The economy is “into the autumn”

The US Manufacturing Purchasing Managers Index (PMI), released by the Institute for Supply Management (ISM) in September, recorded only 47.8%, the lowest level in a decade. This is after August, the US manufacturing PMI is once again below the line of glory (50%), indicating that the US manufacturing industry has contracted.

The ISM report shows that the trade war has led to a sharp deterioration in the external environment of the US manufacturing industry, which has become one of the main reasons for the decline in the manufacturing industry. The data shows that the US new export order index is only 41%, the lowest level since March 2009. ISM Chairman Timothy Fiore said that the decline in new export orders began in July this year, indicating that global trade remains the biggest economic challenge.

Employment boom is hard to cover the recession

However, US Federal Reserve Chairman Powell still has great confidence in the US economy and said in his speech on October 4 that the US economy faces some risks, but overall it is still good. Providing confidence to Powell was the employment data released by the US Department of Labor on the same day. The data shows that the US unemployment rate in September was only 3.5%, the lowest value in the past 50 years; in addition, the number of new non-agricultural employment in the United States in September was 136,000, slightly lower than expected. The newly added employment is mainly concentrated in the medical industry and the commercial service industry. The two industries have newly added 39,000 and 34,000 employed people respectively. It can be said that in the case of shrinking manufacturing industry, the US job market is still showing a prosperous scene.

So what does the unemployment rate deviate from the manufacturing PMI? In theory, the manufacturing PMI reflects the future economic climate from the micro level of the enterprise and is therefore more forward-looking. The employment data has a slow response to the economic situation due to job stickiness and other reasons, and thus has a lag. Often, the new job slowdown suggests that economic growth is slipping to the brink of recession, and rising unemployment often means that the economy has fallen into recession.

Historical data indicates that changes in manufacturing PMI are usually ahead of changes in GDP growth, while unemployment changes lag behind GDP growth. Therefore, the unemployment rate has reached a new low in the past 50 years. It does not prove that the US economy is in its heyday. Instead, the manufacturing economy is declining and entering the contraction zone, which can better reflect the current severe situation facing the US economy.

What worries the market is that the manufacturing recession is being transmitted to the service industry through manufacturing services. In September, the US non-manufacturing PMI recorded only 52.6%, down 3.8 percentage points from August, the lowest since August 2016. Among them, the business activity index dropped by 6.3 percentage points from the previous month, recording 55.2%. Once the economic weakness spreads from manufacturing to services, both employment and private consumption will be severely hit, and the US economy will also really fall into recession.

The manufacturing PMI in September was not the first indicator for the US economy to warn, and the US economic recession has long been a sign. At the end of March, the US 10-year bond yields were lower than the US three-month bond yields for several consecutive trading days, forming an “upside down”. At the end of August, the yield on the US 10-year government bond also appeared to be “upside down” with the yield of two-year government bonds. Although the “upside down” of the latter two has ended, the “upside down” of the former two is still continuing.

Often, long-term bonds face greater uncertainty and less liquidity than short-term bonds, and therefore have higher yields to maturity. However, when the economy goes down, the market’s expectation of low interest rates in the future will lower the yield of long-term bonds. Therefore, the long-term short-term yield of government bonds is often considered to be a harbinger of economic recession, or the capital market has already had strong expectations of the US economic recession.

Monetary policy space is limited

What is more terrible than the deterioration of economic data is that the US monetary policy lacks enough space to cope with the economic recession. In 2007, when the crisis occurred, the US federal funds target rate was as high as 5.25%. In order to resolve the financial crisis, the Fed reduced the federal funds target rate to zero in a year and a half, and launched a large-scale asset purchase program. Today, the Fed has cut the federal funds target rate range twice in order to boost the economy, with a target interest rate floor of only 1.75%. Compared to 2007, the Fed’s current monetary policy space is very limited.

The Fed may also be aware of the limitations of the monetary policy space, and therefore hope to leave more “ammunition” in the possible sudden economic crisis, rather than consuming too much monetary policy space in the slow recession of the economy. Therefore, although the Fed cut interest rates twice in late July and mid-September, Powell had to cool down the loose monetary policy, reduce the market’s expectation of continued easing, and avoid the market’s dependence on monetary policy.

However, in the market view, Powell’s position and the Fed’s approach have created a strange and contradictory picture. Powell’s practice of balancing market expectations has not only failed to appease investors, but has caused the market to suffer. During the two consecutive interest rate cuts by the Fed, the US stock market, which should have been boosted, was ups and downs due to Powell’s frequent “cold water”.

Powell’s self-deception has not only failed to achieve the desired results, but has also led to confusion in market expectations. In the implementation of monetary policy, management is expected to be very important. Reasonable expectation management can sometimes make monetary policy more effective, and unreasonable expected management may induce wrong market behavior. Before 2008, the US monetary policy makers did not have clear expectations for management. Alan Greenspan, the former chairman of the Fed, often took a vague stance and was proud of the market.

However, after the 2008 financial tsunami, the Fed began to pay attention to the role of market expectations. Ben Bernanke, then chairman of the Federal Reserve, began to regularly convey monetary policy expectations to financial markets through interest-rate meetings, press conferences, and speeches from Fed officials, guiding market behavior and maximizing the effects of monetary policy.

It is a pity that the Fed’s monetary policy space is very cramped. Powell’s interpretation of monetary policy can only be vague, lest the market expectations are too strong and will wrap the Fed’s monetary policy in the future.

In fact, in addition to adopting monetary policy for countercyclical adjustment, the government can also introduce fiscal policies to stimulate the economy. Although US economic growth is dominated by consumption and services, the marginal change in GDP growth is heavily influenced by fixed asset investment. In recent decades, the share of US federal and local government investment in infrastructure has continued to decline. Until the current President Trump took office, this proportion has dropped from 4.2% of the highest peak to around 1.5%. Therefore, there is a huge space for infrastructure investment in the United States.

Debt surges, finances are stretched

It is in this regard that Trump proposed in an infrastructure plan submitted to Congress in February this year to increase $200 billion in federal government infrastructure investment over the next decade, stimulating and driving a total of $1.5 trillion in infrastructure investment. . According to estimates by the US White House Council of Economic Advisors, a $1.5 trillion in infrastructure investment will drive 0.1 to 0.2 percentage points of GDP growth each year.

However, like monetary policy, the implementation space of US fiscal policy is also very limited. First, the former US President Barack Obama consumed a lot of fiscal policy potential during the last economic crisis. After the crisis in 2007, Obama, who had just entered the White House, significantly increased his fiscal spending and introduced various welfare policies to stimulate economic growth. During Obama’s administration, the federal government’s deficit surged and US public debt grew by nearly $10 trillion.

Second, the tax cuts adopted by Trump after taking office have increased the financial burden on the US government. On December 22, 2017, Trump signed the Tax Cuts and Jobs Act. The Joint Committee on Taxation expects Trump’s tax cuts to generate more than $1 trillion in deficits between fiscal year 2018 and 2027, even considering the positive impact of tax cuts. Most of these deficits will appear in the first five fiscal years.

As a result of two consecutive governments borrowing money to “live”, as of September 10 this year, the US public debt was as high as 22.8 trillion US dollars, equivalent to 111% of US GDP last year. In the past fiscal year 2019 (October 2018 to September 2019), the US federal government’s fiscal deficit has approached the trillion mark ($984 billion), but it has to pay up to $574.6 billion in interest on these public debts. .

With the continuous accumulation of public debt, the US government’s debt repayment pressure has been increasing, which has severely squeezed the space for fiscal policy. Trump’s infrastructure spending plan has also been repeatedly blocked by the US Congress. Therefore, even if the economy continues to release the recession signal, the already stretched US government may not be able to provide enough funds to stimulate the economy.

Today, what is worrying about the US economy is not the emerging signs of recession, but once the economy is confirmed to be in recession, the US governors are unable to introduce enough counter-cyclical adjustments. Whether it is monetary policy or fiscal policy, the US government faces the dilemma of “ammunition”. Ten years of economic growth have masked too many short-sighted moves by US rulers, and I wonder if the US government can adapt to the darkness when the glare of stars fades.