Perspectives on the U.S. and Global Recovery

The U.S. economy had a very strong second quarter, with real GDP rising at an annualized 6,5% rate. Prospects for the third quarter were projected to come in just slightly below the second quarter pace, but the rise of the Delta variant of the COVID-19 virus has caused some downward projections to emerge in the weeks since Q3 started. In early September, we learned that the impact of the Delta variant was substantial.

The dramatic surge in the outbreak, which was disproportionately concentrated in the southern states, did not lead to significant changes in regulations governing social interactions. However, it did scare enough people to have a voluntary impact on social interaction and on the willingness of consumer-facing businesses to hire. High-frequency data shows that the number of people passing through airport security checkpoints has fallen as a share of 2019 volume. The number of people willing to make online reservations to dine at restaurants has fallen as a share of 2019 volumes, after rising significantly. Finally, since July the volume of gasoline supplied to markets also fell. In other words, data suggests that the willingness of individuals to engage in social interactions, or travel, after recovering strongly in recent months is going in a negative direction.

The employment report shows how public health events can influence economic activity. The establishment survey found that in August, 235,000 new jobs were created. That contrasts with the revised July addition of 1,053,000 new jobs. Job growth was significantly lower than projections from most economists across the /nation. Interestingly, manufacturing gained 37,000, which included a 24,100 increase of employment in the automotive sector. There was a strong 74,000 increase in employment in the professional and business services sector. The problem was in consumer-facing businesses. After increasing by 289,600 in July, employment at restaurants declined 41,500 in August. Employment at hotels, rose 73,000 in July, but only rose by 6,600 in August. Overall employment remained 3.5% or roughly 5 million below the pre-pandemic peak of February 2020. The establishment survey found that average hourly earnings were up 0.6% from the previous month and up 4.3% over the past year. This sounds high but inflation is stealing much of the impact of increased wages.

The weaker August jobs report may influence Fed thinking on plant to reduce bond purchases, or “tapering” in recent new articles. Inflation does seem to be losing velocity and supports the contention that the re-opening of the economy and the boost in demand, created the current situation of supply chain bottlenecks that boosted prices across the board, but that this boost in inflation will prove “transitory” in nature. Producer prices increased in August by slightly more than forecast as persistent supply chain disruptions squeeze production costs higher. The PPI for final demand increased 0.7% in August and was up 8.3% from a year earlier, a fresh series high. Excluding food and energy, the core index advanced 0.6% and was up 6.7% from August last year. The PPI for goods increased 1% after a 0.6% gain the previous month, while the cost of services rose 0.7%. Widespread labor shortages have also boosted price pressures. The latest wave of COVID-19 infections, driven by the Delta variant, have disrupted production at factories in Southeast Asia, a key raw materials supplier for manufacturing in the United States. Although surveys by the Institute for Supply Management this month showed measures of prices paid by manufacturers fell significantly in August, they remain elevated. Factories and service suppliers are still struggling to secure labor and raw materials and face logistic delays.

The CPI report shows a slightly different picture of inflation, one that falls more in the line of the Fed’s thinking that inflationary pressures will start to cool in coming months. The CPI for August increased 0.3%, down from the 0.5% advance in July. In the last 12 months, the index was up 5.3%. Much of the August increase in consumer prices came from energy, up 2.0% and food, up 0.4%. Excluding food and energy, the core index rose just 0.1%, the smallest increase in February 2021. The energy index rose 25% over the past 12 months and the food index 3.7%. The index for airline fares, used cars and light trucks and motor vehicle insurance all declined for the month. The index for lodging away from home declined 2.9%. While index decline for airfares and lodging away from home is likely related to COVID-fears from the consumer, the index for food away from home increased by 0.4%, suggesting a mixed picture from the COVID-impact on inflation for August. The slowdown in inflation represents both an impact from increased CVID infections in August that started to retreat in early September and possibly a shift to a slower pace of increase as the economy slows and greater production starts to align demand with production. August could be the start to slower inflation, but it is still early to determine that.

Industrial production increased 0.4% in August after moving up 0.8% in July. Last month’s shutdowns related to Hurricane Ida held down the gain in industrial production by an estimated 0.3%. Although the hurricane forced plant closures for petrochemicals, plastic resins and petroleum refining, overall manufacturing output rose 0.2%. Mining fell 0.6%, reflecting hurricane disruptions to oil and gas production in the Gulf of Mexico. Utility production increased 3.3% reflecting warm temperatures boosted demand for air conditioning. At 101.6% of its 2017 average, total industrial production in August was 5.9% above its year earlier level and 0.3% above its pre-pandemic level. Almost all major market groups posted increases in August. Despite an estimated 0.2 percentage point loss by Hurricane Ida, manufacturing output increased 0.2% and was up 1.0% above its pre-pandemic level. Durable goods output edged up with a large gain in furniture and related products. The largest loss was seen by electrical equipment, appliances and components. The output of nondurable goods edged up, with gains for food and beverage and tobacco products. Chemical output saw a large loss. The outlook for the industrial sector remains firm. Demand is strong but supply chain issues and labor are constraining production. Those problems will fade in time.

Retail sales surprised on the upside in August, rising 0.7%, up 15.1% from a year earlier. There was a large downward revision to July’s number, where sales fell 1.8%, instead of the -1.1% original estimation. Total sales over the last three months were up 16.3% from the same time period a year earlier. Total sales excluding motor vehicles and parts were up 1.8% in August and 0.8% excluding the auto sector and gasoline. Motor vehicle and parts sales fell 3.6% for the month. Furniture and home furnishing store sales increased 3.7%. Building material stores saw a 0.9% advance. Food and beverage sales increased 1.8%. Sporting good sales saw a 2.7% decline. Food and drinking establishments sales were unchanged. COVID infections have kept sales at restaurants and bars flat and congestion at ports is hurting electronic product sales. Semiconductor shortages are hurting auto sales. However, U.S. consumption is not slowing nearly as much as it appeared a month ago. The report suggests that the economy may come stronger in the third quarter than analysts projected a month ago when COVID infections and the loss of fiscal stimulus appeared to slow spending.

The Delta variant of the COVID virus is disrupting global manufacturing. In China, factories and ports are being disrupted by the outbreak of the virus and resulting restrictions imposed as part of its zero-tolerance policies. A typhoon in early September did not help things by causing further closings of key ports. The JP Morgan Global Manufacturing PMI eased from 55.4 in July to 64.1 in August. The output index declined from 54.4 to 51.9. Supply chain disruptions continued in August, highlighted by a marked increase in average vendor lead times, with the extent of the lengthening staying close to June’s series record. Companies reported transportation delays and shortages developing for a wide range of inputs and raw materials. With rising demand chasing constrained supply, average purchasing costs rose sharply, leading to a further near-record increase in selling prices. With China slowing, the effect was felt in the other nations in Southeast Asia. The ASEAN Manufacturing PMI slipped from July’s 44.6 reading to44.5, a 13-month low. The decline was felt the most in Myanmar, where the PMI reading of 36.5 was among the lowest on record. Vietnam saw its index at 40.2, the lowest since April 2020 amid the ongoing COVID outbreak. In the Philippines, the index came in at 46.4, the first deterioration since May but the sharpest decline for 15 months. In August, the 7 ASEAN nations recorded contractions, highlighting the impact of rising COVID cases and lockdown measures in the region.

In China, the Caixin General Manufacturing PMI fell from 50.3 in July to 49.2, below the expansionary 50 mark and the lowest reading in a year-and-a-half. Lower production led to the August fall of the index and rising COVID cases and additional restrictions were cited as the reason for the August decline. China’s factory and retail sales faltered in August with output and sales growth hitting one-year lows as fresh COVID outbreaks and supply disruptions threaten the nation’s impressive economic recovery. Industrial production rose 5.3% from a year ago in August, down from an increase of 6.4% in July and the weakest reading since July 2020. Consumer spending also took a hit by rising only 2.5%, the slowest reading since August 2020. The world’s second biggest economy has made an impressive rebound from last year’s COVID-led slump but momentum has slowed in the last few months due to supply chain bottlenecks, semiconductor shortages, curbs on high-polluting industries and a crackdown on property investment. Meantime, a new outbreak in Fujian is posing further downside risks in Q3. Production cuts in August hit aluminum and steel output and fuel export curbs hit China’s crude oil output. Xi’s crackdown on education, gaming and a host of other industries is hurting investor confidence and investment.

Not all the news from Asia and China is bad and there are hints that things might improve. China’s exports rose 25.6% from a year earlier, picking up speed from a 19.3% gain in July. South Korea’s exports also showed an impressive August jump in exports. The jump in Chinese exports was broad-based and advances in furniture, electronics and recreational products reflect retailers in advanced economies replenishing their inventories ahead of the Christmas shopping season. It did seem that some of the port congestion was partly cleared last month. The eastern coastal ports suffered congestion as a terminal at the second largest container port was shut down for two weeks due to a COVID-19 case. That put further pressure on global supply chains already struggling with a shortage of container vessels and high material prices. The stretched global shipping capacity has left many boxes of finished goods piled up on Chinese factory floors, a factor that will boost Chinese exports in coming months. Many Chinese factories are fully booked through the first quarter of 2022.

The economy is still expanding at a strong rate although it is slowing and transitioning toward trend growth. The near term looks more uncertain as a rise in COVID infections have slowed spending and employment growth as Americans have become more cautious. We do not think the recent surge in COVID infections will lead to widespread restrictions. The number of vaccinated people in the U.S. remains high and future outbreaks are likely not to hurt the overall economy. Therefore, any slowdown in spending will be made up in future quarters. The recent retail sales report suggests that although spending might have been dampened in the third quarter, it continues to be healthy. The Federal Reserve is likely to begin tapering its purchases of bonds by year’s end. Inflation, although still elevated is showing signs of cooling off. Business investment is strong but would be stronger as ongoing supply chain bottlenecks and labor shortages are constraining investment. Inventories are low and at some point, when the supply chain problems fade, a sizable inventory build will follow. Employment growth will remain strong well into next year. Near-term risks are political with the debt ceiling, budget, and infrastructure bill up in the air. We think the infrastructure bill will pass and some form of a budget and debt ceiling agreement will pass. In the long run, there are changes to the American economy in the form of labor issues that will emerge from the pandemic. The virus caused changes in the economy that will only become clearer with time.