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Inflation Peaks, Economy Weakens; The Fed's Last Hurrah – Forbes

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It was a down week for equity markets due to the ugly CPI print (+9.1% Y/Y) on Wednesday (July 13). Some recovery occurred on Friday with markets using the +1.0% M/M Retail Sales number as the latest hope that the economic slowdown will result in a soft-landing.

While the coincident and lagging indicators make it appear that the economy is just slowing, nearly all the leading indicators are flashing caution (see chart above). Thus, our view continues to be that markets get oversold and rally on the hopes of a soft landing. But we remain doubtful that one will be achieved. For example, the 1% growth in nominal retail spending looks great on the surface, but when set against the backdrop of a 1.3% rise in the CPI, Real Retail Sales were negative in volume terms.

Viewing Future Inflation

The June CPI spike was due to soaring energy prices which peaked right around the time the June price surveys were conducted. The PPI (Producer Price Index) was also hot for June coming in at +1.1% M/M with the energy segment up a whopping +9.9% M/M. Because food and energy prices are often volatile (no kidding!), inflation watchers look at “core” CPI and PPI which exclude food and energy. The table shows “core” Y/Y inflation data.

While the reductions are not dramatic (yet), the trend is in the right direction.

Of course, food and energy are essential to everyday life, so, if these continue to skyrocket, it’s a big problem. Let’s also acknowledge that inflation is a rate of change, not a level, so if all the prices were suddenly frozen at their current levels, inflation would be 0% even though prices would still be high.

Here is the good news! The price of oil (WTI crude for August delivery) which was $123.70/bbl. on March 7 and $122.11 as late as June 7, closed at $97.57 on Friday (July 15). That’s a -21% fall from the peak. According to AAA, the national average for a gallon of regular gasoline in mid-June was $5.01. In mid-July it had fallen to $4.58, an -8.5% drop. While not as dramatic (yet) as the fall in WTI, it is still coming down, (Yes, gas prices always go up much faster than they come down!) The good news is that there will continue to be downward pressure in prices at the pump. The chart shows that the price of WTI crude has fallen in four of the past five weeks.

The good news doesn’t stop there. In the agricultural trading pits, the 2022 pop in ag prices has completely reversed (see chart) and this is substantially true for all commodities (see second chart).

Remember, inflation is the change in prices. So, the implication of what we are seeing in the oil, ag, and commodity pits are future falling prices, i.e., a bit of welcome deflation. Here are some specific examples: Between July 1 and July14, oil: -13%; base metals: -13%, food commodities: -11%, and, as noted above, between mid-June and mid-July prices at the pump: -8.5%. We have also seen downward price pressures in the cost of shipping. The Baltic Dry Index, which measures the cost of shipping dry bulk materials, has fallen -64% from its recent peak.

Causes

What’s causing this? Part of the fall in commodity prices, especially in the metals complex, is the stagnation in China’s economy as a result of their zero-Covid policy. Their city shut-downs have been well publicized. They just reported Q2 Real GDP at +0.4% and there is much skepticism about that number among China watchers. Europe’s economy is already in Recession and perhaps headed for Depression. And, as noted below, the U.S. economy is less than healthy. The result is that futures prices are in a state of “backwardation” as traders in the commodity pits see lower future demand and lower future prices.

To sum up the good news, it does appear that the rate of inflation peaked in June and will fall rather quickly in the foreseeable future, i.e., through the end of the year.

The Labor Market’s Health

As we noted in our last blog, the unemployment rate is calculated from the Household Survey which showed -315K job losses (although that number was completely ignored by the media). The unemployment rate stayed at 3.6% because the denominator, the labor force, supposedly shrunk. The Household Survey showed up with negative numbers in two of the last three months and, historically, has been a better indicator of the health of the labor market than the headline Payroll Survey (+372K). Unemployment is a lagging indicator. Because employee turnover is expensive, businesses hold on to their employees for as long as they can, first reducing hours worked (and that’s what we are seeing). And that’s why employment data are lagging indicators. Thus, when the weekly Initial and Continuing Unemployment Claims begin to rise, one knows something sinister is afoot.

Initial Unemployment Claims rose +21K the week of July 8 (Not Seasonally Adjusted; +9K Seasonally Adjusted). Until this most recent report, Initial Claims had been rising, but slowly. But now, since the low point last spring, Initial Claims are up nearly +80K. Historically, once Initial Claims rise above 60K, recessions have typically followed. Initial Claims are a flow variable, meaning that Claims are now rising 80K per week. Doing the math, at the current rate, in 13 weeks (one GDP Quarter), there will be a million+ more people unemployed. So, this is not trivial.

Continuing Claims (those unemployed more than one week) also jumped +72K in the July 1 week (Continuing Claims are reported with a week-lag). That’s 72,000 people that were previously laid off who haven’t found another job. The total out of work for more than a week is now 1.4 million. What has happened to that tight labor market?

Not Keeping Up

To make matters worse, inflation has eaten into America’s standard of living. The first chart below shows that Average Weekly Earnings have been negative on a Y/Y basis since April 2021.

The next chart shows that the average employee is no better off today than they were in April 2019; that’s more than three years ago and prior to the Pandemic.

We also note that credit card balances have spiked as consumers have attempted to maintain their living standards. This, however, won’t last as credit limits are approached.

For several blogs, we have highlighted the University of Michigan’s Consumer Sentiment Index. The overall survey is at the lowest level in its 70+ year history.

And, it doesn’t look any better for the housing industry, the auto industry, or for the manufacturers and sellers of big-ticket items, like appliances, carpeting, home improvement etc. We’ve included the chart for houses below and note that recent headlines have bemoaned the fact that housing markets are cooling as interest rates have risen, and there have even been the first signs of falling housing prices in some formerly hot markets.

Final Thoughts

The next set of Fed meetings are the week of July 25. The bloated CPI numbers (remember, this is a lagging indicator) have put a 100-basis point (1 pct. point) rise in the Fed Funds rate into play. There are two possible reasons this Fed might raise the Fed Funds rate from its current 1.50%-1.75% range to 2.50%-2.75%. The first is that it is truly fixated on the 9.1% Y/Y rise in the CPI, a lagging indicator, which, as explained above, will be the peak for this cycle. The second, and in our view, more credible reason, is that they may want to get to a “neutral” policy position, which economists have calculated in the 2.50% range. Give the rapid deteriorating data, the July meeting may be their last chance to do so if, as we expect, the data shows Recession and falling inflation by the time they are scheduled to meet again (September).

In any case, we believe that at least a 75-basis point rate hike is a lock for the July meeting, but also believe that it will be the final or near final rate hike of this cycle because, by September, even the lagging economic indicators will have deteriorated to the point where they can’t be ignored and the inflation data will be moving to the downside. Finally, if indeed this scenario plays out (an end to rate hikes) after the Fed’s September meeting, the equity markets may respond positively.

(Joshua Barone contributed to this blog)

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Euro-Zone Economy Grew Less Than Estimated in Second Quarter – BNN Bloomberg

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(Bloomberg) — Sign up for the New Economy Daily newsletter, follow us @economics and subscribe to our podcast.

The euro-area economy grew slightly less than initially estimated in the second quarter as signs continue to emerge that momentum is unraveling.

Output rose 0.6% from the previous three months between April and June, compared with a preliminary reading of 0.7%, Eurostat said Wednesday. Employment, meanwhile, climbed 0.3% during that period.

While the data still suggest Europe’s economy was on a relatively firm footing coming into the summer, analysts worry that energy shortages will drive record inflation higher still, tipping the continent into a recession. A downturn lasting two quarters is now more likely than not, according to a Bloomberg survey, which puts the probability at 60%.

Inflation is expected to average almost 8% in 2022 — about four times the European Central Bank’s goal. Officials have stressed the importance of reacting forcefully to prevent expectations of higher inflation from becoming entrenched, though some economists question how far interest rates can be lifted if there’s a recession.

©2022 Bloomberg L.P.

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B.C.’s export economy continues to cash in on its Cascadian connections – Business in Vancouver

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It is well known that the United States is British Columbia’s largest export market and number one international commercial partner.

Even if the specific details of export magnitudes are not widely known, most people recognize that being physically adjacent to the world’s largest economy means B.C.’s trade will invariably be tilted to the south. A common language, similar business and legal environments, and previous trade agreements further augment this powerful cross-border trade orientation.

In a typical year, B.C. sends about half of its merchandise exports stateside. In 2021, the share was even higher: 55 per cent. China, a distant second, accounts for 15 to 16 per cent of the province’s international merchandise exports, followed by Japan at around 10 per cent.

Less well known is that the distribution of B.C.’s exports within the U.S. is similarly shaped by geography and the size of the various state economies. In particular, the three West Coast states – Washington, Oregon, and California – collectively absorb 45 to 46 per cent of the province’s U.S.-bound merchandise exports. We estimate that, if services are included, these three states buy more than half of everything the province sells to the giant American market.

When it comes to cross-border trade, geography and size matter – a lot. The I-5 highway, connecting coastal cities from San Diego through California to Portland, Seattle and Vancouver, with arteries extending into northern B.C., has long supported economic activity along the west coast of North America. It has also enabled steady trade growth. The built-up networks of railways, pipelines, electricity transmission lines and seaports and airports – and the sharing of a common time zone – all serve to reinforce the pattern and depth of commerce along the west coast.

Underscoring the point that geography matters, last year B.C. exported $9 billion in goods to next-door Washington state, equal to 30 per cent of U.S.-bound merchandise exports. In fact, exports to Washington state match the value of B.C.’s exports to China, the world’s second largest economy.

The size of the individual state economies is also a key factor shaping cross-border trade. California is the largest economy in the U.S., and one of the biggest in the world. So, it’s not surprising that California ranks as B.C.’s second largest individual state export market, taking nearly 12 per cent of our U.S.-bound goods.

Broadening the picture to include services, California stands out even more, given that it boasts world-class advanced technology and film and entertainment industries. California is also important as a source of international visitors to B.C. When service exports are included, our research suggests that California accounts for about one-fifth of the value of British Columbia’s U.S.- bound exports.

California is unique among the province’s trading partners in that service exports exceed merchandise exports in dollar terms. B.C.’s exports of film and television productions have increased sharply and are now close to $2.5 billion annually; the bulk of this involves business done with California. Also, California accounts for a disproportionate share of B.C.’s exports of scientific, technical and professional services and of technology-based services, and the state is also a leading supplier of international tourists to the province. In total, once tourism activity fully resumes, we project that B.C.’s service exports to California will soon exceed $6 billion, almost twice the value of our merchandise exports to the Golden State.  

In sum, international goods exports to B.C.’s three neighbouring coastal states amounted to almost $14 billion in 2021. With some educated guesswork, and assuming tourism fully recovers, service exports to these three states should soon reach $12 billion annually. Thus, the combined value of goods and services sold to California, Oregon and Washington amounts to almost $26 billion, equal to 55 per cent of B.C.’s total goods and services exports to the United States.    

An updated and more complete look at the direction of provincial exports and the role of the three coastal states in B.C.’s global trade underscores the significance of the “Cascadia” region in shaping the province’s economy. When services are counted, this dynamic U.S. region purchases an eye-popping 30 to 33 per cent of B.C.’s international exports.  And these are not stagnant markets; all three states have diverse, growing economies. This means there is scope to further deepen B.C.’s already substantial commercial ties with our West Coast neighbours.

Jock Finlayson is the Business Council of British Columbia’s senior adviser; Ken Peacock is the council’s senior vice-president and chief economist.

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Chipmakers Are Flashing More Warnings on the Global Economy – BNN Bloomberg

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(Bloomberg) — Mounting concern over semiconductor demand is sending shudders through North Asia’s high-tech exporters, which historically serve as a bellwether for the international economy.

South Korean behemoths Samsung Electronics Co. and SK Hynix Inc. have signaled plans to dial back investment outlays, while across the East China Sea, the world’s biggest contract chipmaker Taiwan Semiconductor Manufacturing Co. indicated a similar expectation.

Fading tech demand highlights a darkening picture as Russia’s war on Ukraine and rising interest rates damp activity. The following charts look at the chip industry and its implications for the world economy.

In recent weeks, major chip manufacturers Micron Technology Inc. Nvidia Corp., Intel Corp. and Advanced Micro Devices Inc. have warned of weaker export orders. 

Gartner Inc. predicts an abrupt end to one of the industry’s biggest boom cycles. The research firm slashed its outlook for revenue growth to just 7.4% in 2022, down from 14% seen three months earlier. Gartner then sees it falling 2.5% in 2023.

Memory chips are among the most vulnerable segments in the $500 billion semiconductor market to global economic performance, and Samsung and SK Hyinx’ sales of dynamic random access memory, or DRAM, a chip that holds bits of data, are central to Korean trade.

Next year, demand for DRAM is likely to rise 8.3%, the weakest bit growth on record, says tech researcher TrendForce Corp., which sees supply climbing 14.1%. Bit growth refers to the amount of memory produced and serves as a key barometer for global market demand.

South Korea’s exports are bolstered when demand outpaces supply in bit growth. But with supply likely to expand at almost twice the pace of demand next year, exports may be headed for a major downturn.

Signs are rising that trade is already starting to deteriorate. Korea’s technology exports slipped in July for the first time in more than two years, with memory chips leading the falls. Semiconductor inventories piled up in June at the fastest pace in more than six years.

Among potential victims will be Samsung, the world’s biggest memory-chip producer and a linchpin of Korea’s trade-reliant economy.

Samsung recorded rapid sales growth when demand was strong relative to supply. As the chip outlook turns gloomy, shares of Samsung have been declining this year, with occasional rebounds on better-than-expected profits.

Samsung and SK Hynix control roughly two thirds of the global memory market, meaning they have the power to narrow the gap between supply and demand. 

Memory is loosely tied to other types of semiconductors, built by firms such as TSMC that produces chips in iPhones, and Nvidia, whose graphics cards are used in everything from games to crypto mining and artificial intelligence. 

The Philadelphia Semiconductor Index, which includes these firms, has ebbed and flowed together with memory demand in recent years.

Korean exports have long correlated with global trade, meaning their decline will add to signs of trouble for a world economy facing headwinds from geopolitical risks to higher borrowing costs.

Micron Technology, the world’s third-largest memory maker, last week issued a warning about deteriorating demand, triggering a selloff in global chip stocks.

Korea’s stock market has been among leading indicators of the country’s trade performance, with investors dumping shares well before exports slump.

“The trend is important for Asia as its economic cycle is very dependent on tech exports,” said Alicia Garcia Herrero, chief economist for Asia Pacific at Natixis SA. “Fewer new orders and the large inventory pile-up mean Asia’s tech sector will see a long destocking cycle and a shrinking profit margin.”

The International Monetary Fund last month downgraded its global growth forecast and said 2023 may be tougher than this year. 

Deutsche Bank AG sees a U.S. recession starting in mid-2023 and Wells Fargo & Co. expects one in early 2023. A Bloomberg Economics model sees a 100% probability of a US recession within the next 24 months.

©2022 Bloomberg L.P.

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