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Economy in Brief

Does one Rotten Apple Spoil the Bunch?
by Robert Brusca  January 3, 2019

The story of an ongoing slowdown for global growth is not news. It is, in fact, the baseline case for most forecasts for 2019. Most of the special-case stories in play as the New Year unfolds (or unravels as the case may be) are about how things could get even worse.

Of course, very few have a baseline case in which the trap door opens and the global economy falls in, but there is one of those out there lurking as well. Most risks are more manageable, however.

The data in the table below chronicle the state of the manufacturing sector for the global economy for emerging markets for ASEAN manufacturing and for developed market economics.

Need a pick up to reach mediocrity
Note that none of the queue percentile rankings of the current PMI levels is high. The ASEAN group does the 'best' of this lot with a ranking at 52.5%, above its historic median since January 2014 (the median lies at a ranking of 50.0). Both emerging and developed economies have weak standings. They reside in (or very close to) the bottom one third of their queue of values since January 2014. So as 2019 begins, conditions already are weakened. That lack of momentum is a key factor because it raises risk for the year ahead since it is an admission of weakness to start the year. If the year is going to be average, conditions will have to improve to get there.

All three major groupings show PMI gauges losing momentum further from 12-month averages to six-month averages to three-month averages. And the December reading is below the three-month average for each group except the ASEAN grouping – and even there it is a very close call.

Cars, phones, fast-food and trade conflict
Financial markets have been in tatters for the whole month of December. Early this year, on very tentative information, conditions are still touch-and-go. But recently two stock market darlings, Apple and Tesla, reported results that have spooked markets and sent the tech sector scrambling. Who would have thought that jacking cell phone prices up to $1,000 per phone would have such an impact on sales? Judging from the U.S., there are some pretty odd trends out there as cell phone sellers act as though they have no competition for pricing so that the sky is the limit. Meanwhile, I have never seen so many ads for fast food places that seem to offer more and some of the most unhealthy foods for the most obscenely low prices. This divergence reflects the actual bifurcation in the real economy: the rich buy cell phones and poor eat fast-food. Some are doing extremely well and many are just getting by. Despite still strong job growth, it is still strong job growth in mostly low end jobs. And now even that is challenged as the trade threat lurks. In China, trade war fears are blamed for the sharp downshift in demand for Apple phones, although there have been rumblings that Apple sales were soft for some months. But Apple is such an important stock that it is a sentiment leader. Having Apple miss its sales expectations so badly for the first time in 12 years has not gone down well. The slowing in China has hit Apple hard. But that is only one of the unpleasant realities out there. Tesla's problems are something else altogether. The markets' uneasiness is not just about Apple and Tesla; it has more to do with the reality of falling fast food prices.

Risk du jour
There are many other risks in the offing. Let's plough through a few. A North Korean diplomat to Italy has just turned up missing. And while Kim Jong Un has rambled on about a new path, he apparently sent a letter to Donald Trump that has been referred to as a great letter by Trump who says he looks forward to meeting with Kim again soon. Xi Jinping began the New Year rattling his saber at Taiwan reminding it that he has a one-China policy and that the clock is ticking. Brexit is still creating its chaos in the U.K. For now the controversy surrounding the new Italian government and its budget as well as France and its 'Yellow Vest' revolt seem to have subsided. In Iraq, Trump has agreed to slow the U.S. pullout to be sure that it is done in a way not to endanger the Kurds who have been strong U.S. allies. Trade war is still the number one concern and while most are hopeful that there is some sort of deal in the making with China, it is hard to tell. Once the U.S. and China have a deal, the U.S. will have to turn its attention to the EU where a standstill agreement on trade has in some sense been operative. In the U.S. economy itself, the government shutdown may churn out more ill effects. For now it is creating some financial difficulties for furloughed government workers who are not being paid. And there are government services not being provided. The IRS, for example, will take your money if you pay it, but it is NOT sending out any refunds. The generation of refunds is expected in the pre-April period. And if they are late in being paid, we could see weakness in U.S. consumer spending result.

A couple of years of political in-fighting at home
So as we peruse economic data, we also have to factor something in for the other part of living and investment that affects us all. Even before the Democrats are seated in the House and have had a chance to flex their new-found muscle, we have the first democrat that has declared for office in a presidential election that is still two years off. Elizabeth Warren has announced that she will run. The sooner that election tomfoolery gets started, I'm sure the worse off we all will feel because politics has been like that lately.

A shifting or a grinding of gears?
Clearly, 2019 does mark some important changes. We can argue about how much central banks shifting gears and sucking our stimulus is either the main factor or an ancillary one. But I have been worried about simultaneous rate hiking and balance sheet shrinkage and of what would happen when there was generally less support coming from central banks at the same time. It does not strike me that all that is benign.

What a person can believe
In economics, you can never really execute the counterfactual case. Oh, economists can go back and rerun their models and tell you that different things were worth different amounts of growth here and there. And while I am 'One Of Those' (I have a PhD in economics and have used models to forecast), I also have a healthy 'disrespect' for the process – I guess more than the economists who are in charge at the Board of Governors I remain unconvinced by modeling. It is a tool, not a panacea for decision-making. I remain very concerned that the economists at the Fed seem to want to emphasize the message of the multi-equation models they run and cast stones at the signal from the ever and rapidly flattening yield curve – a signal that has been historically extremely reliable. This is I think a mistake. Some think that the Fed's bloated balance sheet has distorted the yield curve. I doubt it has had much impact at all; history is clear that all active attempts to twist the yield curve have been abject failures. In fact, the Fed's own QE program was so ineffective that the Fed stopped it. So if it wasn't working, what is it able to distort now as we unwind it? One of the things I want from my central bankers is consistency. And it's clear that the Fed wants us to believe diametrically opposed things. We are supposed to believe that it still has QE to use in a pinch and yet it is also clear that the Fed has done everything it could to raise the Fed funds rate so it would not have to do that if the economy turned sour. Basically, QE is a safety net, but one you should try hard never to fall into. On balance, I think that the argument meant to discredit the yield curve signal does no such thing and yet it is only one of many things in the mix that the Fed is doing its hardest to ignore. There are lots of risks out there and the Fed has ignored most of them by slavishly pushing rate up to or toward an elusive normalcy. So now we have market chaos and a very flat yield curve. Ignore the yield curve at your own risk.

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