The “expected” scenario, a resumption of trade talks, is what emerged from the G20 meetings. The best the agreement between Presidents Trump and Xi did was to temporarily reduce the specter of further growth killing tariffs. We still have the existing ones that have significantly slowed world trade, created a “soft patch” in the U.S.’s economy, and contributed to the emerging recessions in Europe and China.
Capital spending growth is almost nil. The cost of borrowing is already low, so, an additional lowering of short-term interest rates is unlikely to spur additional capital investment. Inventories have been built to unsustainable levels, no doubt due to pre-purchases to beat feared new tariffs or increases in existing ones. It is clear from the Regional Fed surveys and from the ISM Manufacturing Index that production and new order levels have come down, and we are beginning to see some initial weakening on the jobs front.
A Worried Fed
The markets have priced in a Fed “ease.” So far, it’s been all talk. They haven’t yet moved to policy accommodation, and, in fact, they are still in tightening mode via Quantitative Tightening (i.e., the run-off of Treasury securities from their portfolio holdings which reduces bank reserves). This is scheduled to continue through September. Here is what Fed Chair Powell said after the June Fed meetings:
- There is weakening global growth;
- The risks of a slowdown in the U.S. are increasing, especially on the business side (weak capex and negative business sentiment).
It looks like the Fed is worried. Shouldn’t we be worried as well? As of this writing, the equity markets continue to be upbeat because a) investors believe that the Fed will act in time to prevent the U.S. from entering a recession (i.e., engineer what is known as a “soft landing”) and/or b) that the “trade wars” will soon end, causing an increase in world trade and a reversal of the downtrends in most major industrial economies.
Regarding the “soft-landing,” the Fed’s track record on this score is abysmal. In the 13 rate cutting environments since WWII, “soft landings” only occurred three times; the other 10 periods of rate cutting were too little and/or too late, and recessions resulted. As noted, while the Fed has talked the talk, it has yet to walk the walk.
Regarding trade negotiations, the official Chinese position appears to be that, unless the U.S. wants to make most of the concessions, there isn’t likely to be a “trade deal” anytime soon. Some even say that President Trump already gave away too much when he agreed to allow Huawei to purchase U.S. made silicon chips. (Note: It appears that was a Chinese pre-condition to re-enter trade negotiations.) Remember, President Xi is top dog for life, while President Trump has 16 months before he faces an election. The Chinese appear to have the upper hand when it comes to timing.
In the end, the circumstances pulling the world’s industrial economies down were the same on Monday, July 1st as they were on Friday, June 28th.
Bonds Are Worried
Despite reactions in the equity space, bond investors continue to be concerned about the future state of the U.S. and world economies. As of this writing, the 10-year Treasury Note has sunk below the magic 2.0% level while the 2-year and 5-year flirt with 1.75%, Just eight months ago, the 10-year was at 3.25%. It also should be noted that $12.5 trillion of sovereign debt (Germany, Japan, Switzerland, the Netherlands) sport negative yields, yields even lower than they were at the height of the last recession. We almost never see the prices in both equity and fixed income markets rising at the same time for as long as they have recently (8 months).
The U.S. Data
- The six regional Fed manufacturing indexes all showed accelerating weakness in June. The N.Y. Fed’s Empire State Index showed the largest monthly decline on record, and significant downtrends are occurring in the Dallas, Kansas City, Philadelphia, and Chicago indexes. Meanwhile, the ISM Manufacturing PMI for June fell to 51.7 from 52.0 in May. Last August, this Index registered 60.8;
- The Atlanta Fed’s newest estimate of GDP growth for Q2 is 1.5%. Atlanta had been significantly north of 2% for most of the quarter. The NY Fed’s model is forecasting 1.3%, and an even a slower Q3. We will know more at the end of July when the first GDP stab is released;
- Consumer Confidence took a hit in both major surveys: The Conference Board’s reading for June was 121.5, down from May’s 134.1, while the University of Michigan’s monthly survey ended up at 98.2 vs. 100.0 the prior month;
- The Cass Freight Index, and index that is highly correlated to U.S. economic activity, fell -6.5% in June;
- New Home Sales fell -7.8% in May vs. April, and May is off -3.7% from a year earlier; if spec buying (from hedge funds and REITs which are now purchasing new homes to put on the rental market) is eliminated, then purchases of new homes by individuals or households fell more than -11% on a year over year basis;
- Initial jobless claims are now on the rise. For the middle week of June, new claims were 227k, up +10k from the week earlier, and +34k from the cycle low. From an historical perspective, when new claims rise +83k from their cycle low, recessions have always occurred. Something to watch closely;
- Durable goods orders for May fell -1.3% from April, and are off -2.8% from a year earlier;
- On a positive note, U.S. personal income continues to rise (+0.5% in May vs. April, and +4.1% vs. a year earlier). Wages weren’t quite as upbeat (+0.2% May vs. April; +3.6% vs. a year ago).
That is just the U.S. data. Data from Europe are abysmal, Japanese exports continue to fall, and the private surveys out of China indicate that their manufacturing sector is now in contraction (their “official” numbers will never say so). Note from the above data that, so far, downtrends are confined to the business sector. The problem is, when businesses have issues, they begin layoffs, as is now occurring in the auto and retail sectors. If layoffs hit hard enough, there is bound to be a negative consumer reaction.
Robert Barone, Ph.D. is a Georgetown educated economist. He is a financial advisor at Four Star Wealth Advisors. www.fourstarwealth.com. He is nationally known for his writings and Robert’s storied career includes his having served as a Professor of Finance, a community bank CEO, and a Director and Chairman of the Federal Home Loan Bank of San Francisco. Robert is currently a Director of CSAA Insurance Company (the AAA brand) where he chairs the Finance and Investment Committee. Robert is the co-portfolio manager of the Fieldstone UVA Unconstrained Medium-Term Fixed Income ETF (traded on NYSE Arca under the symbol FFIU)