During periods of inflation, interest rates typically go up and the economy slows down. People lose their jobs and GDP drops. Everyone calls for tax cuts and stimulus programs. But the government’s reaction to the pandemic was to front-load the stimulus programs. For over two years, we have had a good economy with a hot job market and growing inflation.
Former Treasury Secretary Lawrence Summers, now an economics professor at Harvard, warned about inflation long before it recently became a problem. He currently believes it will take a lot longer to bring inflation down to the Fed’s 2pc target and that interest rates will climb to 6pc next year.
“For my money, the best single measure of core underlying inflation is to look at wages,” he said. With wages up over 5pc annually and the job market strong, bringing inflation down is a challenge. Meanwhile, prices have been dropping sharply for oil, shipping, trucking, lumber, metals, and market-based measures of rents, used cars, and more.
We are in a new cycle that is not like other cycles we have seen before. There is still over $1.3trn in savings to help us weather the storm. I am counting on the economy slowing down as interest rates rise. We can never know how long inflation will last or how severe it will be, but most of us who have been through these downturns before will take appropriate actions. We know that things will change and we will be back in good times again. When? I can’t say.
The newly released Consumer Price Index (CPI) numbers rose less than expected in November, indicating inflation eased a bit. The CPI rose in November to 7.1pc year-over-year, marking the slowest 12-month increase since December 2021. That’s a 0.6pc drop from October’s 7.7pc year-over-year stats. Monthly CPI rose by 0.1pc, compared with October’s 0.4pc rise.
The core price index, excluding food and energy, rose only 6pc annually and was down 0.3pc from last month. Medical costs and used car prices fell while shelter was still strong. The CPI is moving in the right direction and may tamp down the Fed’s inclination to raise interest rates at a fast pace, but it still has a long way to go.
The Producer Price Index for November is at 7.4pc annually and down from 8.1pc in October. It has now risen by 0.3pc for the last three months, with food and energy prices continuing to experience large swings. Outside these typically volatile food and energy categories, “core” producer prices rose 0.4pc in November and 4.9pc from a year ago, down from 5.4pc in October.
PCE (personal consumption expenditures), the Fed’s preferred measure of inflation, dropped in October to 6pc annually, compared with 6.3pc in September. On a monthly basis, it was up 0.3pc in October, the same as September. Core inflation in October dropped to 5pc from 5.2pc in September. This gives the Fed a little more room to reduce the size of the interest rate increases.
The Fed’s strategy is to raise interest rates gradually and watch what this does to slow the economy. The latest Fed meeting brought a 0.5pc rate increase, bumping rates from 4.25pc to 4.5pc. Traditionally, many economists believe that the maximum impact of rate increases comes 12-24 months after the Fed actually raises them. Using that theory, we will see the slowdown/recession just in time for the next election. Fed Chair Jerome Powell stated, “If you’re waiting for actual evidence that inflation is coming down, it’s very difficult not to over-tighten. We think that slowing down at this point is a good way to balance the risks.”
The Fed is still a long way from its 2pc target. Trying to gauge inflation falls under my favorite acronym: VUCA (volatility, uncertainty, complexity, ambiguity). Inflation has been “volatile” and mainly on the upside. When inflation will come down is “uncertain.” Trying to bring it down and control it is “complex” as hell. How long this will take is “ambiguous” — but it will take more time than any of us want and cause pain to those who lose their jobs.
The shift from goods to services continues. This is reflected in November’s ISM manufacturing index falling into contraction at 49.0, down from October’s 50.2. We were last in contraction in May 2020. The November new orders index fell further into contraction. Production is still in expansion. Supply chain issues are improving.
ITR uses a 12-month moving average to generate its forecasts. When applied to US industrial production in October, the moving average surpassed the previous record high that was set in March 2019. ITR anticipates production will continue to rise into record territory through at least 2024. The rate of change in October did tick down to 4.3pc. Using ITR’s analysis, the production rate will continue to generally decline into late next year.
Capacity utilization in the manufacturing sector dropped in October but is still in positive territory. Capital goods shipments and orders are a very positive sign for manufacturing. Reshoring and capital investments by foreign investors will continue to support industrial production.
– Shipments of “core” non-defense capital goods ex-aircraft (a key input for business investment in calculating GDP and a leading indicator for manufacturers) were up 1.2pc in October after being down 0.5pc in September. Shipments are up 6.3pc in Q3 on an annualized basis.
– Orders for core capital goods, which will lead to shipments in the future, were up 2.1pc after being down 0.7pc in September. These orders have recovered sharply since the pandemic and continue to help the economy.
– Light vehicle sales rose slightly in November to over 14.4 million units, versus 13.9 million in October.
– US civilian aircraft production continues its long-term uptrend and is up 4pc in November over last year.
– Employment remains strong with a 3.7pc unemployment rate. Average hourly wages rose 0.6pc in November and are up 5.1pc on an annual basis.
– The Shapiro Nonferrous Scrap Activity Index for November, which tracks our daily purchases for the same accounts across our 10 locations and a diverse industrial base, was down slightly from October and the same as our yearly average.
CHINA AND THE WORLD
China’s zero-Covid policy has been a hot mess. The economy sank into a deeper funk last month under the weight of the strict zero-Covid measures, with housing in the toilet and exports plunging 8.7pc in November – the most since the start of the pandemic in February 2020. The unemployment rate is near 6pc and retail sales fell 0.5pc. Both the official PMI and the Caixin are in contraction.
The government recently relaxed the zero-Covid policy because of the people’s frustration, recent protests, and an economic slowdown in manufacturing and services. China had focused on trying to manage the symptoms and not on the root causes. Their vaccinations are not nearly as effective as the West. Their approach to locking down cities and frequent testing also is having a negative psychological impact, which will take a very long time to change.
In Europe, business activity contracted at its fastest pace in nearly two years. In November, inflation slowed to 10pc from October’s 10.6pc. However, wages were up only 3pc, compared to over 5pc in the US. The world economy will be as weak next year as it was in 2009 after the financial crisis as the conflict in Ukraine risks becoming a “forever war,” according to the Institute of International Finance. The International Monetary Fund expects the global economic growth rate to slow to 2.7pc in 2023 – down from 3.2pc projected for this year and 6pc in 2021 – as inflation cuts into economic activities.
THE RUSSIA-UKRAINE WAR
Russia’s attack on Ukraine is now in its ninth month. It has inflicted tremendous damage in Ukraine, but it is now losing the war. Ukraine now has the ability to use drones to attack Russia within a 350 radius of its border, and it has used drones within 100 miles of Moscow.
Ukraine is targeting the Russian oil complex by attacking refineries and pipelines and stifling Russia’s abilities to export oil. This will hurt Russia’s main source of income and could bring about negotiations. Before the drone attacks in Russia, Putin intimated that he would not be using nuclear weapons. Now the saber-rattling begins again. If negotiations get started and a settlement occurs, everyone in the world will benefit. This war has been a large factor in worldwide inflation, too.
Metals woke up in November. The dollar has weakened, and there is an inverse correlation between the dollar and metals. Edward Meir of Marex [formerly ED&F] sees the dollar continuing to weaken based on both fundamentals and technicals. Also, he sees inflation slowing in Q1, which will also weaken the dollar. Metal prices will be impacted by the slowing worldwide economies.
There was hope that China’s change in its COVID-19 policy would be positive for metals. But China is still faced with issues including the housing bubble, slower manufacturing, reduced exports, looming labor and supply chain issues, and lingering public fears about COVID-19 restrictions. We have a long way to go before China’s reopening will increase metals demand.
The Aluminum Association reports that consumption in domestic markets through September of this year (demand less exports) increased 7.5pc year-over-year. Spot prime aluminum was up 10¢/lb over last month. The Midwest premium has leveled out at 20¢/lb. Meanwhile, the consumers are in a year-end slow buying mode. Most prime aluminum scrap and secondary scrap was close to the same as October.
Copper and nickel prices rose close to 10pc. Stainless steel prices were up 25pc on 304 and 15pc on 316. Steel prices also rebounded slightly after seven consecutive down months.
I am bullish on America because we are smart and creative. In August, President Biden signed into law a $200bn boost to scientific research, which will become fully funded over the next several years. Some of this money will go to curiosity-driven people and projects, and the approval time will be weeks rather than many months. I believe there will be many new successful advances from the people and projects. Heidi Williams, a Stanford economist, said in a Wall Street Journal article: “Science is about taking risk, and that means many projects aren’t going to work. We should build a system for funding science that explicitly acknowledges and supports that.”
Thank you for supporting Shapiro Metals in 2022, especially during such economically “interesting” times. We wish you happiness during the holiday season and into the new year!
“There is no doubt that it is around the family and the home that all the greatest virtues, the most dominating virtues of humans, are created, strengthened, maintained.” -Sir Winston Churchill
Life is good. Family and health are precious.
This report was prepared by Bruce Shapiro and reflects his current opinion of the economy. It is based on sources and data he believes to be accurate and reliable. Opinions and forward-looking statements expressed are subject to change without notice.