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 In fact the contraction of the previous three months of 2.7% has now been replaced by growth of 2.7%.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?

It is a case of harder times for the US economy

A feature of the current world economic slowdown has been that the United States has been outperforming its peers. Some of that has been genuine and some simply because the news flow was slowed by the time Federal workers were unpaid. However the chill winds are now being recorded and reported. From the Atlanta Fed.

The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2019 is 0.4 percent on March 13, up from 0.2 percent on March 11. After reports on durable manufacturing and construction spending were released by the U.S. Census Bureau this morning, the nowcast of first-quarter real gross private domestic investment growth increased from -2.9 percent to -2.4 percent, and the nowcast of first-quarter real government expenditures growth increased from 1.7 percent to 2.5 percent.

As you can see the latest data nudge things a little higher but only to the giddy heights of 0.1% per quarter as we record GDP growth. It is noticeable that investment growth is is still solidly negative whilst we are seeing the Trump fiscal expansion in play perhaps also. Whilst one may disagree with the details of it the plan is turning out to be anti-cyclical as fiscal policy is supposed to be as opposed to the pro cyclical effort that we observed so devastating the Greek economy only yesterday.

Stuck like glue

However the head of the Atlanta Fed Ralph Bostic wants us to focus on other matters.

The U.S. economy, by most standard metrics, is doing pretty good,” he said. “We’ve been in a growth trajectory for 10 years now coming out of the Great Recession. Unemployment is at historic lows, 3.8 or 3.9 percent — rates we have not seen since the 1960s. Job creation is happening somewhere around 200,000 to 250,000 jobs a month. And we’re not seeing signs of accelerating inflation.

So classic deflection territory as whilst that was true when he made the speech on the 5th by the 8th we had a rather different view on job creation.

Total nonfarm payroll employment changed little in February (+20,000)

That seemed rather extreme so let us look for some perspective.

After revisions, job gains have averaged 186,000
per month over the last 3 months.

So our tentative view is that a slowing economy is now feeding into lower employment growth. Yesterday we saw that this is also beginning to impact on the unemployment situation.

Initial jobless claims data came out worse than expected. Last week it grew from 223K to 229. Continued claims stood at 1776K against 1758K one week earlier. ( fxpro)

So whilst these numbers are much lower than we saw a decade ago we are now facing a situation where the falls in unemployment and the unemployment rate are about to be replaced by rises. Perhaps Ralph meant that with this but it is hard to say as you can see.

 because there are a lot of things going on.

So Ralph as Marvin Gaye would say “What’s going on?”

The Federal Reserve

If we widen the analysis to the chair of the Federal Reserve he has been shifting his position.

 Because interest rates around the world have steadily declined for several decades, rates in normal times now tend to be much closer to zero than in the past. Thus, when a recession comes, the Fed is likely to have less capacity to cut interest rates to stimulate the economy than in the past, suggesting that trips to the ELB may be more frequent.

Odd if a recession is not feared by Jerome Powell why he is so bothered about it isn’t it? Also the question is begged as to why all the interest-rate cuts and the QE below seem to have us more afraid of recessions?

Between December 2008 and October 2014, the Federal Reserve purchased $3.7 trillion in longer-term Treasury and agency securities.

As to the programme to reduce the balance sheet or Quantitative Tightening then as I pointed out on the 12th of February that seems set to be put away in a cupboard and maybe to the back of it.

Current estimates suggest, however, that something in the ballpark of the 2019:Q4 projected values may be the new normal. The normalized balance sheet may be smaller or larger than that estimate and will grow gradually over time as demand for currency rises with the economy. In all plausible cases, the balance sheet will be considerably larger than before the crisis.

Tucked way in there is a potential rationale for the QE to infinity I discussed back on the 12th of February as well. If we switch to Chair Powell a few days later we get a hint of what he is really aiming at. The emphasis is mine.

Low- and moderate-income homeowners saw their wealth stripped away as home values dropped during the financial crisis and have not recovered as quickly or completely as others. Because home equity has been the main source of wealth among low- and moderate-income people, the crisis dealt a particularly severe blow to these households. Most Americans rely on home equity to send their children to college, invest in their own education and training, or start or grow a business. These aspirations are the basis upon which a strong economy is built. 

Also Chair Powell continues to apparently deliberately ignore the countries which have negative interest-rates of which Japan comes to mind today as it has just reconfirmed its -0.1% official rate.

Just over 10 years ago, the Federal Open Market Committee (FOMC, or the Committee) lowered the federal funds rate close to zero, which we refer to as the effective lower bound, or ELB. Unable to lower rates further.

If like in the UK they felt unable to lower interest-rates further due to problems with “the precious” ( the banks) they should say so as otherwise it is simply untrue.

Money Supply

Here the news looks better because the growth rate of the narrow M1 measure has picked up. It has grown at an annual rate of 4.6% in the most recent quarter up to the 4th of this month as opposed to 4.1% over six months and 3.2% over the preceding year. Whilst there has been a rise in checkable deposits the main move has been in money or cold hard cash. Yes the same money we are supposed to neither want nor need! Although of course the US banking system is somewhat backward in electronic developments.

So in the latter half of 2018 the US economy may well see a beginning of a pick-up in economic growth. The only caveat here is that the 2018 numbers were revised lower which flatters the recent growth numbers as we mull whether they might also be revised lower?

Comment

The official data is finally telling us the scale of the US slow down as the Atlanta Fed now cast gives us a running score. We now know it is close to flatlining like so many others although it id fair to point out that as Ralph Bostic hinted out its recovery has been stronger than elsewhere and let me add it was growing more strongly in 2018. Ironically that means it has slowed the most as economics lives up to its reputation of being the dismal science.

The latter part of 2019 may see a bounce but it does not look that strong so we may be in for a period of stagflation of sorts. The of sorts part is that inflation is historically low but then wage growth is no great shakes either if we look at the weekly pattern. This is because whilst hourly wages rose by 3.4% in the latest employment report hours worked fell back by 0.1 so weekly wages rose by less.

So let us end with some lyrics inspired by Ralph Bostic..

Well if you’re stuck for a while consider our child
How can it be happy without its ma and pa
Let’s stick together
Come on, come on, let’s stick together ( Roxy Music)