Derailing Supply Chains
By Philip Marey, Senior US Strategist at Rabobank
Derailing supply chains
Yesterday, market sentiment was undermined by street protests against zero covid policy in China. Most European stock markets declined and the Euro Stoxx 50 lost 0.68%. Then in the US the S&P500 lost 1.54% after hawkish comments from Fed speakers added to the bad mood. The upward impact on US treasury yields remained modest however, while the EUR/USD had already peaked by noon CET.
Fed speakers yesterday confirmed that the terminal rate from the September dot plot is heading for an upward revision. New York Fed’s Williams said that “stronger demand for labor, stronger demand in the economy than I previously thought, and then somewhat higher underlying inflation, suggest a modestly higher path for policy relative to September. Not a massive change, but somewhat higher.” Richmond Fed’s Barkin said he favored slowing the pace of rate hikes in recognition of past aggressive moves and that the peak may need to be held for longer at potentially higher levels to dampen inflation. Fed Vice Chair Brainard said that the Fed must lean against the risk of inflation expectations rising above the 2% target and St. Louis Fed’s Bullard repeated his view that that the Fed needs to at least reach the bottom of the 5-7% range. He said that markets are underestimating the chances that policymakers will need to be more aggressive next year in raising interest rates to curb inflation and that there is still a heavy degree of expectations that inflation will go away naturally. Tomorrow, Fed Chair Powell will add his views in a speech and Q&A about the economic outlook and the labor market at the Brookings Institution.
The zero covid policies and protests in China have raised new supply chain concerns. Meanwhile, there is also a threat of a supply chain disruption in the US. Yesterday, Congress returned to work for the lame duck session. One of the priorities is to fund the federal government before a December 16 deadline, otherwise a partial government shutdown may be necessary. However, a major distraction has presented itself already. While supply chain bottlenecks have eased in the United States, railway union workers are threatening with a strike again, this time in December. In the summer, the White House appointed a mediation panel that helped broker a five year agreement that offers railway workers a 24% increase in wages from 2020 through 2024 and one additional paid day off. However, 4 out of 12 unions have rejected the deal. In contrast, the other 8 have ratified it. Both sides have agreed to a cooling off period until December 9. The impact of a railway strike on the economy could be substantial. About 40% of long distance cargo in the US takes place by railroad. This includes feedstock, coal, lumber, construction material and automotive parts. What’s more, even a short strike could have long term repercussions in the supply chain.
However, Congress is likely to intervene before this happens. Under the Railway Labor Act, Congress can order negotiations to continue and delay the strike deadline for a certain period. Alternatively, Congress could also send the dispute to outside arbitrators. Ultimately, Congress can make both sides accept an agreement that their members have voted down. This is what President Biden is urging Congress to do. He said that the mediated agreement should not be modified because there is little time to reopen negotiations. Speaker Pelosi said the House of Representatives would vote this week on legislation to adopt the tentative agreement. However, the railroad companies often take precautionary measures ahead of the deadline, such as no longer accepting certain types of cargo days before the strike deadline.
This means that we could still see supply chain repercussions, even if a strike is averted.
Today, the German CPI for November will be published. The Bloomberg consensus expectation is that the inflation rate remained unchanged at 10.4% (year-on-year). The EU harmonized version of the German CPI is even expected to fall to 11.3% from 11.6%. Later today, we get US house prices (Case-Shiller) and US consumer confidence (Conference Board). Expectations are that US house prices have declined again month-on-month, by 1.20% in September, after a 1.32% decrease in August. House prices have been falling since July, as the housing market is one of the first casualties of the Fed’s late but steep hiking cycle. In year-on-year terms, house prices have been falling since April. This means that shelter inflation, an important component of core inflation, will eventually come down as well. Residential investment has already receded and this contributed to the technical recession in the first half of this year. So far, monetary policy is working, but the lags for consumer spending could be much larger. Consumer confidence, as measured by the Conference Board, has been falling back since inflation broke out. The expectation for today is a further decline, to 99.9 in November, from 102.5 in October.
However, the tight labor market and savings from the pandemic era are still supporting consumer spending. We expect it will take until the second half of 2023 for the US economy to fall into an NBER-approved recession, i.e. one that includes a substantial rise in unemployment.
Unfortunately, the Fed will have to make sure that inflation has been squeezed out of the economy, before it can loosen monetary policy again.
Therefore, we don’t expect rate cuts before 2024. As Powell explained in Jackson Hole, the Fed wants to slay the inflation dragon in one go, and not make Volcker’s mistake of prematurely cutting rates before inflation was under control.