The Deer in the Headlights

The big event of August, the one that was going to move markets, was supposed to be Jay Powell’s remarks at the KC Fed’s annual symposium at Jackson Hole.  Turns out, his speech was a non-event!

The Powell Non-Event

The media made it their purpose, prior to his speech, to spotlight the fact that the FOMC members, the Fed’s rate setting committee, are very divided on the appropriate policy, given the current state of the economy. Indeed, they seemed to emphasize such extreme views as those of Esther George (KC) and Eric Rosengren (Boston), both hawks that don’t believe that the 25 bps reduction at the end of July was called for. Nevertheless, Powell’s remarks made it clear that: a) there are concerns about the slowdown in Europe, in China, in the emerging market space and elsewhere; b) there is concern about the manufacturing sectors both at home and abroad which appear to be slowing due to the tariff wars; and c) these concerns are partially offset by the U.S consumer and the employment markets which look to have remained strong. Because of the latter, he reiterated his position that the Fed was not in an easing cycle, but he did hint that there would likely be a further rate cut (25 bps) at the Fed’s September meetings. While the text of his speech was being parsed on Friday morning, August 23^rd, the equity markets had a slightly positive tilt, and there was slight upward pressure on interest rates.

Bombshells

Then came the bombshells. First, a report from a reliable source indicating China would be playing tit-for-tat and would be imposing tariffs on $75 billion of imports from the U.S. in September. Markets reacted negatively. Trump responded first by “ordering” U.S. companies to leave China (kind of an empty threat since he doesn’t have such powers). But, markets did react more negatively. Finally, markets really tanked when Trump announced that Chinese goods scheduled for a 10% tariff on September 1^st and December 15^th would actually get a 15% tariff ($300 billion worth of goods) and that the existing 25% tariff ($250 billion of goods) would rise to 30% October 1^st.

The DJIA hit its high for the day during Powell’s speech, and fell from there, closing down -623 points, and continued the volatility that was August’s trademark. Interest rates fell hard too.

The Gloom is Overdone!

There are those that say, “the gloom regarding the economy is overdone.” And, that could possibly be the case, although the data continue to deteriorate. The reality is that there is already a global recession in trade, and Friday’s antics are only going to make that worse, much worse. There is also a global recession in manufacturing and in capex. Even assuming that a U.S. recession is avoided, we still have ourselves a case of economic stagnation (and a Fed whose FOMC is so divided that they appear to be “deer in the headlights.”) Recession or not, we have the following:

• An oversupply of resources and capacity leading to deflation. (The price of oil continues to show weakness despite Iran sanctions, havoc in Venezuela and Libya, and OPEC cutbacks – clearly a big fall in demand);
• Cracks are appearing in the employment sub-indexes of the sentiment surveys; and the workweek’s hours have shortened;
• Deflation appears to be the base case; Amazon is the poster-business for this, but it is everywhere with new apps appearing every day that reduce prices to consumers;
• This leads to a lack of corporate pricing power which impairs corporate spending, capex, even their ability to hire and/or service their debt;
• All of this points to lower interest rates.

It is naïve to think that the consumer will remain buoyant as companies cut their hiring intentions just as they have already cut their capex spending and even their buybacks.

Stay Tuned

Still ahead is the ECB’s next step in its march toward owning all of Europe. They made it clear at their last meeting that they are going to launch a huge stimulus campaign in September, likely getting rid of their 33% cap on a single country’s debt in their portfolio, and giving themselves the ability to acquire equities (just like the Bank of Japan which now owns 70% of Japanese stocks!).

The Data

• In the U.S., total mortgage apps fell nearly 5% the last week in July. Purchase apps were down 6%;
• Sales of Single-Family Homes fell -12.7% in July (to 635k annual rate vs. 728k consensus expectation). June was revised significantly upward, so, on net, this wasn’t that bad – but still negative;
• U of M Consumer Sentiment Index 92.1 in August vs. 98.4 in July; consensus was 97.2;
• U.S. Markit Manufacturing PMI was 49.9 (<50 is contraction), and the new orders sub-index dropped the most in 10 years;
• The KC Fed Manufacturing Index fell to -6 in August from -1 in July;
• The NY Fed Recession Index rose to 38%.  Since the 1980s, whenever this gauge has been this high, a recession has always occurred within a few months;
• Paychex small business jobs index shows -1.18% change from a year earlier, the lowest it has been since May, 2010;
• The BLS says there were 501k fewer jobs created in the 1/1/18 to 3/31/19 period than reported. (It is likely that the Birth/Death algorithm, which plugs in a number based on a mathematical trend and not on economic reality, was biasing the data to the high side!) This is the sharpest downward revision to this data since 2009;
• On the positive side, and there is precious little of this, the Conference Board’s Leading Economic Indicators rose a surprising +0.5% in July (after back to back declines the previous two months).

Europe is a mess with political issues now taking the spotlight from the economic ones:

• Brexit;
• Italian snap elections;
• Merkel’s successor;
• Yellow vest protests against Macron’s policies in France.

On the economic front: outside the U.S.:

• German Manufacturing Flash PMI: 43.6 (8 months in a row below 50!) and factory orders are down more than at any time in the past six years. Then there is the Q2 negative GDP growth print;
• UK retail sales diffusion index: July -49 vs. -16 June; the factory orders diffusion index was -57 vs. -19 the prior month;
• In the export/import data:

1. Developed economies ex-U.S. showed -2.4% for exports and -3.9% for imports from a year earlier;
2. EM economies showed exports -1.8% and imports -5.9%, again from year earlier levels;

There is nothing any central bank can do about these numbers; they are coming from the trade wars (and the Fed and Chair Powell admit that they can’t do much about this).

Conclusions

The data continue to deteriorate. The Fed appears to be a deer in the headlights. But, no matter. The trade wars just went nuclear. There is nothing the Fed or any central bank can do about that. And, it doesn’t really matter if we get a recession. A slowdown has real impacts on economic activity and financial markets. The other shoe, the ECB, is about to drop. On Friday, the 10-year T-Note yield closed at 1.533%. Likely going lower.