Dr. Ken Rietz
August 8, 2023
One of the recurring themes in the financial world currently is the possibility of a “soft landing” soon for the US economy: the hope that the forces that drive the economy will settle back into a more normal operation without any significant disruption. The stock market continues to go up. The jobs numbers are looking good (until they don’t). Do you recall that we were told that housing was the safest investment, until the real estate market burst in 2008? It is easy to cherry-pick warm and fuzzy opinions and data. But a lot of less friendly data is clouding up that optimism, indicating that prices are not going down in the immediate future, and if inflationary pressures continue markets may get nervous again.
We start with crude oil (NYMEX WTI).
The price of crude oil just hit a high for 2023, atop a strong trend. Numerous factors indicate that this trend will not reverse any time soon. From the politics of green energy preventing US drilling to rumpled relationships with leaders in the Middle East and Russia, the global supply of oil is likely to decline or at best remain nearly constant, and the price of crude will continue moving up or level off. Since diesel touches virtually everything that is bought in the US, and gasoline prices are plastered in front of nearly every American, a “soft landing” will be difficult to sell. The administration has indicated plans to refill the Strategic Petroleum Reserve. Draining it further is not a viable option.
China’s economy is supposed to come roaring back from the Zero-COVID policy that shut it down for more than two years, pulling itself up, and the rest of the world with it. Except it hasn’t yet, and it might take longer than originally thought. China’s economy may be facing significant headwinds in the near future. Here are a few brief indications of that.
• The Association of Financial Professionals estimated the Chinese GDP would grow by 7.1%. The Chinese National Bureau of Statistics reported a GDP growth rate of only 6.3%. The Chinese statistics on GDP are notoriously overstated, which means that the real GDP was a lot worse than that.
• The Chinese youth unemployment continues to increase, currently at 21.3%. Since China fudges this number nearly as much as the GDP, it is probably a lot higher. And since Chinese universities won’t give diplomas out to people who can’t document being employed (whether true or not), even the numbers officials worked with are probably too low.
• The Economist has written about fears of deflation in China, and a recession is not a far-fetched scenario.
• According to Nikkei Asia, roughly 30% of China’s GDP is in the real estate sector. Remember Evergrande? It is still going, with a current equity below −84 billion dollars. The most recent culprit? Watch what is happening with Country Garden, another big real estate developer. Its attributable contract sales has dropped signifcantly year over year. The government is trying to help, but according to Barron’s the measures are “insufficient to save the sector.”
• China has tried to be the world’s manufacturer, which made it rich. But now the global economy is slowing down. According to The Business Times (International section) China’s June exports are down −12.4% and imports are down −6.8% year over year. And this trend is likely to continue as other countries try to decouple their economies from China. FDI in China in Q1 2022 was about $100 billion, but in Q1 of 2023 it was about $20 billion. That is not a successful recovery for an economy dependent on exports.
If the second largest economy stumbles more, the world’s economies are going to suffer, and chances are that there will be global consequences.
The last example of the scenario supporting a soft landing is the assumption of a decrease in the Federal funds rate. CME’s FedWatch indicates that the market expects one more rate hike, to 525–550 bps, before the end of this year, which is likely true. But for 2024, the average (mode) rate will drop to 400–425 bps (and skewed to the downside) by the end of 2024. This is almost certainly too low. The Fed’s own dot plot has a median rate of 4.625% for 2024. And the Fed chair, Mr. Powell, has studied the economy enough to know that the worst inflation in recent US history occurred because rates went down too fast after taming inflation. He will not repeat that mistake. He will argue forcefully to keep the rates higher than others might want. And with the Fed rate staying near the 4.75% – 5.00% level, if the landing happens, the chances are that it might not be that soft.
Note that this commentary is not arguing that there will not be a soft landing. It is arguing that if there is any landing in the near future, it may not be soft. A landing more than two years from now could be soft, even though historical odds are against it. There is room for hope.