Saturday, August 11, 2018

US Economy Slowing? Not So Fast!

Real GDP rose 4.1% (saar) during Q2 (Fig. 1). That was good, but not surprisingly good. Actually, given that taxes were cut at the end of last year, it’s surprising that it wasn’t better. In fact, GDP growth was temporarily boosted by exports as US exporters scrambled to beat Trump’s tariffs. Exports of goods and services contributed 1.12 percentage points to Q2’s real GDP growth, the most since Q4-2013 (Fig. 2).

I like to look at the y/y growth rate of real GDP to assess whether the trend growth rate of the economy is changing (Fig. 3). It was up 2.8% y/y during Q2. That’s not a new high for the current expansion, and remains in the 1.0%-3.8% range it has spanned since 2010. In other words, real GDP growth still may be fluctuating around 2.0%, as it has been doing since 2010.

Consumer spending in real GDP rose 4.0% (saar) during Q2, the best since the end of 2014. Again, on a y/y basis, the growth rate for the monthly series was 2.8% during June, just about where it has been since late 2015 (Fig. 4). Real capital spending rose solidly by 7.3% (saar) during Q2, but the 6.7% y/y growth rate was nothing out of the ordinary (Fig. 5).

Could the US economy actually be slowing already despite the fiscal stimulus provided by the tax cuts enacted at the end of last year and the fiscal spending increases passed at the start of this year? If it is, we can blame the Fed for raising interest rates and the Trump administration for imposing tariffs. Both developments have also contributed to a stronger dollar, which may also start to weigh on exports and profits.

I don’t see a recession coming, but I am looking out for signs of weakness. There have been more of them recently, with the obvious exception of the all-important and booming labor market. Now consider the following:

(1) Economic surprises downbeat. The big surprise is that the Citigroup Economic Surprise Index (CESI) has dropped from a recent high of 84.5 on December 22, 2017 to -13.9 on Monday (Fig. 6). That doesn’t jibe with the strength in real GDP, particularly during Q2. Then again, the CESI tends to be weak during Q1 and sometimes during Q2, before rebounding during the second half of the year. In any event, it is a trendless cyclical indicator, which means that after it goes down for a while, it goes up for a while.

Notice that the CESI dropped sharply on the weaker-than-expected payroll employment gain of 157,000 during July, reported on Friday. However, it obviously didn’t reflect the significant upward revisions in May (24,000 to 268,000) and June (35,000 to 248,000)! Nor did it capture the 389,000 jump in the household measure of employment, led by a whopping 453,000 in full-time jobs!

(2) NM-PMI drops. The NM-PMI fell from 59.1 during June to 55.7 last month (Fig. 7). That’s the lowest since last August. The new orders component dropped from 63.2 to 57.0. I am not alarmed, because the series is very volatile and the latest readings remain relatively high. Keep in mind that this is another trendless cyclical indicator. It was so good earlier this year that it couldn’t get much better. Instead, it got a little worse, but still remains upbeat!

(3) Residential construction flattening. Private residential investment in real GDP fell 1.1% (saar) during Q2, and was up only 1.4% y/y (Fig. 8). The weakness has been concentrated in multi-family housing construction, which is down 4.9% y/y (Fig. 9).

Household formation among homeowners has been increasing in recent quarters, while the number of households who rent has been falling. That should be good for single-family residential investment, though it fell 4.7% (saar) during Q2 (but was up 3.5% y/y), as rising mortgage rates may be starting to curb some enthusiasm for buying a home. That’s not confirmed by mortgage applications for new purchases, which remain near recent cyclical highs (Fig. 10).

(4) Auto sales looking toppy. The 12-month sum of US motor vehicle sales peaked at 17.7 million units during February 2016, falling to 17.3 million units last month (Fig. 11). While both domestic light truck and imported auto sales remain on uptrends, domestic car sales have crashed to the lowest since November 2010 (Fig. 12).

I suspect that the Millennials may be causing home and auto sales to top out. They are mostly minimalists. Many are single and city dwellers, renting apartments, which are no longer in short supply after the multifamily housing boom of the last few years. They don’t have much use for a car, let alone a light truck. Instead, they rely on Uber and Lyft or rent bicycles.

The bottom line on all the above is that the US economy isn’t as weak as it seems according to the recent signs of slowing. On the other hand, it isn’t as strong as supply-siders had hoped it would be in response to their tax cut, but the jury may still be out on that score.

Thursday, August 2, 2018

Tug of War In the Bond Market

Helping stocks to recover from the year’s lows in early February is the eerie calm in the US bond market. The Bond Vigilante Model suggests that the 10-year Treasury bond yield tends to trade around the growth rate in nominal GDP on a y/y basis (Fig. 1). It has been trading consistently below nominal GDP growth since mid-2010. The current spread is among the widest since then, with nominal GDP growing 5.4% while the bond yield is around 3.00% (Fig. 2).

Why isn’t the bond yield closer to 4.00% or even 5.00%? After all, the Tax Cuts & Jobs Act enacted at the end of last year and additional fiscal spending passed by Congress earlier this year are projected by the Congressional Budget Office to result in federal budget deficits averaging about $1 trillion per year for the next 10 years (Fig. 3). Furthermore, the FOMC commenced tapering its balance sheet last October and plans to continue doing so through the end of 2024 (Fig. 4). The Fed is on track to slash its holdings of Treasuries and MBSs by $2.5 trillion and $1.7 trillion, respectively, over the next seven years! Oh and by the way, the FOMC is on track to raising the federal funds rate to 3.00% by the end of next year from 1.75%-2.00% currently.

Let’s review some possible explanations for the nonchalant performance of the bond market. Is it the calm before the storm or the calm that calmly continues? Consider the following bullish offsets to the bearish factors just mentioned above:

(1) Near-zero yields in Germany and Japan. The 10-year German government bond yield has dropped from this year’s high of 0.77% on February 2 to 0.45% 0n Tuesday (Fig. 5). Germany may have been hit by uncertainty created by Trump’s trade war. The IFO Business Confidence Index has been falling all year, with its expectations component the lowest since March 2016 (Fig. 6). In any event, the ECB has indicated that the bank’s key interest rates will remain at historical lows at least through the summer of next year!

Meanwhile, there was some anxiety last week about a rumored change of course by the BOJ. The 10-year Japanese bond yield jumped from 0.035% on Friday, July 20, to 0.104% on Monday of this week. It was back down to 0.048% on Tuesday after the BOJ kept its policy steady. It maintained its target for the 10-year government bond yield at around 0.00% and the short-term interest rate target at minus 0.1%. The bank announced one minor tweak: In a statement, it explained that the yields may move up or down “to some extent mainly depending on developments in economic activity and prices.”

Wow, lots of agita about nothing! The BOJ also acknowledged that it will take “more time than expected” to achieve its inflation target of 2%. You think? The BOJ’s monetary base has more than quadrupled since April 2013, when Haruhiko Kuroda, the new head of the bank back then, slammed on the monetary accelerator and never took his foot off of it (Fig. 7). Most of the time since then, through June of this year, Japan’s CPI inflation rate has remained closer to zero than 2.0% (with the exception of 2014, when the sales tax was raised significantly) (Fig. 8).

(2) Subdued inflation. Back in the USA, the latest inflation figures remain relatively benign: Not too hot, not too cold, just warm enough to allow the Fed to proceed with the gradual normalization of monetary policy. The headline PCED rose 2.2% y/y through June, while the core increased 1.9% over the same period (Fig. 9).

The wage component of the Employment Cost Index held at 2.9% y/y during Q2 (Fig. 10). That’s the highest pace since Q3-2008, but still relatively low given the tightness of the labor market.

(3) Record wealth, with lots set on risk off. That still leaves an important question: Why aren’t bond yields rising in anticipation of all the debt that will need to be financed? There is already a record amount of debt everywhere, and more coming can’t be good for bonds. There is also a record amount of wealth in the world. Some of it tends to be managed with a risk-off bent. Ironically, people who expect that “this will all end badly” tend to buy government bonds because they are deemed to be among the safest assets.