Strategic Global Intelligence Brief for May 21, 2018
Short Items of Interest—U.S. Economy
Inflation Difference
It seems that the death of the Philips Curve may have been announced prematurely. This was one of those economic laws that actually worked most of the time. Simply stated, it held that when the unemployment rate fell, there would be wage inflation. It seemed to make intuitive sense that when there were fewer people available to hire, they would become more expensive. This fueled inflation; only over the last few years, it hasn't. The consumer has been protected from these higher costs with a panoply of cheaper options as many businesses shifted from domestic production to imports and employed robotics and machines instead of people. The inflation threat has been subdued in the goods arena, but not in services. This is where there has been strong evidence of mounting inflation, and for a simple reason—service activity can't be imported and it can't be done by machines for the most part.
"Good Cop—Bad Cop"
It seems that the administration is either deeply divided and has chosen to fight it out in public, or there is an attempt to keep rivals at bay with mixed messages. The trade talks with China either went fairly well, or they were a complete waste of time. The tariff and trade war threats have either been shelved for the time being, or they are still on track. It all depends on whether one is listening to Treasury Secretary Steve Mnuchin or Trade Representative Robert Lighthizer. In all likelihood, they are both correct to a point. The talks are ongoing and China is expected to make more concessions, but for the moment, it has been deemed appropriate to call off the dogs—at least temporarily.
Housing Sector Recovery Skews Older and Richer
The U.S. housing sector has largely rebounded from the crisis that triggered the recession. That recovery has been more or less nationwide. Home prices are way up, there are far fewer underwater mortgages and the development of communities has resumed. The one big change is that this sector is not as balanced as it once was. The majority of those that are buying single-family homes are richer and older than once was the case. The young are still living in multi-family units. Some of this is still by choice, but economics has played a huge role as the young can't afford the high prices, the larger down payments and the steeper mortgage costs.
Short Items of Interest—Global Economy
Maduro Wins and Venezuela Loses
As expected, the tinpot dictator in this shattered nation "won" the election. Given that military and police manned the polls and forced votes for Maduro, this comes as no shock. There is no hope whatsoever for the people of Venezuela as long as this utterly corrupt and incompetent regime remains in power. Inflation is at an all-time high, unemployment is estimated at 75% and almost 80% of the country lives in poverty. Crime is rampant as that is the only way to survive and feed one's family. Even China has walked away from this nation since they have lost the ability to produce oil.
Italy to Get a Novice Prime Minister
The wave of populist newbies has continued with the Italians. The pattern has been that the populists will shun the experienced politician in favor of somebody new and untried. The U.S. elected Trump, France staggered away from Le Pen, but put in Macron despite his lack of experience. Now, Italy will have Giuseppe Conte. He is an obscure professor of public administration and law who has never held a single political post. He seems to be a compromise candidate between the two insurgent parties.
Farmers Rally
It is not certain that the Chinese and U.S. will be able to work this out, but even the hint that a trade war may be put off has been enough for grain and soybean prices to rally. The expectation is that China will not be imposing stiff tariffs on these exports from the U.S. That is music to the ears of the farm community given their dependence on that Chinese market. They also know everything could change again at a moment's notice.
Trade War "On Hold"
For some, this was the announcement that had been expected all along. For others, it came as a shock. After two days of intense discussions between delegations from the U.S. and China, it had seemed that progress had been minimal, but on the other hand, there had been some interaction suggesting that there was an opportunity to make progress. China had refused to give in to the U.S. demand that it buy some $200 billion worth of goods and services from the U.S. in order to deal with the trade deficit, but there had been statements that they would "try" to bolster that import market. The Chinese further backed down on the restrictions on sorghum exports and other farm goods. These have not been earth-shattering concessions, but have apparently been enough for the U.S. to postpone the trade war. The announcement by Treasury Secretary Mnuchin was terse and to the point. It was indicated there was a long way to go in terms of these trade talks, but it was not deemed necessary to escalate the conflict at this point.
Analysis: What to make of this? There are basically two schools of thought as regards President Trump's approach to trade. Based on this latest development, one of those theories seems to have more legitimacy than the other. From the start of his campaigning in 2016, he asserted that he was no politician or diplomat—he was a business person and most of all a "dealmaker." Given the kind of business he has been engaged in throughout his career, there is an identifiable pattern that is based on constant flexibility. It means being able to walk away from any deal at any moment if it doesn't meet the goals. It means essentially playing "chicken"—seeing how far one can push a rival to see where they will and will not compromise and who wants the deal more. In case after case, Trump has staked out an extreme position to see what the other side will do and what they are willing to negotiate. In every case, the original demands have been dropped and some kind of new deal was cut—even if it meant completely abandoning the original position. The much-ballyhooed steel tariffs have essentially been abandoned as nearly every nation that sells steel to the U.S. has now been granted exemptions. As of this weekend, that list now includes China—the ostensible target for the U.S. tariff policy in the first place. The tariffs can be seen in this context as a bargaining chip—a way to get something else from these nations.
The alternate theory as regards Trump's tactics was that he has been pandering to his base. The steel tariffs and the threat to impose billions of dollars of tariffs on the Chinese, altering or abandoning NAFTA, backing away from the Iran deal and many other decisions were all made as a way to keep the faith with his core supporters. They are generally seen as virulently anti-trade, isolationist, suspicious of immigrants and foreigners in general, populist in their economic positioning. The reason this explanation for President Trump's actions has been fading is that he rarely follows through on this rhetoric. The tariffs were weakened right away, China is at least temporarily off the hook, NAFTA still exists and so on. These are not policies set in stone by any stretch.
The fact is that all of these restrictions, tariffs and barriers can be thrown up tomorrow if the "deal" doesn't meet expectations. China has moved some ways to where the U.S. wanted it, but is that far enough? NAFTA has seen some compromise by both Mexico and Canada, but has there been enough? What does the U.S. want from the nations with which it does business? The challenge for this "dealmakers" approach is that it clashes with the way that diplomacy and global agreements are made. Deals in business are between a few people who are clearly in charge. That is not what happens between governments and the myriad of constituencies that a politician has to consider.
Tough German Stance on Migrants
The German government was not remotely prepared for the migrant onslaught of a few years ago. It can be critiqued as the height of naiveté, but the expectation had been that a few thousand middle class and generally educated Syrians would make it to Europe—not the millions of people from all over the Middle East and Africa. Germans are not in a welcoming mood these days; the policies are getting tougher all the time. The refugees will now be confined to refugee camps outside select cities and detained there until their claims for asylum can be evaluated. Tens of thousands have already been living in these conditions for over a year. Thousands have been returned home once their applications have been rejected.
Analysis: German patience and generosity has been exhausted. There is no longer a desire to offer assistance. It has become Merkel's greatest political albatross, while her own party has led the way towards a more draconian response.
Real Headwinds Now
For most of the last two years, there has been a segment of the housing sector sounding a note of caution. They have not been listened to for the most part—consigned to the role of Chicken Little suggesting the sky was falling when clearly the housing market was continuing to boom. They watched some of the future indicators and asserted that at some point this would all catch up and take the housing market back to slower growth. They looked at the steadily increasing price of homes and the lack of opportunities for the new home buyer. They pointed out that Millennials were not all that eager to buy homes—partly because that was not consistent with their lifestyle and partly because they lacked the resources and opportunities to enter the market. But throughout this litany of headwinds and inhibitions, there was the accompanying fact that mortgage rates had yet to rise. That left room for the homebuyer despite all the other issues. That last barrier to a retreating housing market has started to fall and it looks like the sector really is going to slow down considerably in the months to come.
Analysis: Mortgage rates are now as high as they were in 2011 and are no longer the bargain they have been for close to a decade. All the other inhibitors are still there as well—high-priced homes, reluctant Millennial buyers, shortage of construction labor that keep areas with housing shortages from catching up with demand. The average rate for a 30-year fixed mortgage is now at 4.61%, up from the 4.55% last week. The low point for that 30-year mortgage was 3.31% set in 2012. Even earlier this year, the average rate was at 3.99%. Now rates are starting to really soar. Why is this happening now and so quickly? Will this prove to be an anomaly and temporary before a resumption of the old pace? Most importantly, what does this mean to the overall economy?
There appear to be three factors leading to the rapid rise of the mortgage rates. The first and perhaps the most important is the rise in the yields of long-term bonds, but this is more an effect than a cause. These yields are rising as there is more concern regarding inflation than there has been in a long time. Commodity prices are soaring—everything from oil to industrial metals and lumber. The inflation threat had been building anyway given the relative health of the economy. Then there are the reactions to developments in terms of trade wars and tariffs. Metal prices have risen dramatically due to the tariffs that are scheduled to be deployed against steel and aluminum. The consternation over the future of NAFTA has affected lumber imports from Canada and cement from Mexico. The sense among users of these construction commodities is deep uncertainty. In the face of this, companies get far more cautious.
The second factor is that banks are getting more interested in the mortgage business as rates rise. There is a somewhat unfortunate trade-off when it comes to lending activity and rates. When the rates are low, the banks are very cautious as their profit margins are narrow. As interest rates rise, there is more willingness to take risks. That likely means more loans will get in trouble at some point. This enthusiasm for higher-risk loans is tempered somewhat by the threat of inflation as banks don't want to be paid back with devalued money. They try to cover themselves with higher interest rates.
The one factor that is somewhat more positive is an increase in demand. The older edge of the Millennial generation is getting more interested in that single-family home. They are starting families now and likely have more settled jobs that would allow them to choose a place in which to settle. The pace of Millennial home buying is still considerably less than that of the Gen Xer or the Boomer, but there has been some steady improvement. The challenge is that the Millennial wants to live in select cities. That has driven prices very high and exacerbated the shortage of homes due to shortages of labor, material and financing.
In the grand scheme of things, the issue that matters most is what happens to the overall economy if this driver is not performing as it has in the past. The U.S. economy marks home ownership, building and sales as perhaps the greatest of all economic motivators as this galvanizes so much related consumer activity. The slowdown in this sector could drag as much as 0.5% off economic growth in the coming quarters.
Business Lending Is Up but Competition Is Fierce
The good news for the mid-size banking community is that the rate of commercial lending is up substantially from what it has been. It is up by 3.3% over what it was at this time last year. The bad news for the mid-size bank is there are far more players trying to get a piece of that action and competition has never been more intense. Hedge funds, equity funds, insurance companies, REITS [real estate investment trusts—a company that owns, and in most cases operates, income-producing real estate] and other institutions are getting in the game with looser requirements than banks are able to offer.
Analysis: To some extent, these nonbank lenders are not really competing with the banks as they often go after the debt-laden companies that banks tend to avoid, but they are also going after some of those bigger commercial customers that banks have long counted upon. This is yet another motivation banks offer for reforming the Bank Reform Act. The banks are far more regulated and scrutinized than these other entities. This puts the mid-size bank at a distinct disadvantage. The market they serve can be limited to begin with. Then, they have to watch out for some other organization poaching the best borrowers in that region. There has yet to be the growth in the banking sector that would be expected by the amount of borrowing. This is the main reason for that anomaly. On top of that competitive pressure, banks are worrying about inflation down the road. There continues to be concern over the impact of trade wars and tariffs as these restrictions cascade through the whole economy. The price of steel goes up and so does the price of a farm tractor. That eventually affects the viability of that farm operation.
The Good Old Days
It is not always a good idea to hang with people of one's own age—especially if that age is somewhat advanced. We tend to reinforce each other's notions and opinions and we tend to remember things that may or may not have been the case. In our day, all the kids were polite and adults were wise and responsible. Of course, we know that wasn't true, but one thing stood out in this conversation, especially in light of all the tragic incidents of late. The question was—when did kids get all these privacy rights? How is it that parents have no idea what is going on in the lives of their children? How do parents not know their children are turning suicidal or are drifting towards very dark places? There were several of us discussing our upbringing and the rules of the house. Nothing was off limits to mom and dad—no closed bedroom doors, no secret journals. The phone was in the middle of the house and so was the TV. There was an expectation that parents could inquire about anything and anybody. A lie was going to bring wrath as never seen before.
Today, it seems the kids live separate lives from even earliest childhood. Parents don't know their actions and certainly not their thoughts. That doesn't strike me as right. Kids are not miniature adults—they are unformed and still learning everything. They need constant guidance and intervention. They need to know their every action is subject to scrutiny and they owe an explanation to those that enable their existence. My dad was a quiet man, but if he sensed there was something on my mind, he was relentless and would not let it go until I told him. Knowing that I would always be answerable to him kept me out of a lot of trouble over the years.
To be honest, I do not understand privacy in a relationship—period. On the rare occasions when I have tried to keep something from my wife, it has been an unmitigated disaster. When I am honest and tell her what I am thinking whenever I am thinking it—the outcome is always far better than I would ever have expected. We keep no secrets. I don't know how a relationship survives when there are such secrets.
