Friday, July 19, 2019

Strategic Global Intelligence Brief for July 19, 2019

Short Items of Interest—U.S. Economy

Small Hike in New Claims for Unemployment
The summer is a period of job volatility as one would expect. There are sectors of the economy that temporarily boom as people head out on vacation and there are sectors that slump. The auto industry often lays people off for a month or two while the plants are retooled. While they are out of work, they get unemployment. The teachers in some areas are able to draw unemployment during the summer as well. The latest data showed that claims for unemployment were up a little this past week, but overall, there has been little change and the job market remains steady. The shortage of qualified workers remains the most vexing issue for business.

Minimum Wage Debate
As expected, the Democrats in the House of Representatives passed a bill that would increase the federal minimum wage to $15 an hour in the next six years. The bill is largely symbolic as it stands no chance of passage in the GOP-dominated Senate. This has been an issue that has preoccupied economists for years as there are arguments that can be made for opposing and supporting the idea. It would certainly benefit those who would see a raise and it would boost consumer activity. The major problem is that many low-wage workers will lose their jobs as businesses strive to keep their labor costs under control. The people who have the lowest skill level are the ones at the greatest risk as many will be replaced by machines and robotics in some manner.

Slight Rise Expected as Far as Consumer Confidence Is Concerned
The University of Michigan consumer survey is due out today and is expected to be slightly more upbeat. No really big changes, but the fact that consumer sentiment has held on as long as it has is bit of a surprise. The sense had been that consumers would be heading into a bit of a funk by now with all the worries about the trade war and the upcoming political battles. Thus far, they are more motivated by the good unemployment numbers and the continued lack of inflation.

Short Items of Interest—Global Economy

Europeans Weigh in on Trump Attacks
The furor over the remarks Trump made regarding four Democratic congresswomen has now reached Europe. Germany’s Angela Merkel has rebuked Trump for his “racist rant.” The animosity between Merkel and Trump is certainly nothing new, but several others in Europe have expressed similar feelings. It remains unclear whether this attack was Trump expressing his personal animosity or a political ploy. If it is the latter, the Democrats have walked squarely into the trap as it has made these four women the face of the Democrats to many voters. Merkel has called this out and warned the Democrats to avoid losing control of their own identity as she has seen a similar process play out in German politics.

Spanish Government Remains in Flux
The Socialists are trying to put together a workable government, but they lack a majority in the parliament and must rely on allies to get anything passed. The government of Prime Minister Sanchez does not want to form a formal alliance with the hard-left Podemos group as that would likely cause their centrist allies to defect, but Podemos is refusing to cooperate with Sanchez unless they are offered that formal affiliation. This has created a stalemate that will make it hard for Sanchez and the Socialists to pursue the reforms they had promised.

Ebola Outbreak in DRC
The surge in cases of the Ebola virus in the Democratic Republic of Congo (DRC) has prompted the World Health Organization to issue an emergency declaration. The situation is not yet as dire as it was in West Africa a few years ago, but given the war-torn nation and the almost complete absence of government in many regions, there is considerable fear.

What Lagarde Means to ECB
The choice of Cristine Lagarde to be the new head of the European Central Bank (ECB) was shocking on several levels. The first is that she wanted the job in the first place as she has seemingly been very happy with her role as the head of the International Monetary Fund (IMF). Remember that she came into that post at a very sensitive moment and has been credited with rescuing the reputation of the organization after the scandals surrounding the previous head—Dominique Strauss-Kahn. Beyond the fact that many were surprised at her interest, her credentials are unusual for this position. In past years, the head of a central bank had to come with extensive background in banking or economics. This has not only been true of the ECB but for almost every central bank in the world. Of late, there has been interest in selecting people with different skill sets to better fit a different central bank environment. Lagarde is a diplomat and a lawyer with extensive experience as a communicator. She relied heavily on the analytical team at the IMF and in her previous positions in the French government. She has never made excuses for this approach. It is very likely that her style and experience as a negotiator is what made her appealing.

Analysis: She will face three tough areas which will test that negotiating prowess sooner than later. Her first challenge will be in managing the governing board of the ECB itself. The men and women on that board represent some widely varied approaches to ECB policy. On one extreme she will have Jens Weidmann from the German Bundesbank who was thought to be the favorite to replace Mario Draghi. He would have been radically different than Draghi as he has been a consistent critic of the bank’s stimulus efforts, bond programs and the like. He is the ultra-hawk and represents Europe’s economic engine. On the other extreme are some of the representatives of the southern tier states that want to expand all of the stimulative plans that had been offered up in the past. Should the ECB be aggressive in terms of growth or cautious in terms of inflation? This will be a fundamental question for Lagarde and she will have ardent opposition no matter what she chooses to support.

Her second challenge will be with the other financial leaders of the EU. The finance ministers will all be expressing their opinions and will likely support the positions of their national representatives to the ECB. They have only indirect influence on the decisions of the ECB, but policies supported by the ECB require the engagement and cooperation of European governments. There are still many in Europe that require bailouts and rescues. There is very definitely bailout fatigue in Germany as well as France.

The third area will be her relationship with the other global central banks. The dominant player in the world of central banking is the Federal Reserve of the U.S. She will likely have a good rapport with Fed Chair Jerome Powell, but most definitely not with Trump. She will also have to develop a new relationship with the Bank of England as Mark Carney is stepping down. Then, there is Haruhiko Kuroda from the Bank of Japan and several of the second-tier banks such as Reserve Bank of India, Reserve Bank of Australia, Bank of Canada, Bank of Mexico, etc. This may well be her greatest strength as she has had occasion to work with many of these leaders in her capacity as IMF head.

Turkish Shift
The relationship between Turkey and the U.S. has fallen to the lowest point in decades. The animosity between Presidents Erdogan and Trump has become palpable and Turkey has reacted very harshly to the pressures that have been imposed by the U.S. This shift has been developing for years and is attributed to the emergence of Erdogan as an authoritarian leader. The conflict with the U.S. has been accelerated as the U.S. has been engaged with the conflicts in Iraq and Syria—mostly due to the fact the U.S. has engaged with the Kurds. The Kurdish question is enormous in Turkey as Erdogan has made them enemy No. 1. The Trump sanctions on Turkey have further angered the Erdogan government and now Turkey has taken a radical step.

Analysis: The decision to purchase a missile defense system from Russia shakes the Turkish relationship with NATO to the core. It will no longer be allowed to fully participate as this defense system comes complete with Russian advisors and operators. The Turks have essentially signaled to the U.S. and Europe that it has options. Russia and Turkey were once at odds and NATO saw Turkey as a front-line state, but those days are over. Turkey is entering the Russian orbit as Putin welcomes Erdogan with open arms. The U.S. is likely to lose its military presence in Turkey sooner than later.

Three (or Maybe Four) Theories Regarding Interest Rates
There are not many activities that investors seem to enjoy more than trying to predict the actions of the Federal Reserve as well as the other central banks in the world. It is obvious why this becomes such a preoccupation given the role these rates play in everything from bond value to the activity of the corporate community. In past years, the Fed chairs were very careful to keep information to themselves and seemed to delight in keeping the investment community off balance. Alan Greenspan was not called “the Sphinx” for nothing. Today, the central banks around the world are committed to policies of transparency and openness. This has not stopped investors from spending a lot of time puzzling out what they think the Fed is thinking from one meeting to the next. There are at least three theories regarding what the Fed’s Open Market Committee is likely to do with the Fed Funds rate: leave the rates right where they are for another few months, lower them by a quarter point or lower them by a half point. It is highly unlikely, but there is a fourth possibility: hike them by a quarter point.

Analysis: The level of interest rates is the fundamental tool a central bank uses to affect the economy. The presumption is that higher rates discourage borrowing and lending, and lower rates encourage borrowing and lending. The Fed has dual mandates to both promote job growth and to stave off inflation. The interest rate tool is far more efficient at the latter than the former. Traditionally, the Fed concentrates more attention on inflation than on expansion—leaving the stimulating mostly to the legislature and the executive. It is assumed by many that controlling inflation is the only motivation for hiking rates, but there are other considerations. If rates are low, it is hard for small banks to make money as they have a hard time attracting deposits. Low rates also contribute to reckless borrowing as we have seen of late and they affect the value of the currency.

The Fed watches and examines the state of the economy with an eye towards the future as it knows that changes in the interest rate take several weeks and perhaps months to work through the economy. At the start of the year, it appeared there was sufficient growth to justify a steady position on rates. The U.S. had been growing at around 3% for the bulk of 2018 and the start of 2019 was also robust. The betting was that Fed policy would remain unchanged and that rates would stay at 2.5%. There was no motivation to push rates up as there had been no sign of either wage inflation or commodities-based inflation.

By the end of the second quarter, the situation had changed and many were suggesting rates needed to come down. The consensus view is the growth rate had started to fall, although the more recent data has indicated that growth will be around 2% as opposed to the 1.8% that had been forecast earlier. The consumer has been coming to the rescue with better retail performance, but there are still worries about the future of the U.S. export sector. The trade wars and tariff wars have been more bark than bite thus far, but none of the threats have been eliminated completely. That keeps the analysts on edge. It has been the status of the global economy that has been worrying the Fed. It has suggested that if rates go down, it will not be because the U.S. economy is in trouble—at least not right now. The sense is that the Fed wants to be cautious about all this and will only lower rates by a quarter point.

There are a few who assert that a half-point reduction is in the realm of possibility as the Fed may want to make a real statement and give the economy a jolt. Thus far, this is a minority position, but the argument can be made if one accepts a few assumptions. The first is that all these trade-related threats will come to pass in one way or another. This will mean a drastic reduction in U.S. exports and a much higher price for consumers. That inflation could also trigger caution by the Fed, but the presumption is the Fed will react to the growth issue more than the inflation issue. Another assumption is that flushing the economy with cheaper money will be stimulative. That is a big assumption given that most companies are struggling to find the labor force they need to expand.

The Fed is not nearly as inscrutable as it has been in past years, but there remains a desire to keep some of its cards close to the vest. Meanwhile, there will rarely be definitive statements regarding intent. The best that can be gleaned is what the Fed members are watching and how they would be likely to react.

New Labor Secretary?
The resignation of Alexander Acosta has opened up another Cabinet-level post. The presumed nomination to replace Acosta is Eugene Scalia—the son of the late Justice Antonin Scalia. He served as solicitor for the Labor Department during the Bush administration and is a partner in a law firm that specializes in labor issues. His position is generally pro-employer, but he has been criticized by those in the Democratic Party that favor expanded protections for unions and workers in general. He has taken strong positions on labor negotiations and recruitment as well as right to work.

Analysis: One of the areas that Acosta was working on was labor force development. It had been a priority during his tenure and there are several programs in place designed to train more people for the jobs that are going unclaimed. The manufacturing sector alone is expected to need 3.7 million people in the next five years. It is anticipated there will be a shortage of over two million. The same situation confronts transportation, construction, health care and many others. It is not clear whether these efforts will get the same attention under a new leader, but the business community will be lobbying hard for the effort to be a high priority. These programs have ranged from providing more money to develop trade schools to financing the retraining of people who seek to get into these careers in the immediate future.

Old Stomping Ground?
I had the opportunity to revisit my tender youth this week when I was invited to do a program for the Federal Home Loan Bank (FHLB) in Iron Mountain, Michigan. This is way up there—on the border of Wisconsin and the Upper Peninsula of Michigan. Back in the 1960s, my parents made an annual trek to the region to see some of Mom’s relatives. We spent a week in places like Florence, Iron Mountain, Niagara, Iron River, etc. After visiting this week, I can safely say, it has changed a lot.

Back in the 60s, one had few options as far as lodging—we usually stayed at Bucky’s Cabins. I still remember the pervasive smell of fish everywhere. When we had occasion to do laundry in Florence, we were urged to avoid the machines on the back wall—those were for the miners and clothes would come out rust colored. I also remember a place with the greatest sign ever: “Winslow’s Funeral Home and Taxidermy.” Never knew that was an option before then. I developed a fondness for pastries and learned that bars were supposed to be called taverns. Today, they have all the chain hotels and Bucky is long since retired. Still a lot of fish smell and the deep woods are never far off. The trip brought back lots of memories of hanging out with my dad and looking at the stars and the occasional display of the northern lights.

Government Debt Levels
For all the issues that have affected Turkey in the last few years, the country has avoided a trap that has affected many other nations. Their debt levels are really quite acceptable, which leaves them far more options than even the U.S. The Japanese have been in crisis for years and Greece has been struggling for a decade. The U.S. situation worsens by the day. The U.S. debt as percentage of GDP will be close to 100% by the end of next year unless there are changes in the budget.