Shapiro Metals – September Market Insights
September 15, 2022
Updated Price Sheet
“Maximum employment and price stability”
The Federal Reserve’s “dual mandate” is maximum employment and price stability, John Williams, president and CEO of the Federal Reserve Bank of New York, told The Wall Street Journal during a Q&A. To lower inflation, he continued, the Fed needs to keep raising interest rates until demand and maximum employment lower to become more in balance with supply. Right now, the only mandate the Fed appears to be following is to reduce inflation. Whoops.
Minneapolis Fed President Neel Kashkari, who prior to the pandemic was the central bank’s most dovish policy maker, said in August that he wants the Fed’s benchmark interest rate at 3.9% by the end of this year and at 4.4% by the end of 2023.
At the Jackson Hole annual retreat meeting on August 26, Fed Chairman Jerome Powell made his inflation policy clear: “Restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy.” This inflation policy, along with higher interest rates, will bring “some pain” to households and businesses.
There is no doubt that the fight is on. Even though inflation is falling now, interest rates are forecasted to rise 75 points at the next Fed meeting later this month. The dreaded wage price spiral is the enemy, and the mandate for full employment will be heard as much as transitory inflation.
The Consumer Price Index (CPI) for August fell to 8.3% year-over-year from July’s 8.5% and was plus 0.1% on a monthly basis from July. The core price index excluding food and energy, was 6.3% from last year but was up 0.6% from last month. The shock was mainly from shelter and medical costs. This news rattled all the financial markets.
The Producer Price Index for August was down 0.1% from July and 8.7% over last year. However, core prices were up 0.4% over July and 7.3% from last year. More bad news on fighting inflation.
PCE (personal consumption expenditures), which is the Fed’s preferred measure of inflation, rose 6.3% from the previous year. While still high, that’s down from June’s 6.8%, which was the sharpest 12-month rise since January 1982. Core prices, excluding food and energy, increased 4.6% in July from a year ago and were down from June’s year-over-year, 4.8%. On a month-over-month basis, core prices rose a seasonally adjusted 0.1%, slowing markedly from June’s 0.6% pace. Jan Hatzius, chief Goldman Sachs economist, believes core PCE will be an annualized 4.5% at the end of this year and 2.5% at the end of 2023.
Recent inflation trends have been positive. Gas prices are down more than 25% since June. Long-distance freight costs have been falling for the past few months, and supply chain issues are improving. Most commodity prices are substantially lower. Even though more jobs were added in August, unemployment rose to 3.5%. Total wages paid, which is based on average hourly pay and total hours worked, rose only 0.2% in August, which is the smallest gain in 18 months.
Bond markets use a number of complex formulas to anticipate inflation and recessions. The bond prices determine what the market is willing to accept for yields based on anticipated inflation and the business climate. The current long-term and short-term rates both suggest a recession but not high inflation.
Goldman Sachs’ Hatzius makes the case for a soft landing and no deep recession. He sees growth in the next year averaging 1.25% after having been negative for the first half of the year. He expects the labor market to loosen and wage growth to fall to 4%, which he considers acceptable with 2.5% inflation as measured by the core PCE.
Many other forecasters, like Larry Summers, predict a long, drawn-out recession that will bring inflation down. In Q2 2020, the economy looked like a disaster that would not end. The government intervened with PPI, and therefore the recession was not as painful as most expected. With two job openings for every job available, maybe this recession won’t be as bad either. We know that VUCA — volatility, uncertainty, complexity, and ambiguity — will play a big role in changing everything.
Manufacturing is holding steady.
July industrial production increased for the first time in three months, by 0.6%, and manufacturing output rose 0.7% after a 0.4% drop in June. This is very welcome news for manufacturing and the economy. July’s average industrial production was 4.4% above the year-ago level, yet industrial production growth is slowing. This is part of the “growth recession.”
Motor vehicle output jumped 6.6% month-over-month as semiconductor bottlenecks and other supply chain issues ease.
Shipments of “core” non-defense capital goods ex-aircraft (a key input for business investment in the calculation of GDP) are a leading indicator for manufacturers and rose 0.7% in July. If unchanged in August and September, these orders will be up at a 6.4% annualized rate in Q3 and will provide a tailwind for third quarter GDP.
The ISM Index for August was the same as July at 52.8, and it is still in positive territory.
The new orders index rose out of contraction territory, hitting 51.3 in August after two consecutive readings below 50. This is a positive sign in light of inflation-adjusted consumer spending on goods trending down for over a year.
The production index remained in expansion territory at 50.4 in August, signaling factories still have plenty to do.
The supply chain index fell for the fourth month in a row and hit the lowest reading since before the pandemic began.
Employment is also improving. The employment index jumped back into expansion territory in August, at 54.2, after three months in contraction.
Finally, the price index signaled that inflation pressures might have peaked. It fell for the fifth month in a row, to 52.5, the lowest level since summer 2020.
The computer chip shortage situation has changed. Many chip consumers over-ordered, built up inventory, and then the economy slowed. Even though the auto industry is still experiencing a shortage, automakers also have slowed down their chip buying as they figured out how to make a lot of money on lower volumes.
US civilian aircraft equipment production for the 12-month moving average through July was 11% above the same period one year ago. ITR forecasts this trend will be relatively flat through the end of 2023 and will rise by double-digits in 2024. Light vehicle production rose to 13.3 million units and is expected to trend upward into 2024. Housing continues to be weak because of elevated costs and higher mortgage rates.
The Shapiro Nonferrous Scrap Activity Index for August was up 10% from July and just slightly higher than the Q2 average.
Housing is close to one-third of China’s economy. Right now, it doesn’t look good and will be a long-term problem. Sales and prices have been dropping for over a year, similar to our housing bubble in 2008 — or maybe worse. We know what that was like and how long our recovery took.
China’s second quarter GDP was up a scant 0.4%, and the August PMI rose slightly to 49.8 but is still in contraction. The Caixin is also in contraction. The continued zero-Covid policy hurts their economy, and Chengdu, a city of 21 million people in western China, just went on lockdown. Inflation fell to 2.7% in August, down from July, along with a drop in PPI (producer price index). Q3 GDP is also expected to fall and will be well below 3% for the year. China’s economy looks like it will be weak for some time.
Similar to the U.S., Europe’s inflation rate reached more than 9%. That’s mainly due to the Putin war, which has created an energy crisis. The Eurozone’s PMI in August is 49.8, meaning it’s in contraction. Germany and Italy both saw their worst readings since the start of the pandemic. It will take some time for the world to recover.
Maurice Obstfeld and Haonan Zhou published a paper about a global “dollar cycle.” It states that a strong dollar creates financial and economic stress around the world. The important part for us in the metals and commodities business is that “a one percent appreciation of the dollar is associated with a much larger percent fall in average global commodity prices.” As the dollar gained strength over the last few months, commodities sank substantially. Will the dollar stay strong? Yes, as long as the Fed keeps raising interest rates. We know that the dollar is just one factor that influences metals, but it looks likely the dollar will stay strong for a while.
Primary aluminum prices dropped 10 cents per pound in August. The Midwest transaction premium also keeps dropping with lower demand. Prime scrap prices for segregated alloys dropped only 5 cents per pound while other prime scrap prices were flat. Aero aluminum turnings dropped a penny per pound. Copper, nickel, and steel prices were also down slightly.
Climate change is prompting droughts, fires, floods, and extreme heat across the planet. It has an enormous negative impact on our ability to eat and breathe. Doing what we can to mitigate climate change is critical for future generations. This will not happen quickly, but the US has passed a bill to help.
The Inflation Reduction Act (IRA) is a political name for what is essentially a bill to help save the planet by providing subsidies for promoting clean energy. It offers renewable energy tax credits, incentives for buying electric cars and sourcing critical minerals domestically, and help to keep nuclear power plants operating. The law’s more than $21 billion for rebates and federal tax deductions for household energy-saving upgrades over the next 10 years is also good news for the HVAC industry. The IRA is a good start toward mitigating climate change.
According to the Democratic Senate that passed the bill, the Inflation Reduction Act is supposed to raise $739 billion in revenue, spend $433 billion, and pare the budget deficit by roughly $300 billion over a decade. My guess is Republicans believe the opposite, but it’s likely no one will review the numbers in the future anyway.
For those who want to know more about the IRA will help with future climate solutions, I suggest reading this article in The Wall Street Journal.
“It is failure that guides evolution; perfection provides no incentive for improvement, and nothing is perfect.” -Colson Whitehead
Life is good. Family and health are precious.
Comments are appreciated. If there are other people you know that would like to read this, let me know and I will add them. 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.