Economic Outlook: RMES Perspective from the Markets and Prices

JOHN E. SILVIA DYNAMIC ECONOMIC STRATEGY

Economic Outlook: RMES Perspective from the Markets and Prices John E. Silvia Dynamic Economic Strategy July 15, 2021

A Question on Demand Follow the Indicators: We Live in World of Cycles—not Boom/Bust

Jobless Claims—4 week moving average still declining (+) Housing Permits—slowdown (-) both single family and multifamily Nondefense capital goods orders-ex-aircraft –slowdown (-) Consumer Sentiment –up over 3M ago (+)

Strong NFIB hiring, prices numbers

A Question on Supply • Re-opening price pressures • Airfares, rental cars, hotels

• Bottlenecks • Chips—New cars • Energy/ shut down pipeline • “Oil demand to surpass pre-pandemic levels by end of 2022, says IEA” 6/11/2021 FT

• Hiring workers –job openings exceed number of unemployed • Mismatching jobs, unemployed key issue for labor market

• But inflation gains are broad based—food, furniture, apparel • So not just re-opening and bottlenecks • Weaker dollar—import prices up 11.3% YOY • NY Fed underlying inflation gauge—3.15% May, 1.35% last November

A Question on Labor Supply Bottlenecks • Job Openings Exceed Number of Unemployed

• Quits rate up –workers quit when confident they can do better

• “The Pay Is Generous, the Work Nonexistent” WSJ 6/14/2021 • Not just unemployment benefits • Federal supplement, health care, child-care • In some states, total benefits exceed median household income • Job Growth: surprise on the upside?

• Yes, labor force participation still unchanged since October • Unemployment rates for both college and high school graduates still above May 2021—year ago numbers

A Question: Transitory Inflation?

• Certainly not • It is the intent of the Fed to raise the rate of inflation • Core PCE deflator (Fed’s target) was 1.7% in 2019

• Fed expectation for 2.0 % in 2022 • Fed expectation for 2.1% in 2023

• “Behind Fed Confidence on Inflation, Some Anxiety Creeps In” WSJ 06/16/2021

Recession Employee cost per unit GVA CPIU PCYA

2020-10-01

2019-07-01

2018-04-01

2017-01-01

2015-10-01

2014-07-01

2013-04-01

2012-01-01

2010-10-01

2009-07-01

2008-04-01

2007-01-01

2005-10-01

2004-07-01

2003-04-01

2002-01-01

2000-10-01

1999-07-01

1998-04-01

1997-01-01

1995-10-01

1994-07-01

1993-04-01

1992-01-01

1990-10-01

1989-07-01

1988-04-01

1987-01-01

1985-10-01

1984-07-01

1983-04-01

1982-01-01

Employee Unit Labor Costs and CPIU Employee Unit Costs and CPIU

10.0 1

8.0 0.9

6.0

0.8

0.7

4.0 0.6

2.0 0.5

0.0 0.4

-2.0 0.3

0.2

-4.0 0.1

-6.0 0

Core PCE deflator CAD per USD

2020-10-01

2019-07-01

2018-04-01

2017-01-01

2015-10-01

2014-07-01

2013-04-01

2012-01-01

2010-10-01

2009-07-01

2008-04-01

2007-01-01

2005-10-01

2004-07-01

2003-04-01

2002-01-01

2000-10-01

1999-07-01

1998-04-01

1997-01-01

1995-10-01

1994-07-01

1993-04-01

1992-01-01

1990-10-01

1989-07-01

1988-04-01

1987-01-01

1985-10-01

1984-07-01

1983-04-01

1982-01-01

Core PCE Deflator and the Canadian Dollar Inflation and the Canadian Dollar

8.00 1.80

7.00 1.60

6.00 1.40

5.00 1.20

4.00 1.00

0.80

3.00 0.60

2.00 0.40

1.00 0.20

0.00 0.00

A Question: Future Direction of Interest Rates and the Dollar • Up, The Fed wants higher inflation and with higher inflation comes higher interest rates • Current U.S. Treasury rates are being surpressed by Fed buying—any move to taper will reduce the demand for Treasury deficit finance while the supply of Treasury finance rises as a share of GDP (ability of economy to buy) • A weaker dollar will discourage foreign buying of U.S. Treasury debt. Dollar, DXY, down 5.4% versus a year ago.

• A move by the Fed to raise the funds rate will increase the base rate for interest rates • Economic growth in the EU and China have increased.

Profits per unit GVA Yield Curve

2020-10-01

2019-07-01

2018-04-01

2017-01-01

2015-10-01

2014-07-01

2013-04-01

2012-01-01

2010-10-01

2009-07-01

2008-04-01

2007-01-01

2005-10-01

2004-07-01

2003-04-01

2002-01-01

2000-10-01

1999-07-01

1998-04-01

1997-01-01

1995-10-01

1994-07-01

1993-04-01

1992-01-01

1990-10-01

1989-07-01

1988-04-01

1987-01-01

1985-10-01

1984-07-01

1983-04-01

1982-01-01

The Yield Curve and Profit Margins Profits per unit GVA and the Yield Curve

80 3

60 2.5

2

40 1.5

20 1

0 0.5

-20 0

-0.5

-40 -1

Question: Investment Outlook • From the Economics Viewpoint • Real Economic Growth continues, Inflation rises, dollar weakens, profit growth slows in line with slower real growth and rising interest rates • Still favors risk assets such as equity and high-grade corporate bonds • Looking for Income: Mortgage REITS, BDCs (yield for illiquidity) • Emerging Markets: “The Skies Are Darkening for Emerging-Market Stocks” WSJ 6/18/21 • Commercial Real Estate—migration and job patterns • Warehouse development, industrial vacancy rates, apartment asking rents • “SPAC to reality: Wall Street’s favourite money maker comes up short” FT 6/2/21

NFCB Debt as % MV Equity RFS DP PCYA

2020-07-01

2019-05-01

2018-03-01

2017-01-01

2015-11-01

2014-09-01

2013-07-01

2012-05-01

2011-03-01

2010-01-01

2008-11-01

2007-09-01

2006-07-01

2005-05-01

2004-03-01

2003-01-01

2001-11-01

2000-09-01

1999-07-01

1998-05-01

1997-03-01

1996-01-01

1994-11-01

1993-09-01

1992-07-01

1991-05-01

1990-03-01

1989-01-01

1987-11-01

1986-09-01

1985-07-01

1984-05-01

1983-03-01

1982-01-01

Debt Equity Ratio and RFS Debt as a share of Equity and RFS

120.00 15.0

100.00 10.0

80.00 5.0

60.00 0.0

40.00 -5.0

20.00 -10.0

0.00 -15.0

Question on Federal Deficits • • • • •

There is no free lunch Starting point: low interest rates, low inflation, excess savings All these factors drift away over the next three years Deficits must be paid—slower growth, higher taxes, higher interest rates, higher inflation, depreciating currency Expect higher interest rates, slower economic growth and depreciating dollar over the next three years.

• “Tax Hikes Alone Won’t Pay for Biden’s Budget Plan. The Bond Market Will Need to Pick Up the Slack.” Barron’s 5/28/21

There is Nothing Permanent But Change

• Heraclitus