“We have to get supply and demand back into balance. And the way we do that is by slowing the economy.” -Jerome Powell
Powell and most Fed board members have stuck to the same mantra: We are in a war against inflation. They will keep raising interest rates to bring inflation down and prevent a dreaded wage-price spiral. Some of the victims of this war will be employees, a theory supported by the Fed forecasts that unemployment will rise in the coming months. Hopefully, this will cause some slack in the labor market and take the heat off of increased wages.
Powell recently said, “I wish there was a painless way to do that. There isn’t.” Furthermore, “No one knows whether this process will lead to a recession or, if so, how significant that recession would be.” In setting expectations, he further commented, “The chances of a soft landing are likely to diminish to the extent that policy needs to be more restrictive, or restrictive for longer.” There’s no lipstick on this pig.
The Fed wants the labor supply to improve while reducing the wage and price spiral. We hear large tech companies and financial institutions announcing layoffs, but there are still almost two job openings for every person who is unemployed. “You can’t lay off what you didn’t hire,” said Ron Hetrick, senior economist at Lightcast, a labor market analytics firm. There are “a number of industries out there that say ‘We’re still waiting to hire. We never even got to enjoy the party when it started.’”
Inflation
The Consumer Price Index (CPI) for September was the same as August at 8.2pc year-over-year and on a monthly basis was up 0.4pc which was 0.3pc higher than August. The core price index excluding food and energy, was up 0.3pc on an annual at 6.6pc the highest in 40 years and up 0.6pc on a monthly basis the same up as August.
The Producer Price Index for September was up 0.4pc from August and down 0.2pc over last year to 8.5pc. However, core prices were up 0.3pc over August and down 0.1-7.2pc from last year. Two-thirds of the increase was due to services on travel and accommodations, retail, food, and inpatient hospital care.
PCE (personal consumption expenditures), which is the Fed’s preferred measure of inflation, rose 0.3pc in August and 6.2pc from the previous year. These increases are similar to last month. However, core prices, excluding food and energy, increased by 0.6pc in August and 4.9pc from last year. That will translate into more interest rate increases at the next Fed meeting in November. Current expectations are for another three quarters of a percent bump. All of this is more bad news on fighting inflation.
The Recession
The Fed forecasts unemployment will rise from 3.5pc now to 4.4pc a year from now. Derek Tang of LHMeyer/Monetary Policy Analytics commented on Twitter that for the Fed to predict such a steep unemployment rise is unprecedented “before a recession has already begun. They are trying to tell us there will be a hard landing; there is no other way.”
Other prominent economists, former Treasury Secretary Lawrence Summers and former International Monetary Fund Chief Economist Olivier Blanchard, believe that bringing inflation down to 2pc would probably require unemployment to rise to at least 5pc in an optimistic scenario, and possibly as high as 6-7pc otherwise, and it will need to stay there for longer than a year. “Inflation pressures have become broad-based across a wide range of goods and services,” said New York Fed President John Williams, a close advisor to Jerome Powell. “Demand for labor and services is far outstripping available supply. This is resulting in broad-based inflation, which will take longer to bring down.”
In the current economy, rising interest rates have yet to calm the job market. Even though job openings fell from 11 million to 10 million in September, 263,000 new jobs were created, which is higher than predicted. Unemployment fell from 3.7pc to 3.5pc.
Even though you might hear that “no one wants to work anymore,” 80.2pc of Americans in their prime working years had jobs in September, which is higher than the year before the pandemic. More workers are taking better-paying jobs in warehouses than in restaurants and the leisure industries. Still, manufacturers cannot find talent with the skillsets they need to fill many available jobs.
Home prices are at a record high, and higher interest rates have an immediate effect on housing. Last year, the 30-year mortgage rate was just over 3pc, and now it has shot up to 7pc. That’s the highest level since 2008, and it will keep rising. Home loan demand is down 30pc from last year. The high rates will slow both housing and inflation.
I am certain of only one thing: VUCA – volatility, uncertainty, complexity and ambiguity – will be with us for a long time.
Manufacturing
Manufacturing is beginning to show stress from consumer spending shifting from goods to services. This is also reflected in the Shapiro Nonferrous Scrap Activity Index for September, which was down 6pc from our yearly average. Automotive, aero, HVAC, recreational vehicles, and most other industries were down in September.
Some other key manufacturing numbers:
– Shipments of “core” non-defense capital goods ex-aircraft (a key input for business investment in calculating GDP) are a leading indicator for manufacturers and rose 0.3pc in August. If unchanged in September, these orders will be up at a 7.1pc annualized rate and will provide a tailwind for third quarter GDP.
– Orders for core capital goods, which will lead to shipments in the future, rose 1.3pc in August, the largest monthly increase since January.
– The ISM Manufacturing Index for September fell to 50.9 from August’s 52.8.
– The new orders index fell into contraction at 47.1, down from 51.3 in August. This is the lowest since the pandemic started.
– The production index remained in expansion territory and rose to 50.6 from 50.4 in August, signaling factories still have plenty to do.
– On the negative side, the supply chain index fell for the fifth straight month, employment fell into contraction, and the price index also fell. All of these are now the lowest they have been since the pandemic started.
Remember the chip shortage? And the bullwhip effect when companies over-ordered a product and ended up with too much inventory? Well, memory chips — found inside a variety of products like smartphones, personal computers, and data servers — provide a barometer of health for the semiconductor industry, which is reckoning with a sudden shift from pandemic strength to an abrupt drop-off in demand and prices. Even so, the auto industry needs chips, and supply is not expected to fully recover until next year.
The rest of the world’s economies have slowed more than the US. Their energy costs are considerably higher and contribute significantly to the economic slowdown. The dollar’s strength continues to grow with the interest rate increases. This causes our imports to increase and reduces demand for exports, and it will continue the decline in the ISM.
North American light vehicle production rose to 13.6 million units in August, 2.8pc below August 2021. Automakers still face a chip shortage, but demand is strong – even though it is facing some headwinds with higher interest rates. ITR forecasts rising growth in production by year-end and continuing through mid-2023.
ITR also states that the 12-month moving average for US civilian aircraft equipment production in August came in at 8.9pc above the year-ago level. It says: “Production is likely to trend relatively flat through 2023, with sustained rise taking hold in early 2024. While 2024 will bring double-digit growth rates for the Production 12MMA, activity will not reach 2012−19 levels.”
China, Europe, and Russia
China’s economy looks better than I expected considering its zero-COVID policy is still in place. Industrial production and retail sales are positive. The official PMI rose to 50.1 from 49.4, pulling out of contraction. The private sector Caixin manufacturing index is in contraction, down to 48.1 from 49.5. Housing continued its downtrend in August with prices, sales, and investments falling.
This month, China will have its five-year election. President Xi will be reelected. I am not a great believer in the economic numbers coming out of China because they look too good to be true. Their economy is slowing, and consumer confidence is falling along with their population. But China is known for its long-term strategy. I have thought for a long time that Xi would change the zero-COVID policy. We will see what he does.
In Europe, inflation is still very high, at 10pc. All the problems with the Russia-Ukraine war make it very difficult for the economy to recover. Europe has made great strides in preparing for the winter with very little Russian gas, but they are still in a quandary.
Russia continues to lose the war despite President Putin’s comments to the contrary and has intensified strikes in recent days. The Russian military has proven to be a paper tiger. Putin is now threatening to use tactical nuclear weapons that are extremely dangerous. The US used to have these types of weapons but got rid of them after the end of the Cold War. Tactical nuclear weapons are the black swan that no one wants to see used. It is reported that Russia’s main allies – China, India, and Turkey – have all told the country to not use these weapons, and if it does, they would no longer support the country. I hope they listen.
A big part of the reason Ukraine is winning the war is because the US is supplying them with technologically advanced weapons. HIMARS (High Mobility Artillery Rocket System), is making the difference. “HIMARS is one part of a precision revolution that turns heavily equipped armies into something light and mobile,” Robert Scales, a retired U.S. Army major general who was among the first to envision HIMARS in the 1970s, said in this article from The Wall Street Journal. They have a range of 20-180 miles and are laser-guided. HIMARS can do the job with one rocket carrying a 200-pound explosive warhead. Each Ukrainian HIMARS carries one six-rocket pod that can effectively land the punch of more than 100,000 lbs. of traditional artillery.
Metals
Greg Wittbecker of CRU points out that much of the recent fall in prime aluminum prices is because consumers want to reduce their high-priced inventories before placing new orders. From the price spike in March, when the PMTA was $1.99, prices have steadily dropped every month. In September, the price was $1.25. The Midwest premium average was over 39¢/lb in March and is currently close to 20¢/lb. As inventories normalize, prices should be more stable. In the meantime, the trend is your friend.
Prime aluminum scrap prices dropped 7¢/lb in October, along with spot prime’s 6¢/lb drop. Mixed-grade aero turnings also dropped 4¢/lb as the export markets dropped. Copper, nickel, and stainless scrap prices were steady, and steel prices continued to fall. All of these other markets have been in the same steady downtrend since the March and April highs.
Edward Meir of ED&F Man forecasts aluminum October prices trading between $2,000–$2,320/mt as input prices, like freight and energy, tumble while supply seems to outpace demand – at least for now. “Runs higher cannot be ruled out on fund buying or dollar weakness,” he said.
Harbor forecasts that “LME prices remain in a medium-term technical downward trend targeting $2,000/mt before the end of this year.” CRU accurately forecast Q3 LME to average $2,425/mt, and now it is calling for an average of $2,525/mt for Q4 2022. Most see supply-demand in balance, with Harbor calling for more demand destruction. I know and have a high opinion of these people, and I’m always fascinated to see their analyses. It takes brains and chutzpah to make these forecasts.
“The aim proposed here for any organization is for everybody to gain – stockholders, employees, suppliers, customers, community, the environment – over the long term.” -W. Edward Deming
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.