Brief Notes on the US Economy
• Rosengren Retires Early – Eric Rosengren has been one of the longest serving members of the Fed – having held various positions at the Boston Fed for 35 years. He was due to retire next June due to having reached the age of 65 but has been having health issues for the last year or so. He is stepping down nine months early in order to have a kidney transplant. He has been facing some scrutiny of late over the fact he has made stock trades while serving as the Boston Fed President but these accusations had not actually amounted to much at this point. The important point as far as the overall Fed is concerned is that he is one of the more hawkish members and would have been on the Open Market Committee along with Esther George and Loretta Mester. Will he be replaced by another hawk?
• Lael Brainard Reiterates Fed Position – Brainard has emerged as one of the primary voices from the Fed and she has issued the most sterling defense of the Fed’s assertion of transitory inflation. She asserts that the labor market and inflation levels will return to the pre-pandemic levels within the next several months (depending on the pace of the virus) and that would mean the Fed would not have to exert control over inflation at this point. This seems to be in variance to the notion the Fed would have to hike rates as early as next year. The point she is making is that conditions seem to be favorable as far as resumption of 2019 activity. If that is not the case (due to the pandemic resurgence) there could be negative developments but for the now the future looks a bit calmer.
• Retailers Struggle to Find Workers – The past year or so has not been good for the brick-and-mortar retailer and it seems to be getting worse. The surge in interest in the online option has been clear enough and there seems to be no slowdown in sight as far as the growth of this consumer preference. This is now the time of year when the retailer makes their money and many have been trying to gear up for the holidays but face a major problem as far as staffing. The labor shortage that has affected manufacturing and construction and transportation has also affected the retailer. Part of the problem is that retailers depend on part time workers this time of year and these have often been women seeking jobs while their kids are in school. With many parents still educating kids at home that pool is much smaller than in the past.
Brief Notes on the Global Economy
• Coalition Building in Germany – Nobody really won the election in Germany but at least one party lost. The Social Democrats gained more support in the Bundestag and the Christian Democrats limped to their worst showing in decades. But the SPD has just about one quarter of the seats and that leaves them well short of forming a government. The future of the German government now lies in the decisions made by the Greens and the Free Democrats as both will be needed to form a ruling party. The drama is intensified by the fact that both Greens and Free Democrats are capable of working with either the SPD or the CDU/CSU. It all depends on what is offered to these “kingmaker” parties. What is clear is that the next government will be considerably more to the left than has been the case in past years.
• Oil Prices Rise Due to Natural Gas Shortage – The price per barrel of oil has hit close to $80 and it is almost entirely due to the problems in the natural gas sector. That shortage has already hit Europe and caused massive issues. The oil prices have started to respond to the shortage and many expect these hikes to continue for a while longer before the producers try to make decisions to balance out the market. There is still an incentive to keep prices down so as to discourage the entry of marginal producers but the activity in other energy markets will always spill into oil for a period of time.
“Idiotic”, “Loathsome”, “Repugnant”
The refusal to extend the debt ceiling is 100% political theater. This grandstanding and pandering will cost the US dearly in a wide variety of ways. The credit status of the US suffers and that affects every single person and business in the country. Millions of people who have been working with the expectation they will be paid are now being cheated. The maneuvers that have been forced on the Treasury and the Fed have provoked the comments in the headline above. It is not that the issue of how the government spends money or raises the revenues to support that spending is not an issue. It most certainly is and arguably the most important of issues when it comes to the government. It is the job of Congress to set fiscal policy. The issue is HOW the members of Congress seem to want to go about this.
Analysis: The budget process is where these debates should be taking place. This is how it is done in virtually every other nation in the world. These budget battles are routinely bitter and drawn out and there have been many occasions when a budget can’t be set when it is supposed to be. We have all become acquainted with endless continuing resolutions that allow the government to function under an old budget until some compromise is reached. Other nations face that same battle. It can be frustrating and inefficient but that is what the political leaders are there to do. Once the budget battle is over for the year, the expectation is that everyone can settle down and get on with it. Government workers know if they are getting paid, the thousands of businesses that do work for the government know they will get paid. Those that invested in the US through purchasing treasuries know they will get the return they expected. At least that is the way it should be. The US is near unique in introducing yet another hurdle.
The budget that was agreed upon in Congress routinely creates the need to borrow money by selling more of those treasuries. This is because one group of legislators refuses to limit spending to the available revenue and the other group of legislators refuses to raise more revenue to pay for that budget. The US faces a dilemma. The legislators have failed to pass a budget that can be handled without debt. There is too much spending and not enough revenue. Were this a person, the situation would look like this. One goes on a spending spree with the clear knowledge that there is not enough money in the bank to pay for it. “No problem” says the consumer, I will simply haul out my credit card and defer payment until some later date. Here is where the person and the government differ. If you decide to stiff the people you purchased from by canceling that credit card you have committed a crime and will face prison time or hefty fines and likely both. The government simply declares they have no interest in honoring the commitment made as Congress refuses to borrow the money they promised.
If this impasse is not addressed, the actions taken by the Fed and Treasury will be drastic and the reactions from Janet Yellen and Jerome Powell have gone from frustrated to furious. Two issues make these steps extremely unpopular. The first is that forcing the Fed to buy the securities that will go into default on the open market and it will force the Fed to sell treasuries that it owns to counteract the financial impact of the debt limit refusal. This is referred to as “piercing the veil” as it means the Fed has been forced to directly fund the government. There is supposed to be a clear separation between the Fed and fiscal policy and that vanishes. The other issue is that once the Fed takes this step it will be assumed they always will and the politicians will never resume their assigned role. They will simply keep spending and refusing to raise revenue and expecting the Fed to bail them out every time. In a real sense the Federal Reserve ends up taking control of both fiscal and monetary policy while Congress deteriorates into an impotent collection of shouting politicians unwilling to do the job they were elected to do.
The real tragedy in all this is that there needs to be an extremely focused debate over the burgeoning debt incurred by the US. The pattern of endless borrowing has to stop. The budget process has to mean something again. The side that can’t stop spending money has to be curtailed and the side that refuses to hike revenue has to be confronted with what this means for the ability of the government to function. The debt now gobbles up $400 billion a year in debt service and by the middle of this decade the debt service part of the budget will exceed the entire military budget.
US and EU Trade
US trade officials will be meeting with their counterparts from the European Union this week in an effort to expand the levels of trade between the two entities. Over the last few years there has been an intense focus on China trade and that has been the case for both the US and EU but the reality is that trade between the US and EU dwarfs the levels involving China. The biggest trade partner for the US (outside Canada and Mexico) is Europe and the biggest trade partner for the EU (outside each other) is the US.
Analysis: Lately there have been plenty of tensions affecting trade but most of them are political. The EU was horrified by the debacle in Afghanistan and they fear they will bear the brunt of that refugee crisis. There is anger in France over the creation of an anti-China alliance between the US, UK and Australia that resulted in France losing a major contract to build submarines for Australia. The US has been consistently critical of the EU for its limited spending on defense and the lack of consumer activity. There has been a push for the EU to do more stimulating (especially Germany). Now that Germany will be locked in a lengthy process of coalition building there is fear they will abdicate their leadership role. The talks are not expected to yield anything dramatic but they should reassure the EU that the US recognizes the importance of the region to the US economy.
Some Additional Clues Regarding Economic Progress
There will be some additional data coming this week and it should provide a bit of encouragement. The primary issue for the last few months has been how the consumer would react to the new threats from the virus. This is not like the emergency response in 2020 when the government declared a massive lockdown as a means by which to control the spread of the disease. That move was not supposed to be a lengthy one – just a matter of a few weeks before there would be a “May rebound”. Obviously, that was not the case and the lockdown created more of a crisis than the pandemic in many ways. The worry this time around has been the overall attitude of the consumer. Will they be reluctant to continue the pattern of the last few months – coming back to their old habits. It has varied widely across the country with some states close to lockdown and others wide open. The data coming in now would provide some clues as to how this might impact the rest of the year.
Analysis: The best news of the week came right at the onset with the release of the latest durable goods orders data. There had been an expectation that numbers would be down a bit – a reaction more to the supply chain chaos than to the issues of the pandemic. That seems not to have been the case as the levels were better than had been expected – a gain of 1.8%. This is the more impressive against the backdrop of that supply chain mess. Even as companies have been unable to get crucial parts and assemblies there are still sales and there is evidence that buyers are accepting substitute goods more than would have been anticipated. That means they have been willing to purchase a machine that was not their first choice and that has allowed sellers to reduce inventory levels even as they contend with these shortages.
Tomorrow there will be data coming from the Fed in the way of testimony by Jerome Powell in front of the Senate. This could be a polite but testy exchange as the Fed has been preparing to send a message of recovery. The conversations last week were all about the pace of stimulus reduction as the attention of the Fed starts to turn towards the threat of inflation. The estimate for GDP growth was reduced a bit but still stands well over 5.0% growth and that is still very fast for a country that usually grows at 2.5%. Powell is very likely to try holding the Senate to account for the nonsense over the debt ceiling. If there is any body that has been inhibiting the recovery of the economy in 2021 it is Congress. Virtually nothing of use to the economy has emerged from this bunch in months.
By the end of the week there will be data regarding such vital parts of the economy as inflation, employment and consumer spending. The personal consumption expenditure numbers have been very high for the last few months and they are expected to stay in that elevated state. The PCE number is more important to Fed thinking than the data that comes from the Consumer Price Index or the Producer Price Index as these numbers are “actual” as opposed to the assessment of a typical basket of goods. By most accounts the surge in the viral threat has not inhibited spending but there has been a shift back to buying things rather than services and there is more emphasis on online again. By the end of the week there will be new data from the Purchasing Managers’ Index and it is expected to show some gains – at least as far as the manufacturing sector is concerned.
China Getting Slammed by Pandemic Again
It remains extremely difficult to get a straight answer from the Chinese on the subject of the pandemic. Never mind giving people information regarding the origins of the disease, it is hard to even get data on the current impact. Clues are emerging, nonetheless. The latest data on the service sector shows a sharp decline and there is more than enough evidence to suggest that this has been due to a combination of renewed lockdowns and the reluctance of the population to get back to normal. There continue to be assertions from the government suggesting that everything is under control but this is almost immediately contradicted by reality.
Analysis: The government has boasted of a “zero tolerance” policy as far as the ports are concerned. This suggests that even one case of Covid 19 would be enough to shut down a major port. The assertion was that one case was enough to shut Ningbo – third largest port in the world. Local commentators have leaked information asserting there have been thousands of cases in that city – not just one. Other leaked commentary suggests that nearly every part of the country has seen higher numbers in the last couple of months – similar to the experiences of every other nation as they confront the delta variant. Japan’s numbers are way up and so are Taiwan’s and Korea’s. The challenge in the Southeast Asian states has become as serious as it has been from the start. For China to claim that it has been immune to this outbreak is beyond ridiculous.
Armada Strategic Intelligence System Starts to Show Some Weaker Numbers
The most recent data from the Strategic Intelligence System is showing some signs of weakness as the pandemic threat reignites around the world. This is consistent with many of the global economic assessments released lately. The projections are still showing progress but it is not as robust. Check this out for yourself, the latest issue has been released. Your two-month trial is absolutely free – no obligations at all. Simply go to www.asisintelligence.com and engage with us. We continue to tweak the report with every issue – adding the content that readers have requested.
What We Are Watching – From the Black Owl Report
Housing Rebound in August – After a month of housing starts that plummeted after rising in the prior two months, we saw them rebound in August and return above the 1.6 million units a year mark. Housing starts were up 3.9% to an annual rate of 1.615 million Building permits, which arguably can be very volatile in some segments of the national economy, showed a continuation of strong momentum as they increased 6%. Housing starts have been volatile since last year at this time and material and labor shortages have pushed prices high enough that some buyers have bailed out of the market.
These new starts are good news for anyone in the lumber, fixtures, and construction materials sector. Demand for your products is likely to remain strong through the end of the year and the slump that looked like it might be coming at the end of July may have been a false alarm during July. Housing inventories are rising, and there are currently 6.2 months of housing inventories on hand at the end of July. Six months is ideal for inventory levels and it keeps prices sufficient enough that buyers can afford to stay in the market and builders are being paid sufficiently to cover costs. And, at 6.2 months, they aren’t blown out of proportion enough that builders start to run.
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The definition of surreal is “unbelievable” or “irrational” and that seems to sum up the current reaction to the pandemic. Over the weekend and the prior week, I had the opportunity to travel in and out of some bizarre situations. I gave several talks in various parts of the region (Goodland, Tulsa, Kansas City) and there was not much in the way of mask wearing or social distancing in evidence at any of these. On Saturday we stumbled into a well-attended fall festival. It was just supposed to be an opportunity to have lunch with my stepson and his wife but soon we were amidst those enjoying a funnel cake. The restaurant had us donning masks for the six-foot journey to the table where they promptly came off (as we all know by now the virus is very polite and will not disturb you while eating). I do understand the purpose of the masks – if one suspects one is carrying the virus, the mask keeps you from spreading it to others. It does not protect the wearer much as the virus can find other routes. My question is why the person carrying the virus would want to be in public at all. It would seem testing frequently would be a better means of exercising caution but I digress.
The mask has become yet another way for us to divide. The world has separated into the masked and the unmasked with each side glaring at one another. The unmasked seem to see the masked as government dupes bent on taking away the rights of Americans and the masked see the unmasked as selfish ideologues determined to make everybody sick. The real pandemic now seems to be one of political toxicity.