August 2019 Volume 1

ECONOMIC UPDATE

and for the last several months they have been active with retail sales growing for five of the last six months. The data released yesterday added to that string. At the same time there has been consistent optimism coming from the confidence surveys and there will be another one released this week from the University of Michigan, The mood of the consumer is a very changeable one, it has never taken much to make people uneasy. In past years the price of gas was a major factor as it only took a few cents to alter people’s moods. The rise in the price per gallon of just five or ten cents would cause considerable angst and send consumers into full retreat while a drop of five to ten cents would spur all kinds of additional spending.These days the biggest motivator for consumer mood remains the rate of unemployment but there are other factors as well – everything from the stock market to concerns regarding trade. The warning has been sounded all year when it comes to the trade and tariff wars. The consumer keeps being told that prices are going to surge but thus far they haven’t and many have started to discount the warnings. The fact is that many of the companies that have been dealing with the tariffs have elected to swallow the price hike. They are more worried about loss of market share so they are not passing the costs on to their consumer – at least not yet. There will come a point when they can no longer absorb the additional costs and that is the point at which consumers will face the costs of the trade war. The jobs motivator is still very positive but there are some cracks in this edifice as well. The most important is that there has not been wage increases as would be expected with rates this low. The demise of the Phillips Curve has been discussed at length in these pages but it still remains a little baffling. The fact is that employment is more puzzling than ever. There are over a million jobs available even if every person seeking work took a job. The jobs that have been filled in the last several months have generally been lower paid jobs even though high paid jobs are on offer. There is a severe disconnect between the skills that people have and the skills that are needed. Companies are hiring people who are not qualified in hopes they can be trained but that process damages productivity as the workers are not contributing fully while they are in training and the experienced workers are not working at full potential either as they are distracted by having to train. Second Quarter Projections Improving The data that has been coming in has been more encouraging than had been expected but there is still consensus that numbers in Q2 will not be as robust as they were in the first quarter. The good news is that many are now expecting numbers to avoid the dismal readings that seemed likely as the first quarter came to an end. The predictions had been as low as 1.5% to 1.8% but now the majority of estimates are tracking between 2.0% and 2.2%. This is still down from the 3.1% notched in Q1 but more consistent with the longer term trends of the last couple of decades. Analysis: The factors that led to this improved outlook include the better than expected level of retail activity and a bigger improvement in manufacturing activity than had been anticipated. Retail sales were up 0.4% and that was driven by a variety of sectors – most

notably entertainment spending but there were also better numbers in the home improvement sector. The wet spring and cooler temperatures played a role and so did the lower than usual gas prices. Sectors that had been expected to fall off – such as automotive – held their own and there was more spent on dining than had been expected. The consumer has been expressing some angst regarding the future but for now they trust that jobs will remain stable and the issues they thought would play a role have not been that big a deal. There is still worry about trade but the threats are still seen as future issues and many are now skeptical that inflation will be much of a concern anytime soon. Why Have the TradeThreats Not Been an Issue? The statements from almost every analyst and economist have been consistent – even the White House has been warning that there would likely be price hikes but that these would be worth it in the end. The comments from Jerome Powell have been direct enough – the only factor that would persuade the Fed to lower interest rates would be the struggles of the global economy and the impact that a trade war would have on the US economy. The data has been clear enough, or so it would seem. The US depends on exports for around 15% of its GDP and the tariffs that have been leveled have affected billions of dollars of goods. The US has seen a decline in imports from China and other countries and has seen a decline in demand for US goods but not to the levels that had been anticipated. Why not? Have all these threats been overblown? Have the tariffs really been on anything important? There are three reasons that have been posited for the lack of response thus far. Analysis: The first is based on the fact that tariff policy has been very uneven and has been far more talk than action. There were threats to end imports of foreign steel but then the four largest importing nations were all given exemptions and hundreds of US companies no special exemptions that allowed them to buy that imported steel. Threats were made to place additional tariffs on China but there was no follow through. The Europeans were threatened with tariffs on cars and car parts but that never reached implementation either. Tariffs have been threatened against Mexico but they were not executed. In fact, there have been very few tariffs imposed on anyone although almost every country in the world has been threatened with them. The end result is that consumers have not seen a reduction in the product mix they are accustomed to and have not seemmuch in the way of higher prices. The second rationale is that companies that have been affected by the tariffs have not passed on the additional costs to the consumer. The tariffs that have been imposed have mostly been on Chinese goods and the expectation was that these prices would escalate due to the tariffs. The companies affected have been more concerned with market share and have resisted the price increase that would be triggered by the tariff. This is not a position that can be maintained forever but given that many of the Chinese companies are state owned they will have the support of the government to a degree and that allows them to hold the line on pricing longer than would be the case for companies without that backing.

FIA MAGAZINE | August 2019 24