Getting the Growth Story Right
It isn’t easy to be a macro-economist right now. It probably isn’t ever easy to be one, but right now, macroeconomic analysts are dealing with as much conflicting data as I have seen in twenty years. The risk of “mere noise” clouding one’s analysis is significant. We are all aware of the very positive U.S. economic data from low unemployment, to rising wages, to expanding manufacturing. On the other hand, global trade is declining, tax receipts have decreased, and the yield curve had inverted two weeks ago, and still remains inverted inside the 1-year and 7-year treasuries. But then on the other hand again, corporate bond spreads are tight, which is maybe the biggest tell of all (it is a bullish sign, not indicative of distress), oil prices are not recessionary low but neither are they inflationary high, copper and industrial commodity prices have been strong, and the dollar has been stable as have most foreign exchange currency markets.
So what does one conclude? Either that the negative indicators are false noise, and a signal from markets (credit spreads and equities) are accurate OR that positive indicators will break and the economy turn south OR perhaps something more nuanced all together?
Sorry – it is door #3. No one, and I mean no one, knows where markets and economic strength/weakness goes from here. What I believe the present mixed bag of circumstances is indicating is a positive, healthy economy, and a positive environment for risk assets, but one very aware of vulnerabilities. Central banks have used tools that now force certain uncertainties in unwinding. Global trade is facing headwinds not seen in a few decades. Heavy dispersion of policy and economic state has created a heavy dispersion of environment from country to country (or region to region), which adds to volatility. In a sense, the summary is maybe the best and worst of all worlds, all at once:
Things really are good, but they really are sensitive to conditions that could make them not good.
But while we're on the subject
Not to add to the narrative of "mixed data," but a few interesting things have happened within the world of global economic data (and global market signals). Chinese equities have moved dramatically higher, and that is both in their local currency and U.S. dollar, so the move is not merely currency related (this can certainly be attributed to optimism in a China-U.S. trade deal). But the cost of insuring Chinese sovereign debt (remember the world of Credit Default Swaps) has declined substantially. The cost of insuring European high yield debt is the lowest it has been in a year. Japanese markets have shown signs of strength. Semiconductors have rallied.
It sounds more and more bullish, right?
But again. Global bond yields remain obnoxiously low. And that cannot be ignored through all of the data.
Add it to your lexicon
The term "insurance cut" is not a term in the standard vernacular of finance, but I have a very strong feeling it is about to be. The vice-chair of the Federal Reserve, Richard Clarida, recently used the term in describing a potential decision by the Fed to cut rates when the economy is not in need of monetary support. He alluded to such "insurance cuts" taking place in 1995 and 1998 and therefore having precedence (that the late 1990s were followed by a bubble-burst unlike any we had seen in U.S. equities in decades seems to have not fully registered). The idea is that even if the economy appears to be okay if signs are there that it may be susceptible to slowing an "insurance cut" may be an order to the fed funds rate as a form of preventative monetary policy.
While we're on the subject of the past predicting the future ...
An interesting thought this week ... Has the yield curve inverting preceded recessions, as we have discussed in the Dividend Cafe for years? Yes. But you know what else an inverted yield curve has always led to, and basically in pretty short order? A fed rate cut. If past is prologue, this is worth considering. Am I saying the Fed should cut rates? No. But does this sort of precedent speak to the possibilities of what may lie next in monetary agenda? In a sense, yes.
However, before one bakes in that the Fed will cut rates this year, it is entirely possible that their cessation of "quantitative tightening" (the roll-off of their balance sheet) may serve that purpose for them (either in their minds or in actual monetary impact). I am carefully avoiding taking a high conviction view in our positioning, especially in client bond portfolios, of what the Fed will do.
What's the deal anyways?
At the heart of the modern monetary policy conundrum is this simple statement:
Central banks know that there is excessive debt around the world (mostly sovereign government debt), and they also know that raising rates to stop that debt from expanding would create even worse effects. Period. The medicine becomes a bigger problem than the disease, in that it would feed a deflationary negative feedback loop and increase government spending (due to rising debt service costs).
My view is not the central bank is bad at solving this conundrum, which is surely true enough, I suppose, but that they were never meant to solve this kind of problem, to begin with. The Fed was created to provide liquidity to markets when needed - the "lender of last resort" concept. They were not created to address solvency issues. We dance around solvency in our society because we either don't want to admit hard truths (some companies or banks are insolvent and should be wound down), or we don't want to take the steps necessary to repair insolvent countries (austerity, public pensions, etc.). So we just dance.
A kink in the armor?
I read a report from Blackstone this week (2) that I found noteworthy, essentially suggesting that through all of the positive data in the jobs market, in wage growth, and in the labor participation rate, there is one angle not quite so positive - small business job creation. With small businesses representing ~50% of private sector employment, seeing only 6,000 jobs created there in March and 19,000 in February, we are way under the normal ratio of 40% of new jobs coming from the small business sector. I think this is interesting enough from an economic standpoint, but culturally, I think it is even more problematic. For what has caused the slowdown in small business job creation?
"An inability to find qualified workers"
We do not have a job openings problem. We have a job applicants problem.
Borrowing from the incomparable economist, Charles Gave, the construct for potential outcomes at this point, in light of the recent delay, looks something like this:
(1) No deal is found, and no extension is granted, forcing a Hard Brexit. This scenario is the one we are told to allegedly fear, and this is the outcome I suspect would actually prove most benign for markets. Charles puts it this way: "I remain convinced that if the UK is indeed expelled from Europe, it will be as much a catastrophe for the world economy as Y2K (1)."
(2) After four or five failed attempts, the next one works for Prime Minister May, and some "middle ground" Brexit is achieved. This would be the most politically toxic in Britain's parliamentary system, and invite substantial uncertainty about implementation.
(3) Article 50 is revoked and the Brexit referendum is, in one manifestation or another, effectively overturned. This would turn to political chaos, and a plethora of avenues would still exist for the Brexiteers to win the day, and in the aftermath of the political chaos, none other than Jeremy Corbyn could end up being the new Prime Minister of Britain.
We will wait for the month of April to do a victory lap, but as of right now April tax revenues are tracking 12% higher than last April's, a feat many considered impossible since tax rates were brought lower, not higher. We will see if this holds up, and what is behind it as we get more data throughout the rest of the month. Tax revenues were up 10% in February and 8% in March.
Politics & Money: Beltway Bulls and Bears
- Is the President's constant haranguing of the Fed on Twitter perhaps behind the Fed's capitulation of 2019? Many critics of the Fed have said that they gave in to political pressure and that is why they went from so hawkish to so dovish so quickly. The fact of the matter is that I find the President's haranguing counter-productive to his own agenda because if it is easier money he wants, I think the appearance of bowing to political pressure, if anything, makes them more reticent to go that direction. The fact of the matter is that I believe a lot of negative things about various Fed decisions and governing philosophies, from Greenspan to Bernanke to Yellen to Powell, but I do not believe for a minute that the decisions Powell has made, for right or for wrong, last year or this year, are remotely impacted by the tweet tantrums of the President.
- An interesting conundrum: How do you communicate that the message that the economy is growing, that recovery is strong, that unemployment is record low - all things I agree with - AND THAT the Fed needs to be cutting rates, and taking emergency measures to help the economy? Do those two messages make sense in the same sentence? They, of course, do not. One can argue, plausibly, that enough tightening had taken place given the pressures in credit markets. One can argue, as Larry Kudlow does, that if the objective of tightening was staving off the inflation threats we saw early last year, that inflation indicators had dropped substantially. But one cannot argue that the economy is soaring, AND that emergency measures to aid the economy are needed.
- I was disappointed I did not get to cover this more last week, but there was a potentially significant development in the world of energy infrastructure and addressing our woefully inadequate ability to transport oil and gas in our country. President Trump signed an executive order preventing states from blocking pipeline construction in their own states under the Clean Water Act. It will be challenged in court, so this is not a fait accompli, but a number of anti-fossil fuel states have used the Clean Water Act to provide cover for their blocking of natural gas infrastructure projects (without any genuine believe that water quality is being impacted). Should the executive order survive legal challenges, and many lawyers believe it will, it would prevent states from using questionable legal maneuverings to block legitimate energy infrastructure projects, a tactic that has been working for many years. Any increase in additional pipeline infrastructure drives volume for oil and gas to move from upstream to downstream and creates significant economic opportunity in the American energy sector renaissance.
Chart of the Week
Whenever I get despondent about the state of U.S. debt compared to our total economy (GDP), I like to compare the present debt-to-GDP to two things - (A) That ratio in our own country after World War II, and (B) That ratio in Japan, now. Suffice it to say, the numbers are daunting, but (a) We have been here before, and (b) We don't have it as bad as others. (I am not saying this fully cheers me up, but it's the best I have to fall back on).
Quote of the Week
“Don't dwell on what went wrong. Instead, focus on what to do next. Spend your energies on moving forward toward finding the answer.”
-- Denis Waitle