Is "bad" once again "good"?
It’s been a week of pretty weak economic data. Notables:
10/1 ISM Manufacturing 47.8 vs 50 expected
Construction spending .1% vs .5% expected
10/3 Initial Jobless Claims 219k vs 215k expected
ISM Non-Manufacturing Index 52.6% vs 55% expected
As I mentioned in one of my last Musings, although the economy has been slowing, I remain optimistic that we are not going into recession in the near-term. In my humble opinion, the economy has strong bones and that the two primary drags on our growth are 1) trade worries, and 2) dollar strength due to domestic interest rates still being too high relative to the rest of the world. This article does a good job articulating why the obstacles are mainly coming from without vs. coming from within:
Why am I sanguine amidst a sea of doom and gloom?
- After a lot of hemming and hawing, the Fed finally gets it and has turned accommodative again. After 2 cuts year-to-date, odds of a third cut before year-end just went up to 92% today after the weak ISM data. Today’s market price action also suggests that a bit of a “sell-the-rumor/buy-the-fact” bounce may be forthcoming, as “bad” (economic data) may once again be interpreted as “good” (at least for the markets). Importantly, an accommodative Fed directly addresses the dollar strength issue outlined above. It may be a race to the bottom in terms of competitive currency devaluation around the world, but my biggest concern over a formerly tone-deaf Fed was that continued USD strength would effectively import economic weakness from other countries. Hopefully, Powell is “on the case” now and will prevent that.
- Trade of course is the wildcard, but I think economic weakness at home and abroad will increase the chances of some kind of resolution. I’ve always figured that it would be part of Trump’s playbook to be initially very hawkish on trade – to the tune of forcing the Fed to become accommodative (which it now has) – and then get a deal done before 2020 elections.
Check mate China, part deux
There are some who think China holds all the cards in this trade battle because 1) they have the luxury of a long-term perspective vs. our 4-year Presidential cycles, 2) they have virtually unlimited stimulus options given their “command and control” political/economic system. Once again, I hold a contrarian view here. Here is a post I put on LinkedIn a couple months ago:
I may be in the minority on this, but i don't think this "trade war" is going to hurt us that much besides some CPI increases – hell, the Fed has been TRYING to gin CPI above 2%! China, however, is screwed though.
What can China do to us?
Not buy more goods? Oops, they already sell $500 bn more than they buy.
Tax our car imports? Oops they're already at 22.5%.
Not buy our pork? Oops they just lost 1/3 of their herd.
Not buy our soy/food? Oops they're short on food, we are long.
Not buy our oil? Oops, WTI trades $10 lower than Brent and is the cheapest oil in the world.
Not allow our internet search? Oops they never let GOOG in.
Not allow our e-commerce? Oops they never let AMZN in.
Not allow our social media? Oops they never let FB in.
Oh right, they have the nuclear option – they can dump our tsy's. Oops, with 2’s/10’s flat, our yield curve could USE some steepening. Our banks would love that.
Check mate, China.
The only thing that’s changed above is that WTI now “only” trades $5.50 cheaper than Brent. But what else has changed? Weeks upon weeks of violent rioting in Hong Kong – I believe this is a real-time referendum on China’s policies from their own people. Not only do I believe that Xi’s bargaining leverage began weak relative to us, but his leash is getting shorter with economic weakness stoking civil unrest.
Furthermore, I think China is stuck between a rock and a hard place with respect to its currency. For years, China has benefited from linking its RMB to the perennially weak USD, which artificially super-charged its exports – much like the same way Germany benefited from replacing the Deutschmark with the Euro which has been artificially weakened by the southern European countries. Now, China finds itself stuck the other way – linked to a relatively strong USD; this, coupled with tariffs, should put a “double-whammy” on their exports.
So why not devalue? They’ve already relaxed the peg somewhat, but if they just let the peg go, they would risk major capital flight. But can’t they just clamp down with capital controls? Sure, but then the Hong Kong conflagration extends to Shanghai, Beijing and everywhere else. In this scenario, the Communist Party itself would face an existential threat imho.
Again, check mate, China.
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Kaoboy Musings is a private distribution list/blog that I created to encourage dialogue regarding the economy & markets, geopolitics, investment ideas, and life in general. I have a passion for the markets and investing, and even though I no longer accept investor capital, I try to keep current on global events and opportunities and remain active in the markets. I’ve always found that writing my ideas down, sharing them with smart people, and encouraging two-way discourse and devil’s advocacy is often the best way to validate or invalidate a thesis and stay mentally flexible.
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