Strategic Global Intelligence Brief for May 16, 2018
Short Items of Interest—U.S. Economy
Industrial Production Levels Rise Again
The 0.7% rise in industrial output marks the third month in a row for gains. This indicates a broadly healthy industrial market. The industries that are included in this measure range from mining to manufacturing, as well as the utilities. Over the course of the last years, there has been a 3.5% increase. That stands in marked contrast to the pace set in the previous five to seven years. The laggard had been the mining sector, but with higher per barrel oil prices, the energy sector has started to come alive again. The data coming from other indicators has reinforced this growth—capacity utilization is now at 78%, the highest in several years. It is now just a little short of what would be considered the bottom end of normal.
Housing Starts Down a Little
It may be a little premature, but it seems that the bloom may be coming off the multi-family rose. For the last few years, it has been the apartment and condo demand that had been driving new home starts. This month, that pace slowed and there was not an increase in single-family construction sufficient to offset it. There are still many communities that have an acute housing shortage, but fewer than there once were. Now, some cities and regions have a surplus. Thus far, these surplus communities are not driving prices for ownership or rent down by much on a national basis, but some regions are becoming real bargains.
CFIUS Reforms Dialed Back
One of the ongoing issues between China and the U.S. is technology transfer and protection of intellectual property. There is a concern that China is attempting to acquire U.S. technology at any cost and is willing to bend and break rules to do so. There was an attempt to expand the mandate of the Committee on Foreign Investment in the U.S. (CFIUS) to address not only inbound activity, but outbound as well. Many large U.S. companies lobbied hard against the expansion. It appears they made their point. The bureaucracy of CFIUS was likely to have been overwhelmed. It was asserted that U.S. companies would be at a competitive disadvantage if everything they did was subject to this kind of scrutiny.
Short Items of Interest—Global Economy
Who Is Responsible for Gaza Violence?
As is very often the case, there are radically different interpretations of the incident in the Palestinian area of the Gaza strip. The Israeli Defense Forces assert the provocation came from Hamas and that Israel was defending its borders from organized insurgents. The claim is that those killed (65+) were either terrorists or sympathizers that rallied around the attack. The Palestinians assert that very few had ties to Hamas and point to the eight-month old baby that was killed in the attack. The truth, as always, lies somewhere in between as the protests were clearly organized by Hamas. But just as clearly, many were caught in the wrong place at the wrong time. The focus of the protest was the decision by the U.S. to move its embassy to Jerusalem—a city that is still theoretically contested by both Israelis and Palestinians.
Zimbabwe Gets Access to Loans Again
For over 20 years, there has been no lending activity between the U.K. and Zimbabwe—a decision based on the U.K.'s relationship with the dictator that ran that nation for decades. With the ouster of Robert Mugabe, the country is slowly returning to some semblance of normalcy. Part of that means Zimbabwe having access to loans and investment from the U.K. and other western states.
Factory Jobs Expand in Emerging Markets
There has been a decline in the number of manufacturing jobs in the developed world, but in the emerging markets, these jobs are growing in popularity as more of these nations emulate China and India to develop their own manufacturing base. The fact is that China is no longer the low-cost option when it comes to global manufacturing.
What a Shock. North Korea May Back Out
The rhetoric coming from Pyongyang is certainly familiar and doesn't really surprise anyone who has been observing the Hermit Kingdom for any length of time. It looks like Kim Jong-un is preparing to ditch this much anticipated meeting with Trump. The first sign of trouble was the North Korean decision to break off talks with the South Koreans over the decision to go ahead with joint exercises with the U.S. military. These take place every year. They are designed to coordinate the activities of the two military establishments, but they also send a signal to the North Koreans that the U.S. is firmly behind its ally. The North Koreans dislike these activities and had called for them to be cancelled. That was supposed to be one of the points to be discussed at the summit meeting. Next, were the comments from Kim asserting the U.S. is bullying North Korea on the issue of nuclear weapons and is demanding the unilateral elimination of the weapons. This was also something that was supposed to be part of the negotiations. Kim is now threatening to pull out of the talks altogether.
Analysis: Anybody who has had even a casual interest in North Korea can't be the least surprised by this shift in attitude. There have been such overtures from Pyongyang in the past—during both the Clinton and Bush terms. In both these cases, the North Koreans pulled out in a flurry of denunciations and threats. The same pattern will be seen this time as Kim Jong-un will lay the blame for the failed talks on the U.S. and South Korea. It is very doubtful there was ever the slightest intent to attend this summit as Kim had already achieved what he wanted. He has been recognized as a player in the region and was being treated as an equal by the U.S. and other nations. The real question is what happens now. There are three scenarios in play at the moment.
The first is that North Korea doubles down on its weapons development programs as they claim the U.S. was being duplicitous and only wanted to stage a sneak attack on Kim. This would mean more missile firings, more nuclear tests and likely more buildup of conventional forces. The U.S. and South Korea would then have to decide how to respond. Would there be more and stricter sanctions? Is a military strike possible? Much will depend on how Trump chooses to respond. If he dismisses this as the games of a tyrant, there is no urgent need to respond. If this is taken as a deliberate attempt to embarrass or humiliate Trump, the possibility of hostile action goes up.
The second scenario holds that attempts will be made to bring Kim back to the table with some combination of threats and promises. This seems to be the strategy the South Koreans are most interested in, but this requires the U.S. to engage in a tricky diplomatic maneuver with a tyrant who has no reason to make things easy on the U.S. or Trump. This will be hard for Trump to swallow as Kim has proven to be a master manipulator. On the other hand, Trump has staked a lot of his reputation as a dealmaker on this meeting. He may be highly motivated to make sure it occurs.
The third scenario is perhaps the least likely. This holds that China gets seriously engaged and forces Kim back to the table. China has indicated that it has grown weary of the antics of the Kim regime. There have been reports suggesting China had been pushing hard for these meetings. They might elect to push even harder and make it clear to Kim that he has run out of options
Reversal in Japan
Economic growth in Japan for the first quarter of this year contracted by 0.6%. This marks the first economic decline in Japan since 2015. This was not what was expected as Japan had been notching some pretty good quarters as recently as last year. The problem has been mostly the Japanese consumer, but there have been issues with exports as well. Consumers are always vexing in Japan as they maintain a cautious attitude when there is any sign of economic stress. Efforts to get them to spend are generally not all that successful and the latest schemes have been less than effective,
Analysis: This is not the news that Shinzo Abe wanted to hear at this point. It is also not enough to cause real panic even as this brings to an end a run of eight consecutive quarters of growth. There is no real sign of an impending recession as all the other indicators are strong and pointing to at least modest growth. The level of unemployment is at a near-record low. The consumer has money and little debt if they should ever decide to spend some of that accumulated savings. The export sector has been doing relatively well, but the drop-off in Chinese business has not been offset by more sales to the U.S. There is concern that U.S. trade policies will negatively impact the importation of key manufactured items. That has made business much more uneasy. The yen has also been getting stronger as investors try to hedge their positions.
Fed Indicates Inflation Risks Are Rising
The latest reports from a pair of regional Fed banks lend even more credence to the notion that inflation is building. It is time for the Fed to shift its full attention to this development. The New York Fed released its latest version of the Consumer Expectations Survey. It suggests that consumers now expect inflation to be at 3% or even higher in the year ahead. The expectation as regards inflation is an important determinant as far as policy is concerned. To this point, the consumer has not been convinced the rates were going to go up to this level and stay there. The Fed has been trying to get the inflation rate to at least 2% for the better part of a decade. Only recently, it saw numbers where it would like them to be. A little inflation is seen as grease to the wheels of productivity because it suggests that producers can charge a little more for their output. Without these modest price hikes, there is no expansion, no additional hiring, no new equipment purchases and so on. The challenge for any business is to know how much is too much. If prices go up too far and/or too fast, the consumer is put off and refuses to buy. Seeing the consumer assume that inflation will be at 3% suggests they are prepared to see prices come up a bit. There will be complaints of course, but not enough to dissuade people from buying what they want. If the inflation hike stimulates some additional wage growth, there stands to be even more spending.
Analysis: The other Fed report on inflation comes from the Cleveland Fed. Its model is designed to measure long-term inflation expectations. The data showed a reading of 2.09% as the expectation for inflation over the next decade. This is the highest level reached since January of 2010 and higher than the reading a few weeks ago when it was at 1.98%. It is an average of inflation over a 10-year period and will include the usual ups and downs that occur over the course of the year. All of this provides ample ammunition for those at the Fed that want the focus to shift to its traditional role of controlling inflation as opposed to being the prime mover as far as stimulation is concerned.
The consumer is always a little perplexed when the Fed (or any central bank) talks about inflation. The rate that matters to the Fed is the core rate. This measure deliberately excludes the price of food and fuel. That seems more than a little odd given that these are the two items that make up the bulk of the household budget. When these factors are considered, the rate of inflation is referred to as the "real" rate or the "headline" rate. The reason these factors are excluded from core is that they are highly volatile categories that can move dramatically from one week to the next. This volatility makes it very hard to do year-over-year assessments. Even month-over-month can be tricky. It is also assumed that rising prices in food and fuel will soon show up in other prices. Airfares will rise and so will freight charges as gasoline and other fuels rise in price. The costs of restaurant meals will also rise as food prices hike.
What will it mean for the Fed to turn its attention to inflation? The first and most direct impact is the withdrawal from the stimulating process that began at the time of the recession. The fiscal side of the equation has been nowhere to be found until earlier this year when the tax cuts were finally passed—a move that should have been made three or four years ago. The Fed has been going it alone with every tool it could think of. There were low interest rates of course, but also the massive investment in government bonds as well as mortgage-backed securities. The reserve ratio was lowered and banks received less interest on the money they had stored at the bank. In short, anything was tried to get more cash into circulation. Those days are now over. The Fed is focused on hiking rates back to a point that would be considered more normal—maybe between 3% and 5%. At the moment, the Fed is gunning for two more quarter-point hikes this year. That would bring the rate to 2.25% (it is 1.75% now). To get rates to 3% would involve three more hikes in 2019 and late 2018.
Consumers Unphased?
It seems that there is nothing left for the economist to believe in these days. First, we have to contend with the fact that the Phillips Curve is not working as expected (low unemployment has yet to trigger wage inflation). Now, we are watching a consumer ignore the price hikes in gasoline. That was once a sure thing. If the price at the pump changed, it was enough to alter the consumer confidence numbers. A hike made people suddenly abandon travel plans and look towards trading the SUV for a moped. This year, we have seen a sharp hike and consumers are shrugging it off. They are still spending at a decent clip and there is no evidence they are planning to curtail their driving vacations this summer. That attitude may change if the price at the pump creeps into the upper reaches of $3.50 to $3.75 a gallon nationwide, but many parts of the country are paying that already.
Analysis: There are some signs that oil prices are stabilizing already. That would seem to preclude the possibility of sharp hikes over the summer. The producers that had been waiting to see higher prices before jumping back in are now reacting to these higher per barrel levels. At the same time, there has been a relaxation of production restrictions within OPEC as the price hike has gone about as high as these states are really comfortable with. The higher prices have discouraged additional consumption by some, which did reduce demand a bit. The expectation is that oil prices will not reach up into the $90 range unless there is some additional geopolitical issue or some other event that would affect the production of oil.
The consumer is also a fickle creature and can easily revert to those old cautious ways in a heartbeat. Right now, there is a sense that many are not as worried about the price of gas as they are still reacting to the tax cut.
The World From a Few Thousand Feet
So, yesterday I got my second opportunity to fly in that small plane with Jim Conn. I was equally as captivated as before. It is amazing to see the country from that altitude—it provides a lot of perspective. We flew over farm country and it was quite amazing to see just how much of this nation is devoted to growing things. Granted, one can see those patterns when flying in the big jets, but the detail is missed. The farmers were out in force as they made up for lost time. Minnesota had a very cold winter and lots of snow, so farming was delayed by quite a bit.
The small towns are fascinating as one wonders why they came to be and why they still exist. Minnesota is called the land of 10,000 lakes for a reason! As we flew over them, it was amazing to see how many people live along those shores— enjoying the water. There were huge homes and those of far more modest size. It was simply a perspective one rarely gets. It clarifies the ideas we have about what makes us who and what we are.
I have decided that I can get used to this kind of travel. Now all I have to do is convince those that arrange to bring me to town that they should provide me with pilot and plane or pay for my own flying lessons and my own plane!
