The US continues to post moderate growth, though pockets of weaknesses remain. Global financial markets started the year trying to read the magic eight ball of the Chinese equity and currency markets – a recipe for emotional distress. Overall, my judgement about the current expansion remains unchanged with slightly above-average growth.
The US economy
· Our Astor Economic Index® (“AEI”) shows growth somewhat above the ten-year average and slightly better than last month. The AEI is a proprietary index that evaluates selected employment and output trends in an effort to gauge the current pace of US economic growth.
Source: Astor calculations
· The most important and timely indicators for December 2015 were mixed. On the positive side, payrolls were quite strong and above expectations. The only quibble with last Friday’s report being recent signs of wage growth seem to have stalled. I believe a sustained period of real wage gains will be necessary for a robust consumer sector and hence a strong economy.
· On the bad news side, the weakness in the manufacturing sector as measured by the ISM Purchasing Managers Index continued. Industrial production, as measured by the year-over-year change in the Fed’s industrial production index, turned negative for first time since the recession in last month’s release. I tentatively started calling a manufacturing recession last month and I feel a bit stronger about that now. The non-manufacturing PMI is still fairly strong and though it is off its recent highs, it is still about the average level in the current recovery.
Source: Federal Reserve, Astor calculations
· While I still see the current (that is, for early 2016) state of growth as above average, it is looking like the fourth quarter will see a weak GDP print. The Atlanta Fed’s GDP Now project is currently forecasting growth below 1% (quarterly SAAR).
The Fed
· The Fed finally began to raise rates with its December meeting. 2016’s market volatility, on its own, is unlikely to cause the Fed to reconsider its path unless it gets more extreme. It is said central banks tighten according to plan and ease in reaction to events. The consensus seems to be that the Fed’s plan is to tighten a quarter point at every other meeting or so for a while, as long as the economy continues to hold its present course. Weak inflation prints, however, could give the FOMC pause. With energy prices moving lower again this year it is hard to see early inflation prints being strong. See Tim Duy’s dissection of the December minutes for more.
· If the Fed does stay the course, the next big obsession for Fed watchers will be when they will begin to allow their QE investments to roll off. The Fed currently reinvests coupon and principal payments on its portfolio in similar securities so as to maintain a level portfolio. The first step to reducing the balance sheet will be to cease this reinvestment. (For a dated but still, I think, correct description see my Cleaning Up After The Party Is Over). Expect fevered commentary about the issue this summer if nothing else spices up the dreary lives of central bank observers.
The international environment
· My reading of the global picture has not changed. The fundamental fact of the global economy today is the weakness in China and the attendant disruption in the supply chains built up to feed its growth. I believe we see this result in the broader commodity weakness as well as the manufacturing weakness discussed above.
· There is a great deal written on the Chinese economy, not all of which increases understanding. A few pieces I appreciated:
o Noah Smith on why we might not have to fear the Chinese stock market
o Martin Sandbu on what we should be afraid of (Chinese capital flows)
o Paul Krugman on when China stumbles.
· Note too that the US is not alone, the UK’s industrial production also recently turned negative year-over-year. Globally, the GDP-weighted manufacturing sector PMI has been declining steadily for the last 18 months, though it is still above the lows seen in this measure in 2012. Note too that those low levels were associated with a stagnation, not a decline, in the level of global industrial production.
Sources: Bloomberg, Markit, IMF, Astor calculations
· In addition to the diffuse reduction in commodity demand, there is an energy specific supply shock. One can imagine this an oily game of chicken among suppliers waiting to see who will take remove supply from the market first.
Conclusions
Overall, I see the US as currently in modest growth and perhaps we should be pleased the Economy has done as well as it has in a challenging external environment.
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