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SO WHERE IS THAT RECESSION?
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Many economists have been forecasting a recession for months. The Fed started raising interest rates 16 months ago. Interest rates have now gone from 0 to 5% to 5.25%. During this time, inflation, as measured by CPI, has fallen from near 10% and is now 3%, a two year low. Economists believe there is a lag time for the higher interest rates to start slowing the economy. That time is now, and the economy remains strong. The recession forecasts remind me of an economist, Eliot Janeway, who passed away in 1991, and was known for his numerous gloomy forecasts. He was said to have correctly forecasted 11 of the last 3 recessions.
The good news for the economy keeps rolling in. Early GDP forecast for Q2 is 1.8% growth. Job growth for non-farm payrolls in June increased 209,000. Unemployment dropped to 3.6%. Average hourly earnings rose 4.4% from a year earlier, and the average work week edged up.
Oil prices are down 40% from the peak. The supply chain issues, and logistics are significantly better. Jobs are plentiful and the quit rate of workers has dropped. Despite higher interest rates and higher prices, new home sales are strong due to the lowest sales of existing homes in over 20 years. Many existing homeowners don’t want to sell because of their low current mortgage rates. New car sales are up 13% in the first 6 months of this year and are selling at a pace of 15.4 million cars a year. Spending on travel and entertainment is strong. Consumer confidence is at a recent high.
“If you look at the data over the last quarter, what you see is stronger than expected growth, tighter than expected labor markets and higher than expected inflation,” Federal Reserve Chair Jerome Powell said recently at a conference in Portugal. This is not good news for the Fed’s strategy to slow the economy and reduce inflation. The July 25-26 Fed meeting will likely see another 25-basis point increase in interest rates. Additional rate hikes for this year are also likely.
The Fed still has a 2% inflation target and its main tool to achieve this is higher interest rates. With the higher rates, the economy will eventually slow down. By the end of the year, most of the pandemic’s trillions of dollars of distributions will have been spent, the economy will slow, and consumer debt will start to rise.
ITR a highly rated economic consulting firm has laid out numerous headwinds for the economy over the next 12 months. The Federal Reserve has raised interest rates above a healthy level. The inflation-adjusted US M2 Money Supply is declining, meaning there is less cash in the economy to spend on goods and services. Banks are tightening their loan lending criteria. US Total Retail Sales (adjusted for inflation) are plateauing, consumer savings rates are trending lower than the historical average, and savings balances are not keeping pace with inflation.
The bottom line from ITR is: “While the evidence overwhelmingly points to macroeconomic weakness ahead, we anticipate the recession will be mild and not a Great Recession-like scenario.” Amen.
INFLATION
Inflation keeps falling as wages outpace inflation.
- The Consumer Price Index (CPI) for June fell to 3.0% from a year earlier, a 1% monthly drop and is down to 0.2% for the month. This is the lowest reading in 2 years. The core CPI, excluding food and energy, also eased to 0.2% in June.
- Super Core inflation, the Fed’s new preferred PCE sub-indicator, services only (no goods), excluding food, energy, and housing, was 0.2%, unchanged in June, and the lowest monthly reading in nearly two years. In the last twelve months, prices in the Super Core category are down to 3.9%from 4.6% last month. This is great news, but the Fed will still keep fighting inflation to reach its 2% target.
- Producer Price Index increased in June at smallest pace in almost 3 years. Headline PPI rose 0.1% on the month, with the annual gain falling to 0.1% [yes that is 0.1%]. Core PPI rose 0.1%, with the annual gain falling to 2.6%. Goods inflation abated with lower commodity prices and improving supply chains. Lower CPI and PPI means that there is a much higher chance of a soft landing.
- Personal Consumption Expenditures [PCE], the Feds preferred tool for measuring inflation, rose just 0.1% in May, pushing the twelve-month comparison down to 3.8% from 4.3% in April. “Core” inflation, which excludes food and energy, is up 4.6% on a year ago comparison basis and little changed from the 5.4% peak last February. Note that the Fed is now closely watching a subset of inflation dubbed the “Super Core,” which is services only (no goods), excluding food, energy, and housing. That measure rose 0.2% in May and is up 4.5% versus a year ago. This is slowly moving in the right direction but still too high for the Fed.
MANUFACTURING
Definitely softer
The ISM manufacturing index for June fell to 46 from 46.9 last month, its eighth consecutive monthly drop. All the 10 indices the ISM follows are in contraction. The only positives are that New Orders and Production rose from May, although they are in contraction. The transportation manufacturing industry is the only bright spot.
- Industrial production for May fell 0.2% and came in weaker than expected, posting the first decline of 2023. Capacity utilization at factories came in close to April and near a 15-year high at just under 80.
- Shipments of “core” non-defense capital goods ex-aircraft (an essential input for business investment in calculating GDP and a leading manufacturer indicator) rose a modest 0.2% in May and, if unchanged in June, would be up at a 1.2% annualized rate in the second quarter. While still positive, this is the fifth consecutive quarterly deceleration in the pace of growth and represents the weakest quarter since the COVID shutdown-restricted second quarter of 2020.
- Orders for core capital goods (excluding aircraft and transportation), which will lead to shipments in the future, rose a healthy 0.6% in May with gains across most major categories.
- US Nonresidential Construction Contracts Index rebounded in May and is at a record level up 17% from a year ago. This includes commercial projects, including highways, hotels, and hospitals.
- The Shapiro Nonferrous Scrap Activity Index, which tracks our daily purchases from the same accounts across our 10 locations and a diverse industrial base, fell from May and is 4% under our 12-month trailing average.
CHINA AND THE WORLD
Unfulfilled economic expectations
With the abrupt end of the zero-Covid policy in December last year, China was expecting a reinvigorated economy. Instead, halfway through 2023, it’s facing a confluence of problems: Sluggish consumer spending, a crisis-ridden property market, flagging exports, record youth unemployment and towering local government debt.
There is a lack of consumer confidence caused by the draconian Covid-19 lock downs. Consumers are worried about the loss of work and income and that it could happen again. Housing, 30% of the economy, is still bad. Many national builders are facing bankruptcy along with the oversupply of houses. Car sales continue to be down 20%.
The government’s response has been tepid. They have lowered the interest rates 3 times by just one tenth of one percent each time. China is using a watering can put out a forest fire. At some point China will change its current policy. It would not surprise me to see them come out with a large stimulus plan just like they did when they pivoted on the zero Covid policy. The questions are when and how much they will do.
China also faces an aging population because of the long-term effects of the one child policy. This aging population will decrease China’s ability to grow their domestic industry. China can no longer maintain its competitive low-cost producer advantage. Trying to overtake the US as the largest economy in the world will not happen with this formula.
The June official PMI rose slightly from 48.8 to 49 and is still in contraction. The Caixin dropped from 50.9 to 50.5. Business confidence hit an eight-month low, while input prices dropped at their fastest pace in 7½ years. Unemployment is rising, consumer spending is falling, and home sales are down over 20% on an annual basis versus the slight rise in April. Exports have been in contraction and down now for 5 months in a row. Despite all this, the consensus forecast for growth this year is still 5%. I doubt it unless we see a fast dramatic change.
Surprising news to me: so far this year, US imports from China are down 24.3% versus the same timeframe a year ago, dropping China from first to the third largest exporter to the US behind Mexico and Canada.
Europe has been benefiting from lower energy prices. There are also labor shortages there too. Interest rates are lower than in the US and inflation is higher than here but dropping. Manufacturing is feeling the effects of the slower Chinese economy. Germany is in a recession with 2 quarters of negative GDP. Other countries are also slower. With the slowdown in China and Europe, it will be difficult for the US manufacturing to stay strong.
METALS
Markets continue bearish mode with summer starting.
Prime aluminum prices have continued their decent since February and are down 19% while prime scrap prices have only dropped 12%. July forecasts for prime aluminum prices continue to be bearish. The Aluminum Association reported preliminary estimates indicate that aluminum demand in the United States and Canada for the first four months of 2023, contracted 5.5 percent from the like-2022. Demand for semi-fabricated (mill) products declined 10.0 percent from the level a year ago.
Weighing heavily on all metal prices is the state of Chinese economy. Secondary aluminum prices have been flat since February. Copper has been trading in a 10% range for this year. Stainless steel prices have been lower with the drop in nickel prices and steel prices are sideways.
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