Monday, February 27, 2017

Strategic Global Intelligence Brief for February 27, 2017


Short Items of Interest—U.S. Economy

Consumer Confidence
The data from the University of Michigan survey was a bit of a mixed bag this time. There was a slight decline from the high that was notched at the start of the year as it went from 98.5 to 96.3. The good news is that confidence levels are still well above what they were a year ago. This latest reading extended a three-month period with the best readings in over a decade. The levels of enthusiasm continue to be based on what people expect to happen. That causes some concern as the public has not been that patient in the past. If the expected growth doesn’t materialize or the expected moves do not play out, the levels may start to drop sharply. There is also evidence that confidence is now closely tied to whether one is for or against Trump.

Going After Regulations
The order to various federal agencies seems simple enough, but this approach has been tried many times in the past. It is never as easy as it should be. The order from the president was to create task forces within each agency with the mission to look at all the regulations and weed out those that are not helpful. The test is to determine if they make life better or safer for Americans and do they promote or impeded growth. This is immensely slippery as one can make the case for almost every regulation if one wants to—even the ones that would seem to be ludicrous. Every president in the last 30 years has tried something like this. Yet, we still have a great many complaints regarding the regulatory system.

Durable Goods Orders Up
That is the good news. The bad news is that almost all of this gain was due to additional orders for civilian and military aircraft. This is the vexing part of the durable goods numbers. They can be skewed by the activity in the aerospace sector which tends to obscure what is happening in the rest of the manufacturing community. Since the start of the year, there has been a slowdown in the purchase of machinery, although there have been gains in the level of capital expenditure. It is still a little early to determine what the intent is as far as durable goods purchasing as there have been as many inhibitors as there have been encouragements.

Short Items of Interest—Global Economy

China Loses Pay Advantage
Wages in China have been rising steadily since the rapid growth period in that nation. Now they are generally above states like Mexico, Brazil and most other Latin American countries. In another year, the trends are that wages in China will be above those in Greece or Portugal. This has drastically altered the Chinese value proposition as there have always been complaints about the cost of regulation and transportation. China is simply not the low-cost production center that it was once. There are many companies in China that have an incentive to reduce the size of their workforce in reaction to these higher costs.

Macron Pulls Ahead
The latest polls in France show that Emmanuel Macron is starting to pull ahead of Marine Le Pen in the presidential contest. If the vote were taken right now, the election would be between Macron and Le Pen. He would have the advantage as many who supported François Fillon and Benoît Hamon would likely support him in order to thwart Le Pen. His policies have not necessarily resonated with either the right or left, but the strident populism of the National Front has many worried about the future path of the country.

Indian Concern Deepens
The attack on two Indian engineers that resulted in the death of one has shaken the Indian political and business community. It is not that anybody sees a bigger plot in the attack by a severely depressed man with severe alcohol addiction, but the response from the Trump White House has been judged inadequate. The anti-immigrant rhetoric is seen as giving people permission to strike at the communities they dislike. Indian leaders are seeking assurance that this is not the case.

Lots of Talk and Lots of Reaction this Week
This will be a week where the economy is expected to react to all kinds of announcements and speeches by those people and institutions that matter the most to the business community as well as the consumer. There will be a speech by Trump that is scheduled to get into some specifics as far as the budget is concerned. There also will be additional comments by the Fed along with some data releases that could shed some light on consumer and business confidence. Some global releases will be worth watching as well. This is the end of the month and generally brings a lot of new data and observations.

Analysis: The budget discussion from the White House will be interesting. Thus far, it seems to contain few surprises. This is the budget that has been in development since the start of his term and is likely to garner as much opposition from Republicans as Democrats. There is no attempt to cut the so-called “entitlement” programs such as Social Security, Medicare and Medicaid. This was a campaign pledge to be sure, but there has been a desire to trim all of these by such GOP leaders as Mick Mulvaney (Rep. from South Carolina) who is now the head of the Office of Management and Budget as well as Speaker of the House Paul Ryan. There is a desire to increase defense spending. Then there is the desire to spend one trillion on infrastructure. The cuts are to agencies that have not been popular with either Trump or the GOP such as the EPA and other regulatory bodies. The real issue here is that the budget plan proposed by the president is not much more than an advisory or a wish list as the budget is the responsibility of Congress. This is something that promises a great deal of partisan fireworks.

Speaking of partisan fireworks, there has been an interesting development as far as consumer confidence is concerned. The latest edition of the Conference Board survey is due out Tuesday. Most analysts are expecting a slight dip as some of the enthusiasm has started to fade. The surveys that have been conducted thus far show that there is now a sharp difference between levels of excitement based on politics. Those who call themselves Trump supporters are generally more upbeat than those who are not supportive of Trump. This has translated into their expectations for the economy through the remainder of the year. Business confidence is holding pretty steady, but the variability is entirely connected to the impact that policy may have on that business. Importers are far less enthusiastic than are exporters, the oil sector is happier than the health care sector and so on.

Wednesday will see the release of the Personal Consumption Expenditure index—the measure the Fed prefers as a means by which to monitor inflation. The expectation is that it will have risen a bit over what it was last month and may rest at around 1.6% to 1.7%. This remains short of the Fed goal of 2% inflation, but it is closing in on it. This higher reading should provide some further justification for a rate hike as early as March. One of the most dovish of the Fed governors is Lael Brainard. She has now started to talk about the virtues of higher interest rates and the lack of motivation for continued stimulus. On Friday, Janet Yellen will give the last big speech before the Fed meets in March. There will likely be iterations of support for that hike.

Speaking of inflation, there will be a report on Thursday from Eurostat. It suggests that inflation is over the targeted rate for the first time in four years. This is not expected to change the course of the ECB as most of that increase was due to higher energy prices and therefore not part of core inflation—which is still expected to be under 1.0%. The bottom line is that Europe is not seeing real inflation yet. That allows the ECB to keep rates as low as they have been. A report from China will give some insight into the state of the economy as the latest Purchasing Managers’ Index (PMI) is expected to show a very slight decline from last month’s levels. The PMI will still be above 50 suggesting there continues to be reaction to the stimulus efforts undertaken by the country over the last year.

Who Replaces the Immigrant?
If the plans to reduce the number of immigrants (legal and illegal) do succeed, there will be an almost immediate impact on several sectors of the economy. The studies have all reached the same conclusion; the most affected sectors will be agriculture, construction, food service and the hospitality sectors. For the most part, all of these have one thing in common—low pay. The work is often very physically hard. Many of the jobs in the farm sector are also nomadic. Generally speaking, these have not been jobs that are sought after by the majority of Americans—even if they have been out of work for an extended period of time.

Analysis: The vast majority of those who are out of work in the U.S. right now are in urban areas, lack skills and most have children. The number of single-parent households is significant. That makes them unlikely to relocate—especially for a low-paying job. The businesses that employed immigrants are faced with tough financial decisions. They can elect to pay enough to get Americans to take these jobs, but that will mean much higher prices to the consumer. They can also invest in more technology so that they do not depend on those workers as much. Evidence suggests that this is exactly what has been taking place.

The farm sector is moving rapidly towards robotics and automation and so is construction wherever possible. The food service and hospitality sector is adjusting as well with more emphasis on reducing the work for those in that sector. This trend is similar to the process that retail has gone through—self-service kiosks as an alternative to counter help. There will always be some need to hire people, but if the business is facing far higher costs for that employee, they will have an incentive to replace as much of that work as possible by technology and robotics.

Unilateral Trade Sanctions Sought by Trump
During the campaign and in the first few weeks of the administration, the most hotly pursued topic was trade. It is the perception of Trump and many of his advisors that global trade has been bad for the U.S. and that many of the current economic issues can be laid at the feet of globalization. This is a position that has come under severe criticism from many economists and goes counter to the positions that have generally been held by the GOP. In fact, there has been some odd common ground between the Trump positions and those taken by the anti-trade Democrats over the years. The fact is that many of the arguments that have been made against past trade policy ring true to an extent.

Analysis: The latest iteration of the anti-trade position is the desire to bypass the World Trade Organization when there is a trade dispute. The U.S. wants to be able to pursue sanctions against countries that are deemed to be competing unfairly without having to go through the WTO process. Most of the time, the U.S. has gotten its way through the WTO, but this is due to the fact that countries are generally careful to bring only those cases they think they will win. There are many situations where the U.S. would like to punish other nations, but the sense is the WTO would not rule in their favor, so the decision is made to back away. The new plan would encourage the U.S. to go ahead with unilateral sanctions against countries it thinks have acted in a discriminatory fashion.

The reason that institutions such as the WTO were created in the first place was to avoid the outbreak of trade wars between nations and to bring the full force of the global community to bear against unfair trade practices. The WTO sanction is a universal one and generally causes a reaction while the individual action rarely has the desired impact. The offending nation simply shifts its attention to some other market and doesn’t alter its behavior.

The primary fault as far as U.S. trade policy is concerned has been the fact that too many pacts have been motivated less by the economics of the situation and more by geopolitical considerations. The Trans-Pacific Partnership (TPP) was a good example. The idea was to put together a pact that would serve to isolate China and pull the various Pacific nations closer to the U.S. The means to that end was to provide a whole variety of concessions to these nations to encourage them to take positions that would likely irritate the Chinese. They were to get access to the U.S. market for their manufactured goods and for their agricultural output. The U.S. got very little access to their markets in return. The TPP was rejected—likely for the best as far as the economy is concerned, but not good as far as the politics.

If the U.S. insists on going it alone on trade sanctions, there is a real risk of isolation and blowback. The U.S. remains an export-dependent country that relies on these foreign sales for at least 14% of the GDP. If the U.S. starts to get cut off from these markets, the impact will be swift and uncomfortable. This situation gets all the more serious when one realizes the dollar is only slated to get stronger over the next year or two. The combination of a strong currency and export restrictions could drag the U.S. economy down quickly.

Is the Threat of Secular Stagnation Over Already?
The theory (and that is what it has always been) was that the global economy was heading towards a long period of stagnation along the lines of what Japan has been experiencing for the last couple of decades. The idea was that very low rates of global growth and falling interest rates were being caused by one of two things. This was either inadequate global demand caused by low rates of business development, excessive savings rates in Asia and the wide gap between those with money and those without, or there was a supply issue caused by low rates of productivity and slow growth in the labor force. Most asserted that both of these were taking place and that was why the global economy was stalling. Suddenly, there has been a shift. It appears that conditions are changing enough to reduce the possibility of that secular stagnation.

Analysis: There has been little change as far as global supply is concerned—productivity is still down and the labor force concerns are as real as ever. What seems to have changed and fast is global demand. There has been a surge in both consumer and business confidence. It has been taking place all over the world. There are many factors likely at work here, but at the top of the list is reaction to all the stimulating that has been taking place. The central banks have tried to point out for years that reactions to low interest rates take time. It has been several years and now the energy is starting to be felt.

This is Probably Not Nice
The truth is that I really don’t much like having to travel on Sundays—this is my favorite day of the week for just kicking back and enjoying the company of my wife and the feline five. So, when I do have to jump on a plane, I am a bit disgruntled to begin with. The flights were pretty uneventful, but the short hop from Las Vegas to Burbank offered an opportunity to be a little snarky.

The young woman stuck in the middle seat was a true California vision—short tight dress, sunglasses, stylish coiffure—the whole nine yards. She was obviously quite put out that she was going to have to inhabit that middle seat between two old guys in suits. She was shooting looks that said “don’t you geezers attempt to chat me up.” She need not have worried as I had no reason whatsoever to engage her and neither did the other guy. We both clamped on our headphones and dove into our books. This started to make her nuts—didn’t we see that she was beautiful? To be honest, I have never been attracted to this style and found it very easy to ignore her. She started to try to get some of our attention and to evoke some reaction, but to no avail. She wiggled and squirmed and finally even tried to talk to us, but got nothing but brief nods as we returned to the books. When we finally landed and left the plane she was really miffed and glared at both of us. That was when the other guy spoke to me and commented—“she seems never to have been loved if you ask me. She can’t conceive of a guy that thinks he is the luckiest man in the world to be married to his wife.” All I could say was “amen brother.”