Dichlorodiphenyltrichloroethane, commonly known as DDT, was a colorless, tasteless, and almost odorless insecticide widely used in American agriculture in the 1950s and 1960s. Due to its negative impacts on health and the environment, it was banned in the states. United in 1972. The economies of the United States and the developed world today have in themselves the equivalent of DDT (Demography, Debt, and Ttechnology). These factors will eventually wipe out this nasty pest of inflation, but at the same time demographics and debt are acting to limit the potential long-term growth rate of these economies, and technology can do it in the short term. .
The much-anticipated initial estimate of Q3 GDP (+ 2.0%) appeared lighter than expected on Thursday, October 28 (the consensus was + 2.6%; just a month ago it was +6 , 0%, and it was + 7.0% at the beginning of July). But, perhaps, from an economic point of view, more important news arose after the market closed. The two Apple
We have been anticipating for several months the slowdown in the growth trajectory of the economy. There are a multitude of reasons:
- The helicopter money for federal government programs has ended and most of it appears to have been spent. The savings rate has now fallen to 8.4% (close to its pre-pandemic level), from 10.5% in the second quarter. This would seem to imply that there is not much consumption left in the tank from this source.
- The newly released GDP data indicates that real personal disposable income contracted during the quarter, no doubt due, at least in part, to the end of federal programs. It is likely that this impact will spill over into the fourth quarter. We believe the number of jobs for the fourth quarter will be high.
- We cannot understand how the pandemic could accelerate the potential growth rate of the economy. The top chart shows how growth cooled in the post-Great Recession period from what it had been two decades earlier.
As stated earlier, economic DDT consists of demographics, debt, and technology.
- Demographics: The median age of the American population is 39 years, in the immediate postwar period it was closer to 28 years. Today’s household formation rate is declining, as is the average family size (which is 15% lower than it was in the 1970s). Older generations don’t buy their first home or spend on furniture. If anything, they are downsizing. Grocery and energy bills are lower because the children are (for the most part) alone. This image is not favorable to growth.
- Debt: In the 1970s, the debt to GDP ratio was 150%. Today it is 350%. Rising debt is a growth killer because it weighs on the incomes of consumers and businesses. Entities must make payments of principal and interest that would otherwise be available for consumption (consumer) or investment (business). Economic theory has a concept called “Richardian equivalence”. He postulates that when public debt increases (eg budget breakers of the recent past), people consume less and save more by expecting higher taxes! (There you go! – look at the tax proposals of the Biden economic plan!)
- Technology: Technology that replaces unskilled labor increases business margins and is likely positive for long-term economic growth. But not in the short term because it reduces household income and, at least initially, reduces consumption. The two charts below compare the rate of change in unit labor costs in the 1970s to the post-Great Recession period where technology played a much larger role. Note that unit labor costs have been significantly lower (higher productivity) over the last period. And while there were some initial spikes in labor costs during the shutdowns, they seem to have faded. Technology is one of the main reasons inflation has been so subdued over the past 15 years.
A return to “almost” normal is the best way to describe the labor market in terms of initial jobless claims (CI) and continuing claims (CC). Both charts show this part of the labor market approaching pre-pandemic levels (compare left and right sides). Chart CC shows that, as of the end of August, 9.3 million claimants no longer receive government checks. If this is the case, then why are companies, especially in the leisure / hospitality and retail sectors, unable to find employees? We have seen various explanations, including three million early retirees. But our view remains that the most recent data still reflects the early days of the post-earnings shutdown and that the jobs numbers ahead will be robust.
As previously reported, the third-quarter savings rate almost fell to pre-pandemic levels, so much of the government’s largesse was spent. Those who were receiving benefits but were left on the sidelines still have to have an income to live. When their savings are exhausted, since they must have an income, we believe that they will (soon) return to the labor market.
Preliminary GDP at + 2.0% was lower than the consensus estimate of 2.6% and well below expectations at the start of the third quarter + 7.0%. While some will assess the blame (delta variant, supply chain issues), the service sector was -0.4% below its pre-pandemic level, very close to it. And there appears to be light at the end of the supply chain tunnel, as shown by the fall in the Baltic Dry Index (still high, but the downdraft is dramatic).
Housing and non-residential construction fell in the third quarter, with residential falling by -7.7% year-on-year (after -11.2% AR in the second quarter). Could it be that the nearly 20% year-on-year rise in house prices has something to do with this? Non-residential also fell by -7.2% (-3.0% in Q2). While the media continues to focus on rising wages as supporting consumer spending (these occur primarily in the low-wage leisure / hospitality and retail sectors), with the elimination government support programs and taking price increases into account, real personal disposable income fell in Q3 by -1.4% Q / Q and -1.7% Y / Y. This does not bode well for growth in the fourth quarter.
Â· There is a workforce problem that could potentially disrupt the labor market and the economy – immunization mandates. Currently, these mandates cover approximately two-thirds (100 million) of the workforce. Assuming that 5% end up being non-compliant and being released (made redundant), that’s five million new unemployed. It is still too early to draw any conclusions, as this seems to have become a political issue and he must withstand legal challenges.
Â· Another emerging issue is the shape of the yield curve. In recent weeks, the yield curve has flattened (the difference between long and short rates has narrowed). Such behavior of the yield curve means:
- Markets expect central banks to raise short-term rates (administered rates like the Fed Funds rate).
- But flatter or falling long rates mean that markets also expect the economy to slow down (or at least a reduction in the inflation premium (we think both!)).
- Historically, when the yield curve flattens and then reverses, a recession is imminent. We’re not there yet, but something to ponder.
Â· The Fed is still a wild card. We expect them to announce a âcutâ to their quantitative easing (money printing) program at the next November meeting, but we don’t expect a Fed Funds rate hike anytime soon. The “taper” is long overdue as banks are swimming in liquidity. The inflation that exists has happened on the supply side. The Fed’s short-term tools are demand-oriented (that is, they can have an immediate impact on demand – for example, the cost of a loan in the pandemic state and demand has already started to decline). The Fed knows this, so we are not waiting for any firm date for the first rate hike.
Everywhere we look, growth is slowing. In the United States, support programs are now in the mirror. Bell-Weather companies like Apple and Amazon have seriously missed their revenue estimates. Economic forecasts have been and remain too optimistic (surprise Citi index). We don’t anticipate a looming recession, but we do expect the economy to return to its pre-pandemic growth path of 1-2%.
(Joshua Barone contributed to this blog.)