Will high bond yields be what finally takes it down?
The energizer bunny, a pink mechanical hare that keeps banging its drum owing to long-lasting batteries, will celebrate its 35th anniversary this October. As if to mark the momentous occasion, the American economy is doing its best imitation of the advertising icon. Despite umpteen predictions of a slowdown, it keeps going and going. Recent data suggest it may even be on track for annualised growth of nearly 6% in the third quarter, a pace it has hit only a few times since 2000.
As has been the case repeatedly over the past year, a steady stream of better-than-expected data has left analysts scrambling to lift their forecasts. New orders for manufacturing firms reached their highest in nine months in July. Retail sales were perky last month, too, with consumers splurging on everything from restaurant meals to online shopping and clothing to sporting goods. The construction industry has also been buoyant, supported by a rebound in homebuilding. Underpinning all this is the labour market, which has remained hot, making it relatively easy for people to find work at decent wages. The total number of jobs in America has been growing faster than the working-age population, helping to keep the unemployment rate at 3.5%, just shy of a five-decade low.
The worry is that such strong growth, veering into overheating, will also beget a long-lasting inflation problem. Added up, America is on track for a gdp figure this quarter that may look more like a “no landing” than the “soft landing” expected a short while ago. The Federal Reserve’s branch in Atlanta uses a range of data points to estimate gdp growth in real time: a technique known as nowcasting, rather than forecasting, because it assigns weights to already observed variables without factoring in expectations for future figures. On August 16th, its latest update, the model showed the economy may expand by 5.8% in the third quarter. That would be a shocker after more than a year of aggressive interest rate hikes by the Fed.
Could growth really be that strong? The nowcast almost certainly exaggerates the economy’s vigour. It is normally off by about two percentage points at this point in the quarterly cycle (see chart). One factor this time is likely to be inventories. When firms make sales from their stocks rather than by producing new goods, this drawdown counts as a subtraction from gdp. A recent gap between rising retail sales and declining wholesale transactions suggests that such a drawdown is now taking place and will weigh on growth, according to Andrew Hunter of Capital Economics, a consultancy. Still, even if somewhat exaggerated, the Atlanta Fed’s nowcast is almost always directionally correct. The inference is clear: America’s economy is not just holding up but steaming ahead.
Recent months have offered some respite on the inflation front. Core prices, which strip out volatile food and energy costs, have risen at their slowest pace in more than two years. But if the economy continues to heat up, inflation may well stage a rebound. Andrew Hollenhorst of Citigroup, a bank, warns that shortages of both workers and housing risk a significant reacceleration of prices next year. Where once optimists thought that inflation might be transitory, now pessimists fear that disinflation will be fleeting. That would scupper hopes for a pivot to monetary loosening by the Fed.
The strength of the American economy may also add to financial strains. It is the principal factor explaining why investors have sold off government bonds since May. Yields, which move inversely to prices, have risen by about one percentage point during that time, with long-term Treasury yields climbing to 16-year highs. This has prompted a debate about whether America’s neutral short-term interest rate—where the Fed would set rates to neither stifle nor stimulate growth—has drifted up. Bill Dudley, a former Fed official, has argued that in the long run America may require higher rates to balance the need for more borrowing (implied by higher government deficits) and a smaller funding pool (as retirees spend their savings). A gathering of central bankers in Jackson Hole, Wyoming, taking place after we go to press, was expected to discuss such issues.
Wall Street is now convinced that in the short run the Fed will need to keep rates higher than expected, too. A few months ago most were pricing in rapid rate cuts starting in September; now most think the Fed will wait until May and will move tepidly. Given the economy’s continuous outperformance, pricing in higher rates further into the future seems prudent.
Higher yields are contributing to an increase in funding costs for financial institutions, which are a headache for smaller lenders in particular. Moody’s and s&p, two credit-rating agencies, downgraded a spate of banks this month, a reminder of the continued fragility of the financial sector. Higher borrowing costs are also starting to bite for consumers. Delinquencies on credit cards and car loans have started to increase sharply. Finally, higher rates are clouding the outlook for housing. Like the wider economy, the market has been most notable for its resilience to date. But mortgage rates have jumped over the past couple of months and hit 7.5% this week, their highest since 2001. This is already having a dampening effect on existing home sales, which could spread to homebuilding and construction more generally.
The lesson of recent history is that the American economy inevitably blows through such problems. Nothing lasts for ever, though. The higher yields rise, the greater the challenge. In the advertisements the Energizer Bunny’s batteries never fade. In real life even the strongest batteries are drained eventually—or unceremoniously yanked out.
Economist
China’s rare earths dominance makes U.S. supply chains vulnerable, trade representative says
China’s dominance in rare earths makes U.S. supply chains vulnerable, U.S. Trade Representative Katherine Tai said in an exclusive interview Saturday with CNBC’s Martin Soong.
Rare earth metals are used in high-tech products such as electric car motors. Over the decades, China has built up its ability to process the metals — giving it enormous pricing power in a critical global market.
“What I want to draw your attention to is not just the vulnerabilities around China’s investments [overseas], but the fact that China’s dominant position in the world market now in [rare earths] means that it is able to turn on the faucet and turn off the faucet,” Tai said.
“And until we are able to access and create additional supply chains we remain entirely vulnerable to that leverage,” the U.S. trade representative said. Tai was speaking in New Delhi, India, on the sidelines of B20, the official business dialogue forum of the G20.
Tai pointed out that about a decade ago, China raised rare earths prices so high that some U.S. mines were able to operate in the industry again, only to have to close once China cut prices.
The U.S. held a majority stake in the rare earths metals market prior to the 1980s. But lower labor costs overseas, as well as less pressure on environmental standards, helped send the rare earths industry out of the U.S.
Meanwhile, Beijing supported the industry.
“The advantage in terms of China’s dominance isn’t necessarily a natural advantage,” Tai said. “It’s not that they have more rare earths but that they were able to pursue coordinated industrial and trade policies that allowed them to corner the market.”
The Chinese government sets economic plans at least every five years, with some goals — such as boosting self-sufficiency in technology and reaching carbon neutrality — set years earlier in advance.
While such top-down planning isn’t guaranteed to achieve results, the electric car industry has become an example of where Chinese industry has been able to capture significant market share across the supply chain, including the end product.
The level of U.S. reliance on China-based manufacturing came to the forefront during the Trump administration, and accelerated when the Covid-19 pandemic in 2020 disrupted global supply chains. The Biden administration has announced multibillion-dollar initiatives to encourage companies to develop and manufacture critical technologies in the U.S.
“Where we are in terms of our supply chains today is not where we want to be,” Tai told CNBC on Saturday. “We know that we’re vulnerable. Where we want to be is in a place where our supply chains are more diversified, where we have more confidence in them, where we just have more options.”
In the case of rare earths, Tai pointed out that China has a monopoly in the global market. She noted that in the case of Australia’s lithium production, China is also the only buyer — giving Beijing another point of market leverage.
While lithium is a key component of electric car batteries, it isn’t one of the 17 metals scientifically categorized as rare earths.
This year, U.S. and European government officials have talked of de-risking, or reducing the level of dependency on China alone. In a speech to global business leaders in June, Chinese Premier Li Qiang said de-risking is a false proposition because global economic interests are so entwined.
‘Phase one’ trade agreement
Just before the pandemic began, the U.S. and China signed a “phase one” trade agreement which called for China to increase its purchases of U.S. goods as a way to offset the massive U.S. trade deficit with China.
When asked Saturday about where the agreement stands, Tai said the U.S. is still looking at China’s shortfalls in meeting those purchase targets.
She said another aspect to that discussion is the degree to which U.S. trade with China is “imbalanced.”
Official U.S. data said the country’s trade deficit with China rose by 8.3% to $382.9 billion in 2022.
U.S. Secretary of Commerce Gina Raimondo is set to visit China from Sunday to Wednesday, as high-level U.S. official trips to the country have resumed this summer after a lull.
U.S.-India relations
Tensions between the U.S. and China have escalated over the last several years, starting with trade and spilling over into tech and finance.
Many businesses have increasingly started to look for opportunities in India, while the country’s relationship with the U.S. has improved.
On Saturday, Tai also met with India’s Minister of Commerce and Industry Piyush Goyal, and raised concerns about India’s import license requirements for tech equipment, a release said.
“The stars really are aligning between the United States and India and that’s across all of the policy areas,” Tai told CNBC. She described the relationship as “experiencing new heights.”
She said in her area of economics and trade, the potential for working more with India was always there, but previously, “we just couldn’t figure out how to tap it.”
— CNBC