Shapiro Metals- June Market Insights
What is Inflation?
We hear bad news about violent tragedies daily, such as the senseless, horrific murders in Uvalde and Tulsa and the war in Ukraine. It’s easier for me to focus on mundane topics like the economy, inflation, recession, and China lockdowns.
US GDP for Q4 2021 is quite close to its pre-Covid level in Q4 2019 after being adjusted for inflation. We’re also on track for an upward trend line from then, too. The number of people employed is now very close to the pre-pandemic number. Of course, none of this would have happened without the trillions of stimulus dollars distributed in 2020 and early 2021. Without that, we all would have been complaining about the government not acting fast enough to save us. Okay, maybe that last round in March 2021 was not needed.
One cost of the stimulus is its contribution to our inflation woes which is now over 8%. The Putin war is another factor affecting our inflation, which has increased it about 1%, mainly in food and energy. But Inflation also occurred across the rest of the world at about the same rate, even in countries that did not provide citizens with a massive stimulus.
While our economy is doing well, excluding the inflation factor, we’re paying quite the price with 1 million Covid deaths. We live in a free country where we can make choices including whether or not we get vaccinated. However, after vaccinations became available, most of the people who did not get them and were on their deathbeds wished that they had been vaccinated.
Fed Chairman Jerome Powell recently said, “We can’t allow a wage-price spiral to happen. It is a risk we can’t run. And we can’t allow inflation expectations to become unanchored. It’s just something that we can’t allow to happen, and so we’ll look at it that way.” This is quite a change from the Fed’s transitory inflation policy, but a lot of change has happened since the Putin war began.
Powell is concerned about repeating the scenario from the late 1970’s and early 80’s when we experienced stagflation, a combination of high prices and slow growth. At that time, entrenched inflation was 9% along with a wage-price spiral. Paul Volcker, then-chairman of the Fed, gradually raised interest rates to break inflation. By the time he was finished in the early 80’s, rates were nearly 20%. The economy did retreat sharply and the wage-price spiral broke. But unemployment rose to 10.8% as GDP sank, and it was very painful.
Economist Paul Krugman points out that by 1984, the “United States was experiencing rapid economic growth because the Fed, which had squeezed the economy extremely hard to end double-digit inflation, had relaxed monetary policy because, in its view, inflation had been vanquished. By 1984, and for the rest of the 1980s, the Fed felt comfortable about inflation because it was running at around only 4%.” Years later, for various reasons, the Fed redefined the acceptable inflation rate as 2%; the Fed now needs the rate to be 2% to maintain its credibility, and getting there without a recession is going to be very difficult.
For inflation to come down, the Fed’s actions would slow the economy and unemployment should go up — at least that was the old rule. But with the Covid-induced labor force reduction and baby boomer retirements, I am not sure the labor market will cool as quickly as it did in the past. Powell and other Fed officials have been transparent that they want to see “clear and convincing” evidence that monthly inflation rates are decelerating before they will change the rate increases and money tightening. Inflation expectation levels are not that high yet.
The Consumer Price Index (CPI) for May rose to 8.6% year-over-year and 1% from last month. Volatile food, energy, and rent prices were up the most. When stripped of this, core inflation rose 6% from last year and .6% over last month. It is worse than anticipated and we can expect more interest rate hikes throughout the year. Core PCE, Personal Consumption Expenditures, is what the Fed uses to measure inflation. May numbers will be out soon but will not be good. April’s PCE rose 4.9% on a 12-month basis, which is down from 5.2% in March. Including food and energy, it rose .2% for April from .9% in March. The Producer Price Index for May was down slightly from April to 10.8% on a 12-month basis. The core price index excluding food, energy, and supplier margins rose 0.5% from last months 0.4% gain.
So it is not all bad news. The spot rate for shipping containers, microchips, and North America’s fertilizer prices indicates that some of the key supply-side factors driving global inflation levels are turning around. Other prices besides the headline are not growing as fast either. Inflation might improve, but that won’t occur until the end of Q3.
A recession is defined as two consecutive quarters of declining GDP. Taking that into consideration, and based on historical data, a recession would start 12 months from now.
The case against a recession comes from Neil Dutta of Renaissance Macro Research, who sees inflation slowing as inventories build for goods, supply chains improve, and consumer behavior normalizes. ITR Economics also forecasts a soft landing. They focus on consumer spending as the highest correlation to GDP and predict that consumer spending, adjusted for inflation will decline but remain positive over the next three years. The trillions of dollars pumped into our economy will also be a buffer for a recession.
Meanwhile, the World Bank, International Monetary Fund, and OECD have again reduced their forecasts for world growth in all of the major economies. This is based on inflation, Covid, China lockdowns, supply chain and logistic issues, interest rate raises, tight labor markets, the Putin war, and other yucky stuff.
THE PUTIN WAR
After over 100 days of fighting, the war in Ukraine continues with no end in sight. The war’s economic consequences have disrupted energy and food markets. Gas and oil prices continue to rise and the higher oil prices are helping Putin to finance his war. Higher gas prices have reduced consumer spending on goods and services worldwide. The war is responsible for an estimated 1% of global inflation.
Russia and Ukraine supply 25% of the world’s wheat. I read that there is two years’ worth of wheat that Russia and Ukraine would have supplied in grain inventories. It is also possible for US farmers to switch part of their soy and corn production away from energy-related ethanol markets to food stocks that would help with food shortages. However, that would be a longer-term strategy because farmers can’t instantly switch crops, plus such a switch could negatively affect U.S. gas prices. The only positive outcome from this conflict is that nations will find ways to be more energy independent, use less fossil fuel, and find alternative, less polluting energy sources.
I keep waiting for President Xi Jinping to change his definition of the zero-Covid policy, but that has not happened yet. China and the rest of the world are still struggling with supply chain and logistics problems. China reported that the PMI and Caixin rose in May (I find that hard to believe) but continue to be in contraction. A large part of China’s GDP is in home building, and that has been in a major retraction over the last year.
Even if Xi changes the zero-Covid policy, the psychological damage to the economy will take a long time to fix. The Chinese are known for saving their money; this situation will accelerate their saving and cause a slowdown in spending. Some pent-up demand will help the slowdown, but China has not pumped trillions of dollars into consumers’ hands like the US has. The zero-Covid policy will continue to have a negative impact on growth and metal prices.
The metals markets have settled down since the Putin spike in March. The fear factors discussed earlier, plus the China lockdown, are the main reasons. The annual Harbor Aluminum Summit, which is THE best aluminum conference, took place last week with a record crowd. Harbor’s forecast for the year-end LME aluminum price is $2,300 per ton, while the consensus pricing from other aluminum forecasters is about $3,000. That is what makes a market!
Prime aluminum, the Midwest premium, and scrap prices are now just about where they were at the start of the year. Compared to the March high-water mark, prime aluminum is down 20% while prime scrap is down 15%. Secondary aluminum prices are down 10%. Steel prices are 20% higher, while nickel is up about 33% and copper is about the same. As an old friend of mine who headed metals procurement at Emerson used to say, “The trend is your friend.”
US manufacturing is still strong and consumption is good, so the long-term demand for aluminum, copper, and nickel remains very strong. EVs [electric vehicles] use about 400 more pounds of aluminum and 150 more pounds of copper than conventional cars and trucks. Many forecasts predict a vast shortage for the metals and other critical minerals needed to manufacture EVs in the future. Electric power is another critical factor. There is simply not enough copper to produce the cars and supply the electric utilities for adequate power generation to sustain predicted growth in EV production. Keeping a gas-powered car is a safe bet for now.
The manufacturing sector continues to generate good news. Shipments of “core” non-defense capital goods ex-aircraft are a key input for business investment in the calculation of GDP. It climbed 0.8% in April following strength throughout the first quarter. If this trend continues in May and June, these orders will be up 4.8% at an annualized pace in Q2 versus the Q1 average. That would provide a tailwind to second quarter GDP growth, which is currently tracking around 2% annualized growth following the Q1 GDP decline.
The ISM Purchasing Managers Index rose to 56.1 in May, which signifies growth. The two most forward-looking indices, new orders and production, both posted gains after two months in a row of declines, so they are also in growth mode. Manufacturing jobs are close to pre-pandemic levels and job openings are 150% of the pre-pandemic numbers. The Shapiro Nonferrous Scrap Activity Index for May was up 8% and regained much of what it lost in April. Most sectors were up and we keep hearing that orders are good and labor is short.
Housing prices keep going up while sales and inventories are down. Aerospace is trending up. Car sales are flat, but Ford plans to add 6,200 union manufacturing jobs and invest $3.7 billion into plants in Michigan, Ohio, and Missouri. It looks to expand electric vehicle production and prepare for upcoming labor talks.
As far as employment, 390,000 jobs were added in May, mainly in the service sector. There are still over 11 million job openings. The unemployment rate remained at 3.6% despite the healthy increase in jobs, and the labor force expanded by 330,000. Fed Chairman Powell has called the job market “unsustainably hot.” The job market looks to be a lot hotter for some time.
“You will stay young as long as you learn, form new habits and don’t mind being contradicted.” -Marie von Ebner-Eschenbach
Life is good. Family and health are precious.
Comments are appreciated. This report was prepared by Bruce Shapiro and reflects my current opinion of the economy. It is based on sources and data I believe to be accurate and reliable. Opinions and forward-looking statements expressed are subject to change without notice.