual arrangement remains unknown as the statements are altered on a daily basis. First, there was to be a universal imposition of tariffs on all steel imported into the U.S. despite the fact that previous statements had suggested the U.S. was only really interested in Chinese exports. Then, it was announced that Canada and Mexico would be exempt (and they account for about 30% of the steel imported to the U.S.). After that, it was suggested that other exemptions would be considered if other nations showed they were "real friends" to the U.S. At this writing, the Europeans and Japanese are at the negotiating table seeking those exemptions. It is expected that South Korea, Russia and Turkey will not be far behind. What will it mean if everybody gets an exemption except China? It will mean that around 4% of imports to the U.S. will be blocked. That will not change the dynamic very much.
The expectation is that steel prices will go up due to the tariffs and due to the capacity issues that will result almost instantly. The U.S. steel sector has not come close to supplying the existing need for steel in the U.S. It is estimated that it would take close to five years to build that capacity—assuming that steel makers were willing to go all out to expand. They will not as they know this decision can be reversed in a heartbeat as Bush's tariff in 2002 was.
Industrial Capacity Utilization
After rising steadily for several months, the level of capacity utilization trailed off a little. Granted, the decline was a measly .5%, but it was the upward trend that had everybody excited for a while. So far, the rate has not been able to break past the 80% that signals the bottom end of normal. The problem this time may be that many companies have been adding capacity in anticipation of more activity later in the year. This new capacity is not yet being employed—that may have dropped the percentage down a little. There is also the fact that capacity issues remain in some of the sectors that grew fast in the last upturn. They still have capability that is not being put to very good use and may not unless the economy resumes its 3% growth pace.
PMI New Orders
The decline in the PMI New Orders Index was certainly significant, but not as much as it would appear. The drop from the very lofty position held the month before was to be expected. Even with that decline, the index is close to 65—very healthy indeed. The actual PMI is also higher than it has been in years, but not quite in this exalted region. The jump in the new orders gauge was likely connected to some degree to the enthusiasm that greeted the tax cut, but since then, there has been a realization that consumers are not ready to start over-spending. The tax cut was nice and all, but the real issue has been that wages are not going up at the pace expected. That has limited the activity of the consumer as well as the businesses that had planned to start selling big. Manufacturers are seeing gains in some important sectors such as energy, but the tariff impact worries those that use steel (and that included about 30,000 companies), while the aerospace sector worries about the costs of aluminum.
This is a term that gets tossed around a lot and likely has lost much of its meaning in the process. There are those events that change one's life for the better, but far more that make life change for the worse. I have been thinking about both my father and father-in-law of late and it has saddened me. I was far younger when they died—barely into my 30s. I thought I understood what they were both going through, but I had no clue. Both men suffered very serious heart attacks and both men eventually died from these. In the years after the first of these attacks, their lives altered drastically. My wife's father was an avid gardener. Suddenly he had no strength to do this anymore. He was a big and powerful man and was reduced to sitting in his chair. My father could not concentrate like he was accustomed to and couldn't do his math problems anymore. He too was reduced to sitting.
I have had a tiny exposure to this feeling with the chemo treatments. I am far weaker than usual and seem to need a lot of sleep. I am eager to get outside as well, but can't right now. In a few weeks, this passes and I am back to normal, but I see people at the clinic who are not going to get better and my heart breaks. I have made a promise to myself that when this is all over I will pay attention to those around me who have had that "life changing" experience. Not sure what I can do for them yet, but I plan to try.