The more I research our pandemic-era economics the more I realize that the old rules no longer seem to apply. We are living in VUCA times: volatility, uncertainty, complexity, ambiguity. Developing a strategy to cope with this takes a lot of patience and resilience.
Factors plaguing economic growth in 2020 and 2021 included supply chain, labor, COVID-19, and logistics. Just-in-time delivery worked for a long time and then failed miserably. The industry’s reaction was to not get caught again in that situation, so they transitioned to ordering more than needed and building inventory. That works great until the economy slows down and inventory starts piling up.
GDP dropped 1.6pc in Q1 and 0.9pc in Q2, and inventories have been the biggest factor fueling these drops. The buildup in inventories slowed in Q1, and Q2 brought destocking. Without the inventory problems, GDP for the first half of the year would have been flat to up slightly.
For most of the last decade, the economy grew at about 2pc annually. The economy could be in for an extended slower growth period of under 2pc because of the pandemic, the China situation, and the Putin war. Former Federal Reserve Board of Governors member Larry Meyer [a friend of mine] calls this a “growth recession.” It took me a while to understand the concept of “growth recession.”
We now are experiencing a slowing economy with high inflation and rising interest rates. The upside to the slower growth is inflation trending down. Gasoline futures peaked four months ago, dropped over 30pc, and are now at $1.40/gallon lower. Of course, retail prices are down only 17-22pc, or about a dollar. Just remember the rockets and feathers analogy: Prices rocket up and float down. Demand is another reason for the drop in prices. Consumers are cutting back on their driving, and gas inventories are rising. Also, worldwide demand is off.
Other commodity prices also dropped:
– 30pc for most industrial metals
– 37pc for wheat
– 27pc for corn
– 11pc for Asian shipping containers
Part of the reason for this is that hedge funds and commodity speculators have left the market. That’s a good sign for inflation reduction. Service prices, however, are rising faster and look like they will be strong for a while.
The Fed is laser-focused on slowing the economy by raising interest rates so the jobs market slackens. By doing so, they hope to break the wage-price spiral. Wages and benefits rose 5.1pc in the second quarter compared with the same period a year earlier, led by better pay for private-sector workers. That marks the fastest rate of increase on record since 2001.
Fixing the wage spiral will be difficult in a labor market that will be tight for some time. The Fed raised rates 0.75pc in July and meets again on Sep 21-22. They will have a lot more data at that time to determine how high the interest rates will continue to go up.
I mentioned last month the 11 million job openings, the labor shortage, and inflation drawing workers back into the job market. July job creation was widely forecasted at 250,000 new jobs. Whoops. In July, 528,000 new jobs were created, pushing total employment higher than pre-pandemic and sending the unemployment rate down to 3.5pc.
The strange thing is that prior to the pandemic, about a million more people were working in manufacturing, construction, mining, and logging—plus the retail, warehousing, and transportation sectors—than in February 2020, and about a million more people were working in service industries. If those two million people were working now, the unemployment rate would be close to 3.1pc.
The Consumer Price Index (CPI) for July fell to 8.5pc year-over-year from June’s 9.1pc and was the same as June on a monthly basis. Volatile food and rent prices were up, while energy fell. When stripped of this, core inflation on a year-over-year basis was the same as June at 5.9pc and rose 0.3pc, down from June’s 0.7pc rise.
The Producer Price Index for July fell by 1.8pc on a 12-month basis and dropped by 0.5pc from last month. The core price index excluding food, energy, and supplier margins rose by 7.6pc from last year and 0.2pc from last month. This was the first fall in PPI since early in the pandemic.
Personal Consumption Expenditures (PCE), which is the Fed’s preferred measure of inflation, rose 1pc in June and is up 6.8pc from a year ago. That is the sharpest rise since January 1982. Core prices, excluding food and energy, rose by 0.6pc in June and are up 4.8pc from a year ago. All of these are also higher than in May.
We will continue to hear predictions of a recession for a number of months as the Fed raises interest rates and inflation numbers keep coming in strong. However, we are not close to a recession now — or even this year — unless a few large black swans show up. These could be a new pandemic, an escalation in the Russia-Ukraine war, a Chinese confrontation in Taiwan, or some other stuff I don’t want to think about.
Current economic signs are encouraging. Oil prices have dropped sharply along with metals and food stocks. Housing prices look like they are stabilizing, and ISM services rose in July. This will be reflected in future drops in CPI, PCE, and PPI. Employment remains very strong despite tech companies, and some other large companies, announcing layoffs.
The Fed has been known to overshoot on raising interest rates to tame inflation. Former Treasury Secretary Larry Summers has talked about needing five years of unemployment at 5pc to tame inflation. How high the Fed will push interest rates to tame inflation is unknown, but the process will take a lot longer than most people want and could easily cause a recession.
Yield curve meaning and importance
The term “yield curve” refers to the relationship between short- and long-term interest rates of fixed income bonds issued by the U.S. Treasury. An inverted yield curve occurs when short-term interest rates exceed long-term rates. Under normal circumstances, the yield curve is not inverted since debts with longer maturities typically carry higher interest rates than nearer-term ones to compensate for the greater risk.
From an economic perspective, an inverted yield curve [higher short-term than long-term] is a noteworthy and uncommon event, because it suggests that the near-term is riskier than the long-term. It is one of the most reliable leading indicators of an impending recession. ITR believes that an inverted yield curve for more than two months means we are in for a recession. Recently, yields inverted to their deepest point in about 15 years. We will know more about this toward the end of the year, depending on the Fed’s interest rate actions.
Shipments of “core” non-defense capital goods ex-aircraft, a key input for business investment in the calculation of GDP, rose 0.7pc in June, following a 0.8pc increase in April and an upwardly revised 1pc in May. Shipments grew at a 9pc annualized pace in Q2 versus the Q1 average. Orders for durable goods recovered sharply since the pandemic; they’re up 71.3pc from the April 2020 bottom and now sit 17.8pc above the pre-pandemic high set in February 2020. Industrial production rose at a healthy 6.2pc annualized rate in Q2, and strong business investment will remain a tailwind for GDP growth throughout the rest of 2022.
North American light vehicle production rose to 13.2 million units in June. The capacity utilization is now just above 70pc, up from 56pc in September last year. Single-family housing is lower because of higher interest rates, but it is stable and housing inventories are still very low. Aerospace is picking up.
The ISM Manufacturing Index for July dropped slightly, to 52.8, and is still in positive territory. Supply chain issues are improving, although some key components are still in short supply. The pace of new orders dropped due to recession fears and some customers reporting high inventory levels. Consequently, the new orders index fell to 48 in July, dipping further into contraction territory and hitting the lowest reading since the early days of the COVID-19 pandemic. The prices index, which posted the largest monthly drop since 2010, is a signal that inflation pressures might have peaked. The other good news is that production and order backlogs are still strong.
The Shapiro Nonferrous Scrap Activity Index for July was down 3pc from June, which is a normal summer slowdown.
Nearly 250 million people in 31 Chinese cities have been under lockdowns and quarantine for months because of the country’s Zero-Covid policy. The real estate business in China continues to be a hot mess and represents a third of China’s GDP. Exports are also dropping as the rest of the world slows down. China’s unemployment is at its highest level since they started recording it in 2018. The economy grew at 0.4pc in the second quarter compared to a year earlier, marking the lowest quarterly growth rate since the first COVID-19 shut down in Q1 2020.
China is also starting to see some social unrest. President Xi Jinping is up for reelection [sort of] this year and has yet to show any signs of changing policy. Even if there are policy changes and stimulus there, it will be very difficult to change consumer sentiment and encourage companies to invest. The upside for the world is that these policies will help reduce global inflation.
July Caixin and PMI were softer than June and right at about 50, the line separating expansion from contraction. China may not mention a recession, but it looks very likely to me that one is underway regardless of what they report.
Europe is suffering from high inflation and the devastating effects of the Russia-Ukraine war on energy. Interest rates are also rising there to combat inflation. Their PMI in July dropped to 49.8 from 52.1. Along with China’s slowdown, Europe’s PMI dropped in July to 49.8 from 52.1. A high percentage of Europe’s exports are to China.
The IMF frequently revises the global output downward. Relative to the rest of the world, the US economy looks good.
Sales, construction, and prices in China’s disastrous real estate sector are down 30-40pc, measured annually or monthly, and are affecting metals. According to Edward Meir of ED&F Man, “Twenty percent of global steel and copper consumption, 9pc of aluminum demand, 5pc of zinc and 8pc of nickel consumption, respectively, were all taken up by China’s property sector. With such a key demand ‘engine’ missing in action, metals will have trouble moving significantly higher while the likelihood of surpluses building in a number of complexes will also increase.” The strength of the dollar also keeps commodity prices lower, because other countries pay more to buy them.
Meir also points out that “although we are cautious about LME prices going forward, we do not think we are going to see a substantial sell-off. We say this in view of the fact that metal inventories are practically negligible, while smelting and mining operations remain strained by supply chain issues, labor problems, COVID-19, and of course by the debilitating impact of higher energy prices particularly in Europe.”
Nonferrous scrap prices held steady from July for segregated clips after dropping sharply for three months. Painted aluminum prices dropped 9pc, aerospace turnings dropped a cent, copper was steady, and stainless steel prices dropped 17pc, their lowest level since 2020. Scrap steel fell 15pc and is the lowest since December 2020.
President Biden signed into law the CHIPS Act, which will greatly improve the semiconductor industry and lessen our dependence on foreign sources. The Senate passed a tax and energy bill that has benefits for electric vehicles, fossil fuels, and renewables; it will also reduce the cost of pharmaceuticals and reduce the budget deficit by increasing taxes on the tech industry. This is a great compromise and shows how government should work. It will also benefit the metals business.
Thanks to Edward Meir for this Reuters metals price forecast.
I am sending a link to an article by David Brooks titled “I Was Wrong About Capitalism.” The article gave me insight into opening my mind to change my thought process. Hope you enjoy it.
“Success is not an accident… it is the result of drive combined with undaunting effort.” -Peg Davant
Life is good. Family and health are precious.
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 here are subject to change without notice.