It is not February 2, Groundhog Day, but recently it has felt like it with the same ever-present themes influencing economics month after month. Supply chain issues, unprecedented events, VUCA [volatility, uncertainty, complexity, ambiguity], debt ceiling crisis, and my fallback expression: “There’s something happening here. What it is ain’t exactly clear.” What I thought I knew and what I have learned are not so clear now.
I studied macroeconomics long ago and still find it fascinating. It helps explain the impact of monetary [the Fed] and fiscal [government spending] policies. One of the Federal Reserve’s primary responsibilities is to keep the economy steady through money supply and interest rates. As you pump more money into the economy and lower interest rates, the economy will expand.
Fiscal policy influences the economy through taxes and spending. Cutting taxes puts more money in the hands of the consumers and should stimulate the economy by raising the GDP. If the economy grows at a faster rate, the deficit should not increase. However, this rarely happens, and it doesn’t matter whether there is a Democrat or Republican in office. Deficits keep growing.
One macroeconomic theory states that as unemployment goes down, inflation will go up. This has not been the case for most of the last 20 years, excluding what is happening this year. The 2017 tax cut was supposed to grow the economy from 2pc per year to 4pc per year. That did not happen. The budget deficit spiked last year and again this year because of the huge government stimulus and the economic slowdown. Typically, huge deficits will cause interest rates to spike. That has not happened. Short-term interest rates are still virtually zero. The economy is recovering, but it is still below the pre-pandemic levels.
Prior to the pandemic, inflation was below 2pc, disproving many theories. The Federal Reserve has been saying that the current inflation surge is temporary and should reach 2.3pc next year. I don’t know if all that is true, but the surge in commodities doesn’t exactly look transitory to me. We all know what metal prices have done and keep doing. Energy prices have skyrocketed. Last year, at the depths of Q2, spot oil was less than zero because there was nowhere to store it, but oil just hit $80 per barrel. Natural gas is five times its pre-pandemic price. Domestic and international freight rates have also exploded. Labor shortages continue, even with many employers offering higher wages. Again, this does not look transitory to me.
Fed Chairman Jerome Powell recently said: “The current inflation spike is really a consequence of supply constraints meeting very strong demand. And that is all associated with the reopening of the economy, which is a process that will have a beginning, middle and an end.” The 10-year U.S. Treasury Bond Market is where the “smart money” invests. These bonds are priced low, at about 1.5pc interest, not anticipating inflation and higher interest rates. That confirms what the Fed is saying. I hope I am wrong and inflation does not get out of control.
The Institute for Supply Management (ISM), reported the manufacturing sector continued to expand in September to 61.9, up from 59.9. The details are a version of Groundhog Day. Demand is great and we could produce more, but the restrictions are rapidly rising costs for inputs and transportation (especially ocean freight), shortages of raw materials across the board, and employers’ difficulty filling open positions. This is reflected in the Shapiro Nonferrous Scrap Metal Index, which is down 4pc in September from August. The only good news is that demand is still excellent, and will continue to be fueled by many trillions in excess savings from the stimulus packages.
Annualized auto sales now are at around 12 million cars per year, which is about one-third lower than prior to the pandemic. The US produced at least two million fewer vehicles this year; worldwide the loss is over 7.7 million vehicles. That is a lot of metal. There is an emerging view that the computer chip shortage has morphed from a short-term crisis into a structural upheaval for the auto industry that could take years to fully overcome. Mary Barra, CEO of GM, recently stated, “We’re going to make some pretty substantial shifts in our supply chain. It’s a solvable problem, but it’s going to be here a little longer.”
My favorite lead indicator for business investment, non-defense capital goods new orders excluding aircraft, continues to be strong. It was up 0.5pc in August, the last month it was reported. Even so, COVID-19 is stalling the recovery. Less than 200,000 new jobs were created in September, wages keep rising, and help wanted signs keep going up. Until employment numbers increase, slower growth and supply chain issues will continue. Economists continue to be optimistic, but they also keep shifting the rate of growth into future quarters and reducing the current estimated quarterly growth.
China’s growth continues to fall. Its September PMI fell into contraction at 49.6. That’s down from 50.1 and is the lowest number since February 2020. China’s curbs on “dirty” energy use are at the heart of the dipping PMI. The country’s leaders wanted to reduce pollution, especially for the upcoming Winter Olympics in February. Yet, China is heavily dependent on coal, and manufacturing has had to cut back in some non-essential industries, and in heavy energy use sectors like metals, to meet the government’s criteria. This has caused many supply chain problems.
Another factor is the housing and construction slowdown. Edward Meir of ED&F Man just reported on China’s real estate sector. “A Financial Times study notes that China’s property sector accounts for 20pc of global steel and copper consumption, 9pc of global aluminum demand, and 5pc and 8pc of zinc and nickel buying, respectively. These are staggering amounts of off-take tied to the fortunes of just one sector.” Evergrande and many other Chinese real estate companies are facing financial problems. I believe China will have a solution for this that will preserve the housing sector.
Given what I just reported, I would have figured metal prices for September would have been down. Wrong!
- – Primary aluminum continues its strong upward trend as the Previous Months Transaction Average rose over 10¢/lb and the spot price increased by 9¢/lb. This was mainly due to actions on the LME going up.
- – The Midwest Premium remained strong at just under 35¢/lb, up about a half-cent from August.
- – The Chinese energy policy is resulting in metal production cutbacks, which keeps pressure on prices.
- – Logistics issues and fuel price spikes are still problems.
- – Prime scrap prices were up only 4¢/lb, reflecting increased scrap flows, and secondary prices were also stronger despite reduced auto industry consumption. The export offers for secondary scrap are stronger, but actually getting the scrap exported is a major problem. Moreover, secondary ingot prices are rising due to the cost of silicon, which has gone up nearly four times from a year ago. Much of this is again related to the power situation in China as well as reduced silicon production. Silicon also is used for making computer chips, so expect more supply chain issues for cars and many other consumer electronics products. Holy chip!
Copper prices have been stable. Nickel prices were down almost 9pc, but the scrap stainless prices held. Steel mills remain strong at 85pc capacity even with fewer car sales. Even though Chinese iron ore prices have fallen over 50pc in the last few months, HRC has remained strong as consumers still try to replace their very low inventories. Scrap steel prices saw a nominal drop of $20/mt.
“The greatest thing you can do in life is to be a giver because the world already has plenty of takers.” Walter Scott, Jr., who, along with Warren Buffet and 40 others, donated most of his self-made $4.5bn to the Giving Pledge.
Life is good. Family and health are precious. We have lots to be grateful for.
This report was prepared by Bruce Shapiro and reflects his current opinion of the economy. It is based on sources and data he believes to be accurate and reliable. Opinions and forward-looking statements expressed are subject to change without notice.