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Strategic Global Intelligence Brief for October 5, 2018

Short Items of Interest—U.S. Economy

Can You Say Tight Labor Market?
The unemployment rate has fallen to the lowest point since the days of the Vietnam War. Back in 1969, the rate was very low in part due to all the men who had been drafted into the military, but that is not a factor this time. Even though the number of new hires was down a bit from previous months, there have been no significant sector layoffs. The real struggle now is in finding the appropriate workforce. There is nothing to suggest this is going to get any easier any time soon. There was a slight uptick as far as wages are concerned, but not as much as has been anticipated with a jobless rate this low. The U-3 and U-6 readings are about as good as they have been in decades. That means there are far fewer "discouraged workers" than had been the case earlier. The next piece of data that will provide some insight will be the Job Opportunity and Labor Turnover Survey (JOLTS) as it will show how many people are now willing to quit their jobs and seek greener pastures.

Trade Deficit Widens
Despite all the fulminations from the White House on the subject of trade balance, the U.S. keeps seeing its trade deficit widen. The simple truth is that a good economy in the U.S. will always mean a strong desire for imported goods regardless of what measures are taken to pull that demand back. It is a very simple connection—a consumer-driven economy will react to having more money by spending it and the consumer will look for the best prices that can be found. The U.S. may interrupt the supply chains that engage with China, but these will only be replaced by new supply chains that connect to countries like India and Brazil.

Rate Hike Predictions
The Fed under Chairman Jerome Powell has not been markedly different from what it was under Janet Yellen or Ben Bernanke—at least as far as communication is concerned. The idea was that investors didn't want to go through the histrionics of trying to figure out Fed policy by the width of the chair's briefcase as they did with Alan Greenspan. That said, there remains some wiggle room. The word from Powell has been consistent as far as rate hikes are concerned. He is asserting rates will go up again in December (most likely) and perhaps three more times in 2019. On the other hand, there has been a lot of talk related to how well the economy is doing now and whether it should be cooled a bit.

Short Items of Interest—Global Economy

India Signs Missile Deal With Russia
India has always worked to keep the U.S. and Russia (USSR before that) balanced against one another to some degree. In the Cold War days, the Indians led the so-called non-aligned movement which was just a fancy way of saying they played the two blocs off against one another. Today, the government of Narendra Modi is doing the same thing. The deal with Russia is a reminder to the U.S. that India has options and will continue to keep their domestic priorities in place. The U.S. wants to grow closer to India in the wake of the trade war with China, but India is not interested in being a temporary solution. The U.S. wants India to counterbalance China and Russia, but Russia wants India to counterbalance the U.S. as well as Turkey.

A Correction from Yesterday
Let's hear it for typos. I know we let these escape from time to time, but we try to catch them. Yesterday, we indicated that steel prices had gone up by 4% and we meant to say 40%. In fact, some of the tariff numbers are as high as they have been in decades. The truth is that steel prices have risen by as much as 140% for some product that has very limited distribution. The impact of these price hikes has been significant.

The Bigger Perceived Threat
It has come as a shock to many in Germany that so many Jewish people have flocked to the banner of the AfD (Alternative for Germany). Those who are ignoring the anti-Semitism that runs through the group are far more frightened of a growing Islamic presence in Germany than they are of the group's attitude towards Jews.

The Authoritarian East
The European Union had very high hopes for the nations that had once been part of the old Warsaw Pact. The emergence of this part of Europe from behind the "iron curtain" was the seminal moment of the late 1980s. It was welcomed as a major victory for the principles of democracy and reform. That was 30 years ago and a lot has changed. Today, the nationalists and populists have taken control in Poland, Hungary and now Romania. The governments in these states are best described as authoritarian. They have made it abundantly clear they do not share many of Western Europe's positions.

Analysis: The tension in this region is caused by the fact these nations still need a considerable amount of support from the rest of Europe. They need the aid money and they need the market access membership in the EU grants them. This gives the EU leverage and sets up confrontations. The EU is trying to thwart the autocratic efforts put forward by leaders like Viktor Orbán in Hungary or Jarosław Kaczyński in Poland, while they do their best to ignore the EU orders they dislike.

Elections and Economics
By now, everyone and their brother has heard the phrase—"it's the economy stupid." The story is this was a phrase Bill Clinton's campaign strategist repeated often to the members of the campaign. It was James Carville's way of getting the staff to focus on what usually motivates the non-committed voter. The electorate is generally divided into three groups—the base, the opposition and the uncommitted. There is very little one needs to do with the base other than make sure they vote and there is nothing one can say or do to win over the opposition. As the races come to a close, the focus is on the uncommitted. There are lots of them and they don't vote unless they see a real reason to do so. Hence, there is the strategy of appealing to their economic self-interest. That translates into jobs, economic security, freedom from inflation and the like.

The fact is that presidents have relatively little influence over the performance of the economy and nearly all of that influence is indirect. The responsibility for all taxing and spending decisions is that of Congress. The president can recommend a budget, but it is not binding in any way. The best tool the president has at their disposal is that of the "bully pulpit"—Teddy Roosevelt's description of the ability of a president to get the public on his side demanding that things be in or out of that Congressional budget. The other lever of the economy is control of the monetary system—the value of the currency and the interest rates that will determine everything from bank activity to the credit card rates consumers pay. Nothing moves the housing sector like mortgage rates. It also reacts to the interest rate decisions made by the independent central bank—the Federal Reserve. The president has the power to appoint members of the Board of Governors, but they must then be approved by the Senate. Realistically, the appointments made need to be pre-approved by the financial community unless one wants to risk a financial meltdown.

So—what do the mid-term elections really mean for the U.S. economy? A good starting point for answering this question is to review the adage that elections are all about the economy. Right now, the U.S. economy is arguably in the best shape it has been in for more than a decade. The rate of unemployment is at a nearly 20-year low, growth in the second quarter of the year was at 4.2% and Q3 is expected to be over 3% at a minimum. Inflation threats are visible, but they have not really manifested for most consumers as yet. The poverty rate has shrunk now for three years in a row and wages have started to rise by almost 3% a year. The Fed is feeling confident enough about the economy to start to hike interest rates as a precaution, but they have had the luxury of doing this slowly and methodically. All of this solid economic news would seem to favor the incumbent party in power. That would be the GOP given that they control the House of Representatives, the Senate and the White House. If things are doing so well and the Republicans have been in power as this developed, they should be looking at a very easy set of wins in the November election. However, instead there is consistent talk of a "blue wave" that could put Democrats in control of the House. What happened to the "it's the economy stupid?"

It seems that this assertion only holds true when the economy is not doing all that well and people are starting to worry about their financial future. When jobs are plentiful and growth is solid, the average person now has the opportunity to worry about other things. The consumer confidence surveys have been tracking very positively and show that people are not worried about their jobs now or in the future. They are aware that inflation has become a bigger issue, but it has not affected them so much that it has dampened their enthusiasm to spend. For many consumers, the inflation issue that really galvanizes them is the price of gasoline at the pump. This has not been absurdly high (although it has been rising—up 24% since the start of the year).

The things that worry the economist have not started to worry the consumer. It is clear that steel and aluminum tariffs have driven these metal prices up (by an average of 40%), but this has yet to translate into prices the consumer sees. By next year, it likely will start to show up in everything from automobiles to the costs of construction. The trade war has many analysts deeply concerned, but again this has not hit the consumer yet. The tariffs have really just started. At the moment, the importers have tried to insulate the consumer from the additional costs so that they can hang on to market share. This is not a sustainable strategy, however. By next year, the price hikes will be obvious. Even the higher wages have yet to trigger serious inflation concerns, but that is also temporary. The higher prices that arrive next year will provoke more demands for higher wages. As long as the worker shortage remains an issue, the worker will have the leverage to demand higher pay at some point.

This election is now focused on what has been loosely called the "culture war." The issues are broad and intensely divisive. When it is the economy, there are no differences of opinion as far as the desired outcome—everybody wants the same thing. They want a healthy and robust economy that supports job growth, wage growth and no recession or inflation. The disagreement is over how to get there, but the destination is universal. Not so with cultural issues.

Based on the focus of most campaigns, the issues this time include immigration, gay marriage, abortion, sexual harassment, racism, crime and corruption. There are also issues such as health care and the state of the retirement system, but these have not lit up the emotions of the base like the others have. There is very little common ground to be found as these are all dealt with in terms of a zero-sum game—winners and losers.

Analysis: That the economy has not been the focus doesn't mean that the outcome will not matter. In the very near future, the U.S. will need to start dealing with the impact of higher inflation and there is no clear message from the politicians other than whining about the Fed's decision to start hiking rates as a response. The impact of inflation on those with fixed incomes will be severe.

Learning From Jobs Report
The latest jobs report is out today. Nobody is really expecting anything dramatic to change or alter this month. By the time you read this, the report will have been issued and the headlines will be under review. There are several things to look for when examining the report this time—they may be subtle, but they will still be providing some background on how to interpret the current health of the economy. The basic takeaway is that the job market is very tight. When this happens, it is expected that several economic developments follow, but thus far they haven't and there has been a lot of speculation as to why this would be the case. The most vexing of these is the lack of wage inflation. Not that economists want to see this take place given the impact that wage hikes have on overall inflation numbers, but according to the Phillips Curve, we should be seeing a lot higher wages as employers compete for scarce workers. There are more jobs available than there are people to take them. That should be triggering higher wages to lure workers in. It hasn't as yet. Part of the issue is that business can't find qualified workers and has no desire to overpay those that are not qualified. There is also the issue of expanding use of technology and robotics.

Analysis: One of the things to watch is the impact of Hurricane Florence. In previous years, the storm impact was substantial—especially the ones that hit New York and Houston. These are both heavily populated areas. The process of evacuation was somewhat chaotic as compared to what was experienced in the Carolinas. This will not be a storm that alters the hiring and firing data very much, although some expansion may manifest in future months as the rebuild gets fully underway.

A second aspect of the report to pay attention to is the section on wages. It is not likely that wage growth has increased. It was 2.9% before this report and very few analysts expect it to break the 3% barrier this time. Again, this is more than a little confusing as all the motivations for a wage hike environment are in place. The employers are just not willing to pay more than necessary for people who will require extensive training or who lack the motivation to stick with the company and develop. On the bright side, this shortage of skilled workers has made the hiring environment for college graduates as good as it has been in years.

It is unlikely the overall unemployment rate will go any lower than the 3.9% it registered in August. The rate has been sitting at about 4% for several months now. That seems to be where it is going to stay. There are several reasons that around 4% of the population will be out of work even in the midst of labor shortage. There are people who are transitioning from one job to another voluntarily. Then there are those who are seasonal workers whose transition is a little less voluntary. There are also people who can't move to where the jobs are because they are taking care of family, have child custody issues or simply can't relocate due to the cost of the move itself.

There will be attention paid to the latest data on manufacturing jobs. Over the last 20 years, there has been a profound reduction in the number of manufacturing positions with only a modest rebound in the last few. The reason for this decline has been the advance of technology and robotics as opposed to the notion that all these jobs had been outsourced to countries in Asia, Latin America and Africa. The labor shortage in manufacturing is rooted in the need for more highly trained workers with skills that were not needed even 20 years ago. This labor shortage situation has been affecting many sectors—everything from construction to transportation to health care.

Travel brings out the worst and occasionally the best in people, and certainly within a family. We have all been there as we try to shepherd our progeny to some destination. The kids are either wound up in anticipation or they are in total sulk mode as they accompany the family as opposed to hanging with their friends. However, the vignettes that involve just a couple are often times the most intense.

Last night, I was waiting to board a flight to Philadelphia. The waiting area was chock full of doctors on their way to some meeting. One guy was trying to have a conversation with a colleague, but his wife was constantly interjecting commentary that had nothing to do with the subject at hand—demands that he respond to a kid's text right that instant, remarks about people they all knew that could only be described as nasty and vicious. She ordered him around like a servant. I have no clue what the dynamics of that relationship might be, but he looked to be a very defeated man.

Later, I saw a family of people from South Asia that spanned a few generations. There was the very elderly grandmother, three adult males in their 50s, three teenage girls, two moms and two young kids. The coordination required for all of them to sit together on a Southwest flight was impressive. One of the men was the point person—the one that got early boarding in Business Select. He then had to fend off fellow passengers as he valiantly held four rows while the rest of his relations boarded with the B and C group. It was a well-oiled machine.

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Tuesday, 11 December 2018

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