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Strategic Global Intelligence Brief for September 20, 2019

By Chris Kuehl, Ph.D., NACM Economist

Short Items of Interest—U.S. Economy

Political Divisions Mirror Economic Ones
For decades, the U.S. managed to avoid some of the striation that has long characterized Europe. The majority of the country was more or less on the same page economically, but those days are over, and perhaps permanently. The Democratic Party is dominated by those areas that are most successful economically and have generally higher rates of education and higher wages and salaries. The Republican Party is strongest in the rural areas and working-class neighborhoods where wages are low and economic conditions have worsened. The economic news that emerges daily affects these two sectors very differently—what is good for one is very often bad for the other. It has become very hard to find economic common ground—almost as hard as finding political common ground.

Fed Throws Issue in Trump's Lap
The message from Fed Chair Jerome Powell was subtle in comparison to the angry tweets that Trump launches towards the Fed, but they were pointed and matched the kind of conversation that many central bankers have been having with their own political leaders. If Trump is really worried about the future of the U.S. economy, he should be focused on cooling down the trade war with China and should be focused on getting along better with other U.S. trade partners. This has been the message from other banks as well—the European Central Bank, Bank of England, Bank of Japan and the like—only they are criticizing their own national leaders. The globalization of the economy has been wrenching and uncomfortable for many, but it is not realistic to think there can be a return to the old system.

Intervention in Overnight Markets
For three straight days, the Fed has been required to intervene in the money markets to ensure there was enough liquidity in the overnight markets. Banks have been demanding more than has been on hand and the Fed has had to pour more cash in. The call now is for the Fed to develop a long-term solution so that these emergency measures do not become routine. The idea is for the Fed to establish a long-term facility that can make loans for a week or two—ensuring liquidity for banks that need that infusion.

Short Items of Interest—Global Economy

India's Stimulus Plans
It was only a year or so ago that India was heralded as one of the fastest-growing economies in the world and a nation set to overtake the Chinese in terms of annual growth. Those expectations have been dashed as growth has hit a six-year low. The government has responded with a big corporate tax cut—reducing rates from 30% to 22% and by giving new manufacturers an opportunity to pay just 15%. The aim is to accelerate the process of picking up business as companies decide that China has become too risky. The tax cuts are not aimed at the consumer this time, but are supposed to boost production and business development.

Japan Tightens Investment Criteria
The U.S. is not the only nation that has been worrying about foreign investment and its impact on critical Japanese activity. Japan has new provisions in place that will limit where this investment can be made. Sectors that are considered crucial to national security will be off limits or under far stricter supervision. The nation that has been worrying the Japanese has been China as it appears some Chinese interest has been directed towards sectors important to national security.

Canadian Election in Dead Heat
Current Prime Minister Justin Trudeau is now in a dead heat with the Conservative leader—Andrew Scheer. The latest blow has come as more evidence has surfaced of Trudeau sporting a blackface costume. It has been revealed that he dressed up in this pantomime at least three times as a black man. This has been the kiss of death for a politician who based his platform on political progressivism. The image he has built has taken a hit and his more ardent left-leaning supporters have been defecting to the New Democrats.

A New Cold War?
The relationship between the U.S. and China has never been simple. During World War II, the Communists in China under Mao were allies of the U.S. in the war against Japan. There were many who assumed some kind of alliance would be sustained once the war came to an end. That hope was dashed when the U.S. stood behind its other Chinese allies—the nationalists under Chiang Kai-shek. For decades, the U.S. has stood behind the Taiwanese and opposed any suggestion they go the route of Hong Kong. The Chinese were clear enemies during the Korean War and through the conflict in Vietnam. The Cold War was a simple construct with communists on one side and the free world on the other. The Chinese were lumped in with the Soviets, Cubans, North Vietnamese and others. In the 1980s and 1990s, there was a political shift as communism seemed to be fading away. The collapse of the USSR and the end of the Warsaw Pact seemed to be a vindication for the U.S. and the system of democracy coupled with capitalism. When China began to embrace the global economic system under Deng Xiaoping, the U.S. was convinced that becoming democratic and part of the world order was imminent. Suddenly, China was the new frontier and no longer the pariah. It would take far more space than is available in this piece to detail all the assumptions that have proven to be inaccurate. Suffice it to say that China developed far differently than expected and is today in a very unique position as not quite arch enemy, but far from friend and ally.

Analysis: The trade war between the U.S. and China is ostensibly over economic issues, but the conflict runs far deeper than this for Trump and his supporters. The deficit the U.S. runs with China is a legitimate issue of concern, but the U.S. runs deficits with many nations. This is what happens when one has the most affluent consumers in the world who demand a great deal of product and at a very low price. There is nothing inherently wrong with importing more than one exports as long as the economy thrives anyway. The U.S. does very well as a consumer-driven society. Millions of people have jobs that are tied directly to all that importing. At the same time, the U.S. has lost jobs and business to China and other nations able to produce more cheaply than the U.S. can. That angers those who lost those jobs and businesses. It should be remembered that China (and the other nations) did not force companies to move operations to their countries nor did they force people to buy product made outside the U.S. These were free choices made by American consumers and American companies.

Today, the U.S. and China are intimately intertwined as China sees the U.S. as its major consumer and the U.S. sees China as its major supplier. Despite this connection, the two nations remain at odds over a host of issues—the status of Taiwan, status of Hong Kong, the disposition in the South China Sea, relations with nations the U.S. opposes and so on. China is no closer to being a democracy than it was in the 1960s and 70s and continues to look at the U.S. as an adversary in a variety of ways. The U.S. has alternated between hostility and attempts to cajole China towards an American view of things. Today, Trump has chosen hostility and seems committed to policies that isolate China and sharply reduce contact.

It is not easy to figure out Trump's motivation as his stance as president is far different from his stance prior to holding office. Most of the Trump-branded merchandise was made in China and he invested heavily in project development in China—just like almost every other businessperson. Now China is the enemy. One suspects this is a move to mollify his U.S. political base. Many of those who voted for Trump have been hurt by Chinese competition as they lost jobs when their companies decided to source from China or when cheaper Chinese goods chased the American-made version out of the market. Whatever the motivation, the enmity between Trump and China is real enough and has led to pressure on U.S. allies to take the same position.

Political Confusion in Israel
The results of the election are still not entirely clear, but it seems that Prime Minister Benjamin Netanyahu has fallen short of the votes he needs to stay on as prime minister. Former general and head of the center-left Blue and White Party—Benny Gantz—is the front runner and will be given the first opportunity to form a government. He does not have enough support in the Knesset to put together a functioning government without a coalition partner, however. The initial assumption was that he would form a grand coalition with Likud, but Netanyahu demanded that he remain as prime minister (PM) and Gantz has rejected this. No coalition will be joined with Netanyahu as PM.

Analysis: The king maker is Avigdor Lieberman of the far right. He had been demanding the grand coalition. He also opposes Netanyahu staying on as PM, but is not a natural choice to ally with a center-left party. New elections are very likely.

Did We Learn Much from The Fed This Time?
Yes and no. Doesn't that sound like something one would expect from the Fed or an economist? No matter what—avoid being committed to a position. The thing is we did indeed get some needed insight and information, but there was a strong desire to get more than was on offer this time. It is now apparent that Fed Chair Jerome Powell has been watching old tapes of Alan Greenspan as he has mastered the ability to say quite a lot without saying all that much. The actual decision by the Fed was expected and the markets long ago priced in that quarter-point cut. The only interest in this meeting was in whether the statements that accompanied that decision would point to a clear next series of steps. The hope was that Powell would clearly open the door to further rate cuts before the end of the year. That did not happen, but neither did he completely rule out further moves. What do we know now that we didn't know before?

Analysis: Perhaps the most interesting is that the Open Market Committee is unusually divided right now. The last time there was a three-person dissent was in 2016. It has been even longer since there were dissents from both directions. Esther George from the Kansas City Fed and Eric Rosengren from the Boston Fed repeated their dissent from the last time the Fed lowered rates and still maintain that rates should be higher than they have been—closer to 3% or even 3.5%. The other dissent was from James Bullard of the St. Louis Fed who asserted rates should have been cut more deeply. One of the interesting aspects of Bullard's dissent is that his head of research has been nominated to be a member of the Board of Governors and is waiting for the Senate to start the confirmation process. The Fed traditionally prefers a consensus be built and that decisions be unanimous—dissent tends to worry the investment community. It is quite clear by listening to many of the regional Fed presidents that there is not a great deal of support for a rate cut as they just do not think this move would make much difference. Bill Dudley, the head of the New York Fed for many years and only recently retired, now seeks to speak his mind. He has asserted the Fed should stand pat and allow Trump to fully experience the fallout from his trade and tariff policies. If the economy slows down, the cause will be pretty obvious and nothing the Fed can do will alter the trajectory. Trade worries are what has been stalling business development and expansion.

The second thing that emerged from the talks was a confirmation that inflation threats are not what have been worrying the Fed members of late. Not that they are not paying attention to any kind of outbreak, but the current inflation climate is not what has the likes of George and Rosengren on edge. They are concerned with the extended period of low interest and what that has done to the small banking sector as well as people who have been trying to save in traditional ways. Small banks are suffering as there has been no incentive for people to deposit money in banks. They are struggling to attract business. George has also spoken at length about the fact that low rates encourage reckless borrowing. Billions are borrowed each day and subsequently invested in the hot stock market. This strategy is a quick way to significant gain, but can come tumbling down if there is a market correction. George and others worry that too many banks made those loans and are as much at risk as the entity or person that borrowed all that money.

The third thing that emerged was a consensus view that trade and tariff wars will be the primary factors the Fed will watch between now and the next meeting. The key threat to growth in the U.S. economy is lack of growth in the global economy. It is obvious that trade spats are behind Germany falling into recession. This is not entirely due to the tensions between the U.S. and China, of course, but Germany has suffered as the Chinese pace of economic growth has faded. Germany has also been badly damaged by the Brexit mess. Powell and the others have reiterated that a further slowdown in the global economy would provoke a reaction from the Fed.

Housing Slump Starting to End?
The last several months have been brutal as far as the housing sector is concerned. It seemed that everything that could go wrong was going wrong. The exception was mortgage rates as they stabilized and then started to fall. Other factors were also a concern—labor shortages that added months to the completion of a new home, sharp hikes in the cost of material, generally higher prices for homes and sharply higher prices in the hottest markets. The Millennial buyer was still not getting engaged and the high-end home buyer was slowing down due to the vagaries of the stock market. It was good news that employment numbers remained high and that consumer confidence was still solid, but these situations can change very quickly.

Analysis: The August numbers are letting home builders breathe a sigh of relief as well as everybody else with a foot in the housing market. The expectation was that existing home sales would be down by 1.1%, but the data showed a gain of 1.3%. It seems those lower mortgage rates drew people into the market after all. One development that has been anticipated for years was the shift from renting to buying among Millennials. The factor that seems to have tipped the scales has been higher rental rates and a general scarcity of rental space in areas the Millennials want to live. The hottest market for existing homes has been in the urban areas where there was demand for rentals. The expansion of rental property into the suburbs and exurbs has not attracted the Millennial and they are now looking at those existing homes.

The fear remains that this boost in activity will be short lived—especially if there is a rise in mortgage rates at some point or some adjustment to the employment pattern. Solving the problem of labor and material cost will not be simple; it will continue to drag on the new home market.

Where Am I?
It was bound to happen someday. To be honest, I am surprised it has taken this long, I arrived at a conference on Thursday morning and dutifully checked in. They pointed down the hall and indicated there was coffee and breakfast. I walked into the room they seemed to be pointing toward and proceeded to get my eggs and bacon and sat down with a bunch of strangers—as I always do. One guy introduced himself and asked who I was. I said, "My name is Chris and I am your speaker at noon." He said, "Uh—no you're not. We have no speakers". I asked then, "OK … what group is this?" Turns out I had crashed some other group's breakfast. They were polite and didn't throw me out. I offered to do an economic talk, but they said thanks but no thanks. This took me back to my college days when I crashed weddings just to get some snacks and beers.

There have been days when I am not sure what city I am in or what hotel. I have arrived at the wrong city on the wrong day. I have been confused about when I am to talk, but this was my first opportunity to mooch. I felt even worse when I realized that there was no breakfast at all with the other group—just coffee. I did manage to eat lunch with the right collection of strangers. I don't know—perhaps I am traveling a bit too much these days!

Decline in 10-Year Government Yields
The performance of long-term bonds around the world has been pretty concerning and signals that many in the investment community have decided a recession is imminent, although there is considerable difference of opinion as to what imminent means. This inverted yield curve is not a cause of recession, but an indicator of what the investor thinks is going to happen—much lower interest rates as set by the central banks. That impacts the bond market in obvious ways.

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Wednesday, 26 February 2020