What are the prospects for the US economy?

We find ourselves in a curious situation as we wait for ( or for readers over the weekend) mull the speech of Fed Chair Jerome Powell at Jackson Hole. There are several reasons for this and let me start with the pressure being applied by President Trump.

Germany sells 30 year bonds offering negative yields. Germany competes with the USA. Our Federal Reserve does not allow us to do what we must do. They put us at a disadvantage against our competition. Strong Dollar, No Inflation! They move like quicksand. Fight or go home!…….The Economy is doing really well. The Federal Reserve can easily make it Record Setting! The question is being asked, why are we paying much more in interest than Germany and certain other countries? Be early (for a change), not late. Let America win big, rather than just win!

We can see that The Donald has spotted that the US Dollar is strong with reports that the broad trade-weighted index is at an all time high. Care is needed with that as it starts in 1995 and the Dolllar peak was a decade before it, but the basic premise holds. But the real issue here is of course calling for interest-rate cuts when you are saying that the economy is strong! Is it?

Nowcasting

Let me hand you over to the Atlanta Fed.

The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2019 is 2.2 percent on August 16, unchanged from August 15 after rounding. After this morning’s new residential construction report from the U.S. Census Bureau, the nowcast of third-quarter real residential investment growth increased from -1.2 percent to 0.7 percent.

That is not appreciably different to the New York Fed which has estimated 1.8%. So let us go forwards with 2% as an average. In terms of past definitions from President Trump ( 3%-4%) that is not doing really well but is hardly a call for an interest-rate cut.

Business Surveys

Something caught the eye yesterday in the Markit PMI survey.

The seasonally adjusted IHS Markit Flash U.S.
Manufacturing Purchasing Managers’ Index™
(PMI™) registered 49.9 in August, down from 50.4
in July and below the neutral 50.0 threshold for the
first time since September 2009.

The eye-catching elements were it going below the neutral threshold and the fact this is the lowest reading for nearly a decade. Some of this is symbolism as the PMI is not accurate to anything like 0.1 but there is also the downwards direction of travel. Also it had a consequence as we look wider.

August’s survey data provides a clear signal that
economic growth has continued to soften in the third
quarter. The PMIs for manufacturing and services
remain much weaker than at the beginning of 2019
and collectively point to annualized GDP growth of
around 1.5%

So we started with ~2% and now are at 1.5%.Prospects look none too bright either.

The past isn’t what we thought it was

Earlier this week we saw quite a revision affecting employment trends.

For national CES employment series, the annual benchmark revisions over the last 10 years have averaged plus or minus two-tenths of one percent of total nonfarm employment. The preliminary estimate of the benchmark revision indicates a downward adjustment to March 2019 total nonfarm employment of -501,000 (-0.3 percent).

This begs several questions as it means the monthly non-farm payroll numbers were too high in the year to March by more than 40,000 a month. The worst problem areas were retailing,,professional and business services and leisure and hospitality.

The change in the picture is covered by MarketWatch.

“This makes some sense, as the 223,000 average monthly increase in 2018 seemed too good to be true in light of how tight the labor market has become and how much trouble firms are said to be having finding qualified workers,” said chief economist Stephen Stanley of Amherst Pierpont Securities

In a sense that is both good and bad as he implies the economy might be at a literal version of full employment, at least in some areas. The bad is that growth was weaker than thought.

Money Supply

Back on the eighth of May I posted this warning.

The narrow measure of the money supply or M1 in the United States saw a fall of just over forty billion dollars in March. That catches the eye because it does not fit at all with an economy growing at an annual rate of 3.2%. Indeed we see now that over the three months to March M1 money supply contracted by 2.7%. That means that the annual rate of growth has been reduced to 1.9%. Thus we see that it has fallen below the rate of economic growth recorded which is a clear warning sign. Indeed a warning sign which has worked very well elsewhere.

That has played out and whilst it is a coincidence that the annual rate of economic growth seems now to be what narrow money supply growth was the broad sweep has worked. However that was then and this is now because M1 has been on something of a tear and the last three months have seen annualised growth of 8% pulling the actual annual rate of growth to 4.8%.

Will it be “Boom!Boom! Boom!” a la the Black-Eyed Peas? Well thank you to @RV3003 on twitter who drew my attention to this from Hosington.

First, Treasury deposits at the Fed, which
are not included in M2, fell dramatically as a
result of special measures taken to avoid hitting
the debt ceiling, thus giving M2 a large boost as
Treasury deposits moved to the private sector.
Once the debt ceiling is raised, Treasury deposits
will rebound, reversing the process and slowing
M2 growth.

Did this affect M1? Well maybe as demand deposits have risen by US $75 billion since the March and since the debt ceiling was raised they have fallen back by US $14 billion.

As you can imagine I will be tapping my foot waiting for the next monthly update. Fake money supply growth?

Comment

We can see that the US economy has slowed but if the money supply data is any guide is simply slowing for a bit and may then pick up. That scenario does not fit with the way that bond markets have surged expecting more interest-rate cuts. In fact bond market analysts are arguing that the Federal Reserve needs to cut interest-rates to keep up and avoid losing control, although they are not entirely clear what it would be losing control of.

So I have a lot of sympathy with Jerome Powell who has a very difficult speech to give today. The picture is murky and I would wait for more money supply data before giving any hints of what I would do next. In short I would be willing to be sacked rather than bowing to Presidential pressure.

 

 

Where next for the US economy?

The end of the week has an American theme as we have just had Independence Day and it will be followed by the labour market and non-farm payrolls data. So a belated happy Independence Day to my American readers. But behind all that is a more troubled picture for the US economy that opened 2019 in fine form.

Real gross domestic product (GDP) increased at an annual rate of 3.1 percent in the first quarter of 2019 (table 1), according to the “third” estimate released by the Bureau of Economic Analysis. In the fourth quarter of 2018, real GDP increased 2.2 percent. ( BEA)

There was a further sub-plot in that not only had economic growth picked up to ~0.8% as we measure it the falling trend of the previous three quarters was broken. But as I pointed out on the 8th of May a warning light had started to flash.

The narrow measure of the money supply or M1 in the United States saw a fall of just over forty billion dollars in March. That catches the eye because it does not fit at all with an economy growing at an annual rate of 3.2%. Indeed we see now that over the three months to March M1 money supply contracted by 2.7%.

What about now?

The money supply picture is not as dark as it looked back then. In fact the contraction of the previous three months of 2.7% has now been replaced by growth of 2.7%. However that is below the annual rate of growth of 3.8% so a gentle brake is still in play as opposed to the previous sharp one. This compares to 8.5% in 2017 as a whole and 4.4% in 2018.

As to the pick-up more recently it may be related to this change in Federal Reserve policy.

The Committee intends to slow the reduction of its holdings of Treasury securities by reducing the cap on monthly redemptions from the current level of $30 billion to $15 billion beginning in May 2019.

So it is no longer acting to reduce the growth rate of the narrow money supply on the same scale. As to how quickly that will impact is not so easy to say because if we look back in time the timescales of similar policies were rather variable. This was the so-called Overfunding phase in the UK when we sold an excess amount of Gilts to reduce the money supply and discovered if we cut to the chase that it was not as simple as it might appear. There is a difference in that we were aiming ( and quite often missing) a broad rather than narrow money measure.

As cash was in the news only yesterday let me point out that at the end of May the M1 money supply comprised some US $1.65 trillion as opposed to US $2.14 trillion of demand and chequeable deposits. There is a blast from the past disappearing as until the end of December the US Fed recorded some £1.7 billion of Travellers Cheques, does anybody still use them?

Other Signals

We get an idea from the New York Fed.

The New York Fed Staff Nowcast stands at 1.3% for 2019:Q2 and 1.2% for 2019:Q3.

News from this week’s data releases decreased the nowcast for both quarters by 0.1 percentage point.

Negative surprises from housing data and the Advance Durable Goods Report accounted for most of the decrease.

As you can see they are rather downbeat for the middle part of 2019 with economic growth being of the order of 0.3% as we would measure it. The Atlanta Fed nowcast is a few days more recent but comes to the same 1.3% answer for the quarter just gone.

A particular driver of that is something that like in the UK has lost much of its ability to shock because it has become part of the economic landscape.

The U.S. Census Bureau and the U.S. Bureau of Economic Analysis announced today that the goods and services deficit was $55.5 billion in May, up $4.3 billion from $51.2 billion in April, revised. ( BEA )

That increase in the deficit is a downwards pull on GDP via net exports and is part of a pretty consistent trend in the year so far.

Year-to-date, the goods and services deficit increased $15.7 billion, or 6.4 percent, from the same period in 2018. Exports increased $5.1 billion or 0.5 percent. Imports increased $20.8 billion or 1.6 percent.

That shows that the trade war does not appear to be going that well as you can see. As to the total effects here is the Bank of England on the subject.

The Bank estimates that these measures will reduce global GDP by only around 0.1%, and the
further US-China tariffs that took effect in May and June will roughly double that effect.

But that may not be the end of the story. The additional tariffs threatened by the US on China and on auto
imports more generally would raise average US tariffs to rates not seen in half a century. If
implemented, they could reduce global GDP by an additional 0.6% through direct trade channels alone.

What will the Federal Reserve Do Next?

If the latest speech from Chair Powell is any guide it seems to be trying to take us for fools.

 The Fed is insulated from short-term political pressures—what is often referred to as our “independence.”

I should note that this came before the appointment of a politician to the ECB Presidency but that really is only part of something which which we have long been aware of. Believing in it these days is a bit like believing in Father Christmas. As to the economic situation we were told this.

Since then, the picture has changed. The crosscurrents have reemerged, with apparent progress on trade turning to greater uncertainty and with incoming data raising renewed concerns about the strength of the global economy……The question my colleagues and I are grappling with is whether these uncertainties will continue to weigh on the outlook and thus call for additional policy accommodation. Many FOMC participants judge that the case for somewhat more accommodative policy has strengthened.

Comment

The next signal for the US economy has been the surge in bond markets. The US ten-year yield was 3.24% in the early part of last November as opposed to 1.97% as I type this. The expectation shifted as we noted back then shifted from interest-rate rises to cuts and on a simple level a two-year yield of 1.78% is expecting three of them which is punchy when we have not had any yet. So they have been accurate in expecting a slowing of the US economy and the prospects for more QE bond buying and have got a slowing of the reduction in QE and a September date for its end.

Moving to the labour market most of the signals do not tell us much at this stage of the cycle. After ten years of expansion for the economy jobs growth should have slowed. But there are two numbers which do tell is something. The first is wages growth because with the rise in employment and fall in unemployment it should have surged but has not. Whilst I welcome wage growth of a bit over 3% it has underperformed compared to the past which is perhaps related to another problem. It gets reported less these days but the change in the labour participation rate is equivalent to around 11 million people.

Both the labor force participation rate, at 62.8 percent, and the employment-population ratio, at 60.6 percent, were unchanged in May.

There is also the issue of leveraged loans which ironically lower interest-rates and bond yields are only likely to make worse. Here is the Bank of France on the subject.

Leveraged loans are loans extended to highly indebted companies. Their strong growth in the US over the last five years and their packaging into securitised financial products bear a number of similarities with the subprime market that triggered the 2008 crisis. While the comparison is debatable, the risks posed by the leveraged loan market to financial stability should not be ignored.

Also in an era of H2O and Woodford there is this.

The presence of Exchange Traded Funds and Mutual Funds means that retail investors have access to these loans in the United States – although they still only account for a minority of investors. Moreover, these structures present a maturity mismatch between their assets and their liabilities. Investors can redeem their fund shares very quickly, whereas underlying assets (leveraged loans) tend to have much longer transaction times.

What could go wrong?