Outlook:

We get a fair amount of new data this week, including ZEW and TICS tomorrow plus two regional Fed surveys that may show improvement and remove one more inch of rate cut justification. Even so, the end-July rate cut is all but a done-deal. Talk of 50 bp instead of only 25 bp is silly—the Fed needs to keep some ammunition dry and besides, 50 bp signals panic and overreaction.

One idea not getting enough attention is that the Fed secretly factored in a trade-off between the rate cut and FX market intervention by the Treasury. Technically the Fed is the one that pulls the trigger operationally, but it’s the Treasury that is the executive and makes the decision. So far we like to think the Treasury is sane and reining in the impulsive president, but we imagine Mnuchin’s cravenness knows no bounds. After all, in the latest Treasury bi-annual report to Congress on currency manipulation in May, the Treasury named Italy, Ireland and Germany as belonging on the manipulator watchlist, which makes the Treasury look really very stupid since these countries do not have a national monetary policy—that is set by the ECB

Last week Goldman warned of a low but rising risk of Trump intervening in the FX market to drive the dollar down. Now the Financial Times has a section titled “currency wars” on the front page. It may seem that we are all in a free-market world today and intervention is out of date, but the US embraced currency manipulation with both fists under Carter and Reagan (with lesser events under Bush and Clinton), which is still living memory. Big interventions like the Plaza Accord were a catastrophic failure but that doesn’t mean Trump won’t try for it again. Trump has not let up on the intervention threats despite getting his way with the Fed. The idea that the Fed is fighting a rear-guard action is not a silly one. We won’t know until Powell writes his memoirs.

The FT story reprises the intervention/currency war situation, including Trump’s factual inaccuracy about Chinese manipulation (not true since 2014) and the irony of the US airing grievances when it was the target of the currency war accusation at G20 in Seoul in 2010 (by Brazilian FinMin Mantega).

Bottom line—Trump intervention in the currency market would be disruptive, counter-productive, and damaging in all kinds of pinball ways. Exactly the way he likes things. The vast majority of analysts say intervention would be stupid. We are now starting to worry he will do it.

We don’t know if the Fed promising a rate cut is delaying Trumpian intervention. On the matter of the rate cut, the financial world is still reeling from the irreconcilable fact of the Fed all but promising a rate cut because inflation is mysteriously muted while the most recent CPI inflation data shows it is far from dead. Over the weekend there was a fair amount of blather about the Fed dumping the Phillips Curve altogether, which is silly. The unemployment/inflation set may be abnormal but that doesn’t justify dumping the theory. See the Tidbit below. We say there is nothing wrong with the theory—there is something wrong with the US data that is disguising the true extent of unemployment. Distracting from the underlying problem of not understanding the employment situation, we get the Beige Book on Wednesday.

Two more things to worry about—is Congress going to pass Nafta 2.0? It’s looking increasingly unlikely. This is acceptable to Canada but a whole lot less acceptable in Mexico, which remains vulnerable to attacks from north of the border. The most recent assault on AMLO’s competence is his commitment to a Yucatan Peninsula railroad for which there is no proper cost-benefit plan, let alone environmental impact statement or even a budget.

In addition, the Treasury is starting to talk about the US running out of money by September unless a new resolution gets passed raising the debt ceiling. Again.

Finally, the Q2 earnings season is upon us, with the big banks starting to report today (Citi first). One report has it that profits will have fallen by about 3%, despite a gross revenue rise of about 4%. The rearview mirror may not be a good barometer for upcoming quarters, given that banks tend to do less well in a falling rate environment.

Whither the dollar? We imagine it will slip and slide a bit more, but tomorrow is pullback Tuesday, so don’t bet the ranch.

Tidbit: See the chart on wage growth from the Daily Shot, which got it from Credit Suisse. We have no trouble believing the analysis, but we do have a problem squaring it with labor market conditions.

Growth

 

Not to ride the hobbyhorse too hard, but let’s go back to data inadequacy.

First, the Phillips Curve. It’s not wrong in principle. In fact, it’s perfectly logical. Wage gains that are higher than the general rate of growth will lead to wage-push inflation. That very low unemployment is not leading to rising wages is a puzzle, to be sure, but don’t forget that unions were killed dead by the movement set off by Reagan when he fired the air traffic controllers for an illegal strike. Unions got too big for their britches and boy, did they get a comeuppance. Since so many unions were mismanaged, corrupt and otherwise a stain on the fabric of the economy, we could debate whether this was good thing or not, but the fact remains that labor is the one party in the land/labor/capital matrix without a voice for the past forty years. Remember that Amazon pulled out of a multi-million dollar investment in New York City when a council member wanted to add the right to unionize. Amazon didn’t even bargain—it just walked out. So, institutionally, it’s not a surprise that The Man pays himself and the shareholders and not the workers.

Labor market participation is too low for an economy supposedly running full-tilt. At 62.9%, participation means 62.9% of the people are working to support some 38% not working. With job shortages widely reported and literally millions of jobs going unfilled, something is seriously out of kilter when the unemployment rate is less than 4%. A reasonable development would be either rising wages or a rising participation rate. But we are getting neither.

There’s something wrong with the unemployment number or the participation rate or both. We guess the  truly unemployed who are not being counted are really unemployable, the demographic that is illiterate, obese, drug-addicted, unclean and uncouth, or generally have a bad attitude. They are not even being counted in U6, the widest measure of unemployment. Some may be engaged in the gray economy, aka underground economy—working off the books. Nobody knows the number but for the sake of argument, let’s say it’s 25% of the U6 total, which was 7.5 million in June 2019, or —but that’s probably not more than 10-15% of the total, or 1.88 million persons. Not all are drugrunners or prostitutes; some are your gardener and housekeeper.

Now consider that U6 fell from 8.1 million in 2018 to 7.5 million a year later, or a drop of 600,000. Setting aside demographics like baby boomers dropping out of the count, say all 600,000 took jobs because average weekly pay had indeed gone up by 3% y/y over the course of that year.  The right question is how much more does pay have to rise to get another million or two into the workforce?

 Ah, but there’s a hitch. Maybe those uncounted and those in U6 are simply not desirable workers. We heard a general say on NPR radio that of the 2 million or so age-relevant youngsters available for military service, only about one-quarter would qualify. The deduction here is that employers know the pool of available labor to replace unruly workers—like any that would start a union—is really very poor but it’s also very, very big. You’d think that would incentivize them to treat their existing good workers very well, including wage hikes, but realistically, automation is cheaper is the long run. And the workers see automation threatening their jobs all the time, and they got the message. It made them docile.

Does raising the minimum wage to $15 make a difference? Only a little and at the margin. Both gardeners and housekeepers make more than that.

Bottom line—there’s nothing wrong with the Phillips Curve as a general statement and something the Fed can keep. There’s something wrong with the data that undercounts unemployment and fails to account for employability. 

Tidbit: We read commentary over the weekend that Trump wrecking the Chinese steel industry is akin to imposing unduly harsh conditions on Germany after WW II (and look what that got us). The data in particular was that China produces 54.2% of the world’s steel and employs over 100,000 persons. Driving the Chinese economy down in this one sector has wide and deep repercussions that are unacceptable to the Chinese government; and it can’t plan its way out of it. Steel is basic.

So we checked the data. There is indeed an outfit named WorldSteel.org and it affirms China’s production in 2017 was 831.7 tonnes against a world total of 1689.4 tonnes, or 49.23%. Close enough.

But the Chicken-Little scenario may not hold up. For one thing, China itself is forging demand for steel from emerging markets where it’s lending the money to build the Belt and Road infrastructure. For another, domestic demand has a decent chance of replacing export demand if China is right that it has moved on from emerging market status. Instead of basic materials, it needs electricity generation to fuel AI and other service sector activities that are putting China far ahead of the US.

 


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