The initial fiscal response to the pandemic in the U.S. was several rounds of “helicopter” (free) money, a very generous and lengthy addition to the level of unemployment benefits, and a set of new unemployment programs (called Pandemic Unemployment Assistance (PUA) programs) for those not covered by the pre-pandemic state unemployment system. One result was an additional $300/week for 75% of those covered by state programs (some states, representing 25% of those in the state programs opted not to pay the federal $300/week supplement).
But, the larger portion of the fiscal stimulus was the PUA. For much of 2021, between nine and twelve million received such benefits. Both the PUA and the $300/week unemployment supplement ended in early September. Suddenly, this throng stopped receiving a weekly check.
During Q2/21 and part of Q3, the large federal checks sent to households caused a resurgence in consumer spending. Auto sales, for instance, had a record month in April. Retail, too, recovered to its pre-pandemic levels, although the sector weights differed (more goods, less services). But, now, with the worry about the Delta-variant, the cessation of most unemployment benefits, and the end of the eviction and mortgage payment moratoriums, the Q4 outlook for consumption, the major driver of GDP, has dimmed.
Major economic forecasters lowered their Q3 real GDP growth forecasts in late September to the 3% area from the7% level they had forecast as late as August, and now that the weekly checks have dried up and landlords and financial institutions can pursue back rent/mortgage payments, we believe Q4 consumption spending will plummet. In fact, it is not beyond the pale of probability that Q4 could show negative real GDP growth. Furthermore, this is not just a U.S. phenomenon. The world’s second largest economy, China, has already shown significant growth recession and outright contraction in some heavy industries. And the huge leverage in their real estate market is now unwinding as seen with the Evergrande fiasco. Evergrande is a Chinese real estate development company with $300 billion of debt, and it looks like the major losers will be the offshore, dollar denominate bond holders. Since real estate represents 30% of China’s GDP, business contraction appears inevitable.
As of the September meeting set, the Fed appears to have become more hawkish. We can’t see why, as the economy looks to be much weaker. Perhaps they are just going along with the media’s fixation on “stagflation.” Specifically, Fed Chair Powell said the Fed is now thinking about “tapering” its asset purchases, which in lay terms means reducing its monthly money printing of $120 billion via the open market purchases of Treasuries and Mortgage-Backed Securities. We think this is long overdue since the banking system is swimming in liquidity as seen in the record levels of overnight reverse repurchase agreements (banks selling their excess reserves back to the Fed for a meager .05% (.0005; equivalent to $1.37/day per million).
During each Fed meeting, the 18 Federal Open Market Committee (FOMC) members indicate their view of where the Fed Funds rate (overnight borrowing rate the Fed charges banks who need reserves – none of them do, but theoretically, if they did, they would pay this rate) will be over the next few quarters. This is known as the “dot-plot.” At the September Fed meeting, 9 of the 18 now believe that there will be at least one Fed Funds rate hike (of .25%) in 2022, and a few believe there will be two such hikes. At the August meeting, only 7 of the dots indicated a 2022 rate hike. This is one reason that longer-term interest rates have spiked higher in recent days.
The second reason for the rate spike was the impending restrictions on Treasury debt and spending, and possible “technical” default on some T-bills if Congress didn’t raise the debt ceiling in a timely fashion. (On Friday, Congress did vote to move this issue back to late December, and bond yields gave a small amount of the rate spike back.)
Rosenberg Research examined the forecasting record of the “dot-plots” since their 2012 inception and found them to have almost no correlation with what actually happened; in other words, the “dot-plots” have been horrible at forecasting how the Fed Funds rate actually moves. Fed Chair Powell indicated that the employment picture was approaching the very murky “substantial further progress” standard the Fed will require prior to raising rates. The official statement says that “if” employment progress continues (which we think is a given since the overgenerous unemployment benefits have now ended), the Fed “may” begin to “taper” its asset purchases. We certainly hope so. But there is really nothing here (except the dot-plots themselves – which Powell said a an earlier press conference to ignore as far as official policy is concerned) that says that interest rates will rise. And, if the economy continues to weaken, as we think is already in progress, the Fed has no obligation to raise rates or even to taper the asset purchases.
Much of the media’s inflation hysteria is due to base effects, i.e., the fact that prices nose-dived during the initial months of the pandemic due to lockdowns. A return to pre-pandemic prices makes it look like there has been inflation because the denominator is artificially depressed. The chart at the top of this blog shows Y/Y changes in the CPI expressed as annual rates. The blue line is the reported Y/Y increase in prices using 2020 as the base. The tan line is the same except the base is 2019 instead of 2020, and the price change is “annualized.”
Using 2019 as the base, it is clear that there has been an acceleration in the CPI to the 3% area. While this is somewhat elevated by recent standards, it is nowhere in nosebleed territory as the media would have the populous believe.
Furthermore, much of the inflation is commodity based (lumber is the poster child). Prior to the Evergrande collapse, China’s economy was already slowing. August retail sales showed up at +2.5% Y/Y. That number was +8.5% Y/Y in July, and the consensus estimate for August was +7.0% (a huge miss). On a M/M comparative basis, August was -5.0% on top o f July’s -3.2%. The three-month trend is a whopping -27% (annual rate). Construction there is down -3.2% YTD, and steel output is at a 17-month low. Since China is the largest consumer of commodities, the significant slowdown there implies the end of the commodity upcycle. We expect downward price pressures to emerge.
As far as wage inflation is concerned, the Atlanta Fed’s wage tracker, the gold standard for monitoring wage issues, is in a very mild uptrend. But all the wage growth is in 10% of the jobs pie (16-24 year-olds, unskilled, high school education, in the leisure/hospitality sector). The other 90% of the job holders are not seeing wage growth acceleration.
Another critical/negative impact on the economy’s Q4 growth is the end of the eviction and mortgage payment moratoriums. The 11 million renters who are behind on their rent must now use their cash to pay that rent; most of them must also begin to pay back rent. As a result, that rent and back-rent will no longer be available to consume.
Nearly every Fed September survey says the economy has slowed and continues to slow dramatically.
China’s Manufacturing PMI fell into contraction (49.6 September vs. 50.1 August; 50 is the demarcation between expansion and contraction) for the first time since the lockdowns of early 2020. China’s real estate sector makes up 30% of its GDP, and with the Evergrande default, an implosion in that sector has started. That means China won’t be needing the raw commodities it has been so voraciously consuming, and commodity prices should retreat. That will help quell the “stagflation” narrative.
Initial Unemployment Claims (ICs) in the state programs stopped improving in mid-August and rose substantially in mid-September as seen on the righthand side of the chart. ICs are a proxy for new “layoffs,” and is another indicator of economic softness.
The next chart showing total Continuing Unemployment Claims (CCs) looks like a winner, as CCs fell from 12.1 million to 5.0 million (i.e., -7.1 million).
Unfortunately, this didn’t happen because employment improved. It happened because the PUA Programs ended in early September. PUA CCs, alone, fell by -8.6 million between the weeks of August 28 and September 25. The latest data for state CCs is for the week of September 11. We expect to see a continuation of the fall in this number as the remaining weeks of September are reported.
Is this good news? While consumption will fall because these programs ended, data analysis clearly shows that the PUA programs disincentivized lower wage and lower skilled workers from working. Why work when the government pays as much or almost as much as a 40-hour work week? This has caused worker shortages in many service-related industries, causing employers to raise starting wages to attract workers. But that appears to be where it ends. As noted above, the Atlanta Fed Wage Tracker shows rising wages only in that skill/age subset which represents about 10% of the working population. Now that the federal programs have ended, we believe that the available jobs will start to fill, as most need some sort of paycheck in order to live. Thus, our expectation is that the official employment data for the immediate months ahead will be rather robust, but not fast enough to halt the economic slowdown that is currently in progress.
Housing, a substantial contributor to U.S. GDP, appears to have peaked some months ago. That shouldn’t be a wonder as home prices have risen 20% Y/Y. That’s where the real inflation resides:
- Housing starts peaked in March
- New home sales peaked in January
- Mortgage purchase applications peaked in January (and are down -18% since)
- Existing home sales did rise in August, but they are still well below their Q4/20 levels
Stocks and Bonds
The equity markets seem to have gotten a whiff of what appears to be a worldwide economic softening trend. China appears to be shooting itself in the foot with government actions against its large private companies. The Evergrande fiasco there makes near-term economic contraction appear to be inevitable.
In the U.S., the S&P 500 lost nearly 5% in September. Those equity markets remain volatile as we begin Q4, and now appear to have a downward bias.
Interest rates spiked in September’s second half on the belief that the Fed had turned hawkish and would raise rates sooner rather than later. In addition, markets worried that the Congress wouldn’t increase the debt ceiling and that possibly could lead to a technical default on some maturing Treasury paper. Late last week (week ended October 2), Congress pushed the debt ceiling issue out to late December. It is our view that the emerging softness in the world’s two largest economies will cause the Fed to delay rate hikes, and that a substantial reversal of the September rate spike will occur as Q4 unfolds.
(Joshua Barone contributed to this blog)
Swiss National Bank Warns of Risks With Green Economy Push – Bloomberg
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Actively pushing for a green transformation of the economy could undermine the effectiveness of the Swiss National Bank’s monetary policy, Governing Board Member Andrea Maechler said.
UBS logs surprise 9% rise in Q3 net profit
UBS posted a 9% rise in third-quarter net profit on Tuesday, as continued trading helped the world’s largest wealth manager to its best quarterly profit since 2015.
Its third-quarter net profit of $2.279 billion far outpaced a median estimate of $1.596 billion from a poll of 23 analysts compiled by Switzerland’s largest bank.
“Our business momentum, our focus on fueling growth, on disciplined execution and on delivering our full ecosystem to clients – all of this led to another strong quarter across all of our business divisions and regions,” Chief Executive Ralph Hamers said in a statement.
In each of the last four quarters, UBS saw double-digit percent gains in net profit as buoyant markets helped it generate higher earnings off of managing money for the rich.
From July through September, favourable market conditions, and higher lending and trading amongst its wealthy clientele, unexpectedly helped raise earnings over the bumper levels reported in the third quarter of last year.
(Reporting by Oliver Hirt and Brenna Hughes Neghaiwi; Editing by Michael Shields and Edwina Gibbs)
America Inc and the shortage economy – The Economist
IF YOU LOOK only at the scale of the profits cranked out by American businesses, they seem to be indestructible (see chart). Despite a pandemic and a savage slump in 2020, large listed American firms’ net income for the third quarter of this year is expected to reach over $400bn, at least a third higher than in the same quarter in 2019. Yet as earnings season gets into full swing this week, bosses and investors are watching for signs that three related worries are biting: supply-chain tangles, inflation, and hints that a long era of profitable oligopolies is giving way to something more dynamic and risky. Already big firms such as Snap, Honeywell and Intel have given the jitters to investors. Could there be more to come?
Only a quarter or so of firms in the S&P index have reported results so far. Those that have done so have pleased investors with better than expected figures. Superficially the picture is of “back to business as usual”. Bad-debt provisions taken by banks in the depths of the panic over the economy, which proved unnecessary, have been unwound. JPMorgan Chase got a $2bn benefit to its bottom line from this reversal in the third quarter. Goldman Sachs has shelled out $14bn in pay and bonuses so far this year, up by 34% year on year. American Express reported a leap in revenues as small firms and consumers spent on their cards more freely. United Airlines confirmed it was on track to hit its performance targets for 2022.
Yet look again and the three worries loom. Start with supply chains. The number of ships waiting off California’s big ports remains unusually high at about 80, according to Bloomberg. On 22nd October, Jerome Powell, the chair of the Federal Reserve, said that supply-chain problems may last “well into next year”. The knock-on effects are feeding through industry. Union Pacific, a railway firm, lowered its forecast for traffic volumes because semiconductor shortages (often in Asia) have hit car production, in turn reducing the number of vehicles and components transported by rail. Honeywell, an industrial firm, cut its full year sales target by 1-2% complaining of a shortage of parts. VF Corp, which makes shoes (including white ones that fans of Squid Game, a hit TV show, hanker after) complained of supply-chain problems in Asia. So far the problem is not disastrous but it is inflating costs and forcing firms to adapt.
This supply chain headache is one element of a second, broader worry, about inflation and its impact on profits. Commodity prices are a source of pressure, with crude oil reaching $86 a barrel this week. Wages are too: although there are still 5m fewer people employed across the economy than before the pandemic hit, average hourly pay rose by 4.6% year on year in September. The immediate effect tends to be felt by low-margin firms that employ a lot of people: Domino’s Pizza has complained of a “very challenging staffing environment” and falling sales.
Elsewhere a mild inflationary mindset is slowly infiltrating boardrooms. Procter & Gamble predicted that commodity and freight inflation would raise its operating costs this financial year by about 4% and that sales would rise by up to 4%, owing to a mixture of price rises, and volume and mix effects. Honeywell warned there would be a “continued inflationary environment” in 2022. All firms are weighing how much they can raise prices to compensate for higher costs. So are fund managers who are busy running screens for companies that they judge to exhibit the all-important quality of “pricing power”. The shifting psychology of bosses and investors towards expecting more inflation should concern Mr Powell at the Fed.
The final big issue is whether an economy with shortages that is running hot ultimately forces an end to the managerial consensus of the past decade, which has favoured keeping margins high and being stingy with investment in order to maximise short-run cashflow. Already there are signs that attitudes are shifting in response to shortages and pent-up demand: economy-wide investment, excluding residential investment, rose by 13% in the second quarter of 2021 compared with the preceding year. United Airlines has said it will increase its capacity on international routes by 10%. FreePort McMoRan, a huge miner of copper (used in electric vehicles among a wide array of industrial applications), has said that it is “prepared to make value enhancing investments in our business” in response to red-hot prices. Hertz has announced an order of 100,000 cars from Tesla. And on Wall Street a fund-raising bonanza for speculative start-ups continues, including last week the merger of a special-purpose acquisition company with the social-media ambitions of a certain Donald Trump.
Rising investment is exactly what economists want because it increases capacity today and boosts the economy’s long-run potential. Yet whether investors are prepared to take the plunge remains to be seen. Habituated by years of high margins, they tend to run shy of rising investment and competition. Snap’s share price dropped by over 20% on October 21st as signs that the war over privacy settings on the iPhone between Apple and social-media firms, and the intensifying competition in advertising between a wide array of tech firms, is hurting its results. And Intel, which earlier this year boldly announced plans for a huge rise in investment in order to return to the frontier of the semiconductor industry, alongside TSMC and Samsung, presented Wall Street with the bill in the form of much lower than expected short-term earnings: its shares dropped by 12%. If you run a company or invest in one this is the new calculation: demand is recovering and costs are rising. Can you raise prices? And should you expand capacity? By the end of this earnings season the answer may be clearer.
Swiss National Bank Warns of Risks With Green Economy Push – Bloomberg
Saint John saw record real estate prices. So why did assessments barely budge, mayor asks – CBC.ca
Sask. to offer monoclonal antibodies to some COVID-19 patients – Flipboard
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