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Some of US President Biden’s recent executive orders were meant to address the issue of increasing market concentration in key industries. My expectation is that his administration will fight mergers and acquisitions that would lead to greater market concentration, which is seen as reducing competition and thereby suppressing innovation and productivity gains. Yet is market concentration increasing? According to a recent study conducted by economists at the Federal Reserve Bank of New York, concentration among domestic producers in key industries has, indeed, increased. Yet when foreign companies are included in the mix, concentration has not increased. That is, increasing imports have boosted competition, offsetting the negative impact of domestic concentration. If so, then the ideal solution to the problem of excessive concentration is to allow more global competition.
Yet in recent years, there has been an increase in restrictions on trade, with US tariffs on Chinese and other goods having increased considerably. Moreover, the Biden administration has not yet reduced the tariffs that were introduced during the previous administration. However, the evidence cited in the Fed study suggests that increased trade has boosted competition and suppressed the prices paid by consumers. Although the Biden administration intends to use regulatory and anti-trust powers to stifle concentration, whether it wants to use trade policy to achieve a similar goal is not clear. Moreover, uncertainty about trade policy will likely stifle and/or delay investments in supply chains.
Florida, a state with less than 6% of the US population, now accounts for 20% of daily new infections. While the number of infections nationwide have been increasing in recent days, a disproportionate share has accrued to a handful of states, including Florida, Arkansas, Missouri, Louisiana, Texas, and Nevada. This is not entirely due to low vaccination rates. For example, the share of Florida’s population that is vaccinated is roughly the same as the national share. Rather, the surge in Florida and some other states likely reflects a higher degree of social interaction, especially among the unvaccinated. That, in turn, could be influenced by government policy regarding mask-wearing and crowd density. In Florida, the state government has strongly promoted a return to normal economic conditions. It has attempted to ban businesses from discriminating against the unvaccinated.
Still, the states with the highest rates of vaccination tend to have the lowest rates of infection. The highest vaccination rates are in the Northeast and the West Coast, both places with relatively low infection rates. Thus, it is evident that vaccination makes a substantial difference. In fact, many governors of states with low vaccination rates, as well as political commentators who initially dismissed the vaccine, are now calling on people to get vaccinated. There is a growing sense that, in the absence of a further increase in vaccination rates, the crisis will take a long time to end. That being said, the relatively low, but not insignificant, rate of hospitalization and fatality has convinced some people that herd immunity might be achieved without a big human cost. Public health officials, however, say otherwise and have strongly urged more vaccinations.
In any event, the number of daily doses of the vaccine in the United States has fallen by roughly 85% since mid-April, despite much wider availability of the vaccine. Consequently, the United States has slipped in terms of the share of the population vaccinated. As recently as late May, the share of the US population fully vaccinated far exceeded most other developed countries, including Canada, United Kingdom, Germany, France, Italy, and Spain. Now Canada, United Kingdom, and Spain exceed the United States, and the others are quickly catching up. Daily doses as a share of the population are now much higher in Europe and Canada than in the United States.
Meanwhile, there is conflict about what to do about the current outbreak. In Los Angeles County, where I live, the county government has imposed a mask mandate, even though the infection rate remains low. It is a precautionary measure and, so far, has been a success. Still, the fury with which this policy has been greeted has been stunning. This suggests that, after 18 months, many people are no longer willing to accommodate even minor inconvenience.
Finally, if a further outbreak occurs, it is likely that it will have some negative impact on social interaction and, therefore, economic activity—even if economic restrictions are not imposed. The past 18 months have taught us that, when outbreaks occur, some people choose to avoid social interaction, thereby reducing spending on consumer-facing services. The current strong growth of the US economy is, therefore, at risk.
Among economists with whom I have spoken, there is a consensus that, for the US economy, growth likely peaked during the second quarter but is likely to be robust in the quarters to follow. The latest purchasing managers’ indices (PMIs) for US manufacturing and services suggest as much, indicating a deceleration in services growth from June to July but a small acceleration in manufacturing growth. Overall, the composite index, which includes both manufacturing and services, fell in June but remained at an historically high level. This implies that the economy grew at a blistering speed in June and then decelerated somewhat in July. In fact, the notion that growth has peaked might explain why bond yields have fallen.
The PMIs, which are published by IHS Markit, are forward-looking indicators meant to signal the direction of activity in the economy. They are based on sub-indices such as output, new orders, export orders, employment, pricing, inventories, pipelines, and sentiment. A reading above 50 indicates growing activity. The higher the number, the faster the growth. The services PMI fell from a record high of 64.6 in June to 59.8 in July, still a very high number. The deceleration was attributed, in part, to labor shortages and “difficulties acquiring stock.” In addition, survey respondents noted continued increases in costs. Still, new orders were very strong, reflecting robust demand. The pipeline is very full.
The manufacturing PMI increased from 62.1 in June to 63.1 in July, a record high. New orders as well as export orders accelerated, reflecting continued strong domestic and foreign demand. Despite shortages of some inputs, output grew at the strongest pace in seven years. Backlogs grew and lead times increased. As a result, many companies endeavored to accumulate reserves of inputs, thereby exacerbating the problem of scarcity and contributing to further cost inflation. However, Markit noted that “We’re already seeing signs of inflationary pressures peaking, with both input cost and selling price gauges falling for a second month in July, albeit remaining elevated.”
Finally, although the PMIs indicate that the US economy is growing rapidly, Markit indicated that significant risks remain. These include uncertainty about how soon labor shortages will be resolved, how long supply-chain disruption will last, and how big an impact there will be from the current outbreak of the delta variant. Markit said that these factors have “pushed business optimism about the year ahead to the lowest seen so far this year. The concern is this drop in confidence could feed through to reduced spending, investment and hiring.”
Although there has lately been a surge in infections in some parts of the Eurozone, the impact has not yet showed up in the PMI numbers. Markit reports that the Eurozone’s PMI for services increased from 58.3 in June to 60.4 in July, a 181-month high. At the same time, the manufacturing PMI fell from 62.6 in June to 60.9 in July. The decline in the manufacturing PMI was attributed to supply-chain issues. Both PMIs are at an extraordinarily high level, indicating rapid economic growth as the third quarter begins. In fact, the composite PMI, which includes both manufacturing and services hit a 252-month high, suggesting that third quarter economic growth is likely to be very strong barring a sudden reversal of fortune.
The rise in the services PMI is especially notable, given that whatever weakness previously existed was largely due to weak demand for consumer-facing services. Also, strong orders led to backlogs for both manufacturing and services amid capacity constraints, leading to an acceleration in prices. At the same time, business confidence declined due to concerns about the delta variant of the virus that has caused a dramatic surge in infections in some countries. The acceleration of Eurozone growth was led by Germany where the composite PMI hit a record high. Finally, Markit noted fear that further outbreaks of the virus around the world “could lead to further global supply chain delays and hence ever higher prices.”
The European Central Bank (ECB) reiterated its intention to maintain an easy monetary policy. Although it recently said that it will initiate a policy to target a “symmetric” inflation rate of 2.0% (meaning that inflation can periodically rise above that level), it also noted that “the medium-term outlook for inflation is well below” the target. Consequently, the ECB has revised its forward guidance with respect to interest rates. It now says that it expects “the key ECB interest rates to remain at their present or lower levels until it sees inflation reaching two per cent well ahead of the end of its projection horizon and durably for the rest of the projection horizon, and it judges that realized progress in underlying inflation is sufficiently advanced to be consistent with inflation stabilizing at two per cent over the medium term.” The ECB also said that asset purchases under the Pandemic Emergency Purchase Program (PEPP) will be conducted at a “significantly higher pace than during the first months of the year.” It said that asset purchases will take place “for as long as necessary to reinforce the accommodative impact of our policy rates, and to end shortly before we start raising the key ECB interest rates.”
Last week’s announcement means that the ECB is not only unworried about inflation, it appears to be concerned that underlying inflation is likely to remain below the target. That is, it believes that the recent increase in inflation is likely to be transitory and that inflation will soon revert to a lower level. Other central banks, such as the US Federal Reserve, take a similar view. Inflation at too low a level implies relatively high real interest rates, which can have a chilling effect on investment. The ECB announcement did not involve a new policy. Rather, it reinforced an existing policy. In response to the announcement, bond yields fell on the view that an extension of asset purchases will reduce the supply of bonds held by the public, thereby putting downward pressure on yields.
Daniel Zaga, Director of Economic Analysis for Deloitte Spanish-Latin America, and Alejandro Mina, Senior Economist for Deloitte Spanish-Latin America, discuss the latest economic data for Latin America.1
COVID-19 hit Latin America hard. As of July 2021, the region had almost 30% of the world’s COVID-19 deaths, with only 8.3% of the global population. Moreover, because of pandemic-related restrictions, its GDP contracted by 6.8% in 2020, the worst result in more than a century. However, the region is set to rebound in 2021 (by 5.3%). The combination of fewer restrictions, stronger global demand, and a commodity boom has led some analysts to revise their growth forecasts upward. By the end of the year, GDP figures of the better-performing countries (i.e. Guatemala, Paraguay, and maybe Colombia) should reach their prepandemic levels.
Amid the recovery, two challenges lie ahead for policymakers: inflation and debt. Prices have increased due to supply-chain disruption, fuel costs, demand pressures, and currency depreciation. In fact, in Brazil, Dominican Republic, Mexico, Peru, and Uruguay, the interannual inflation rate is already above the upper bound of the central bank’s target. Most banks have not changed their policy rates, deeming the surge in prices to be temporary and due to a base effect (strict lockdowns in May and June 2020). Nonetheless, the two largest economies, Brazil and Mexico, hiked their policy rates in June by 75 and 25 basis points, respectively. Chile did so in July, by 25 basis points. These decisions are seen as a way to contain both current and expected inflation.
The second challenge comes from the fiscal side and the debt position of the region. Latin America needs to improve its weak fiscal metrics. According to the International Monetary Fund, this region has the highest debt burden as a share of GDP (56.3%). Most countries increased their government spending to face the pandemic and now need to increase their tax revenue to finance it. Tax reforms, always unpopular, can be even more challenging in the current climate of deep partisanship and political polarization. However, the need for reform looms large.
Unlike central banks in most developed economies, central banks in many emerging countries are very concerned about rising inflation. Russia’s central bank raised its benchmark interest rate last week by 100 basis points to 6.5%. Since March, it has increased the rate by 225 basis points. These measures come at a time when inflation has risen sharply. In June, consumer prices were up 6.5% from a year earlier, the highest level since August 2016. The high inflation reflects the sharp rise in global commodity and input prices as well as the effect of a resurgence in demand in Russia’s quickly recovering economy.
In a statement, the central bank noted that “inflation is developing above the Bank of Russia’s forecast. This largely reflects the fact that steady growth in domestic demand exceeds production expansion capacity in a wide range of sectors. In this context, businesses find it easier to transfer higher costs to prices.” The central bank indicated that further interest rate increases are possible. With Russian memories of ruinous inflation still raw, the central bank is evidently keen to anchor expectations of inflation to avert a return to an inflation psychology. Moreover, with Parliamentary elections imminent, the government might be concerned that rising prices of food and other basics could further reduce real incomes and thereby undermine popular support for the government. In fact, the government has imposed caps on the prices of some basic foods. On a positive note, Russia’s central bank has mostly been successful in keeping inflation low. The government has given it a higher degree of independence than is often true in emerging economies. The central bank therefore has credibility with investors, which likely helps to suppress borrowing costs.
Earlier this year, US President Biden proposed two large spending bills, totaling more than US$4 trillion over eight years, to be spent on infrastructure, health care, education, childcare, elder care, and climate-related investments among other things. At this point in time, there is some chance that a limited infrastructure bill, supported by some Republicans in the Senate, will pass. Regarding the other spending priorities, Democrats in the Senate have agreed on a US$3.5 trillion program to address the other issues, with the hope that this can be passed using the reconciliation process which restricts the ability of opponents to stop the legislation through a Senate filibuster. However, reconciliation will require unanimity among the Senate’s 50 Democrats, a tall order, and near unanimity among House Democrats. In any event, the spending plan entails some tax increases to fund the program. Perhaps the most interesting of the tax proposals is one to tax imports based on the carbon emissions generated in their production. The idea is that, if the United States is to restrict domestic carbon emissions in production processes, then it must tax imports accordingly to avoid giving imported products an unfair competitive advantage. Notably, the European Union (EU) proposed a very similar carbon border tax recently as well. Thus, the major developed economies appear to be moving in a similar direction.
The plan offered by the Democrats, while not yet providing many specifics, likely involves requiring that imports be taxed based on the volume of carbon emitted in the production process. This will especially apply to imports of steel, aluminum, and other heavy manufactured products. Of course, the devil is in the details. Determining the carbon content of imported goods could be challenging. One former Obama Administration official, however, said, “A carbon border adjustment is most effective if we never have to use it. If we threaten to use it and that means all our trade partners up their game and do a lot more to reduce emissions, then we never have to use it. I think that can be quite important and quite effective.” The carbon border tax is meant to encourage all countries to restrict carbon emissions. However, if the United States imposes this “tariff” but does not restrict domestic carbon emissions, then the country will export polluting goods while restricting imports. This would, effectively, be a disguised form of protectionism.
In any event, it is by no means clear that this measure, as well as the larger US$3.5 trillion bill, will become law. However, there is some chance that a version of this proposal, perhaps watered down, will eventually pass. Regarding the geopolitics of this proposal, it is worth noting that the world’s largest carbon emitters, in order, are China, United States, EU, India, Russia, and Japan. Thus, if the United States and EU both implement carbon border taxes, the biggest impact will be on China. That fact might help to attract bipartisan support in the US Congress. It could also mean increased tension between China and the others. If, however, the EU passes such a carbon border tax and the United States does not, it would likely lead to increased trade tension between the United States and the EU, possibly leading to formal complaints lodged at the World Trade Organization (WTO). Thus, as climate considerations grow in importance, they will have an impact on taxation, regulation, supply chain design, trade relations, and the requirements of attest services.
Meanwhile, there is a debate taking place about whether central banks should focus on climate-related issues. Critics say that central banks should stick to targeting inflation and unemployment, and leave climate and other issues to political leaders. In fact, US Fed Chair Powell said, “We do not seek to be climate policy makers.” Supporters, however, say that climate risk will ultimately affect macroeconomic performance and that, consequently, climate should play a role in central bank deliberations. The latter view has already informed the decision-making of the European Central Bank, which says that climate considerations will play a role in the choice of bonds that it purchases. Climate concern is also evidently held by the Bank of Japan (BOJ), which announced that, going forward, it will provide subsidies to commercial banks that lend money for climate change projects. BOJ Governor Kuroda said, “We can reduce the concerns and the risk of economic instability caused by climate change by making it easier for companies to make such investments.”
The BOJ currently pays a negative interest rate on the deposits it holds for commercial banks. That is, banks must pay the BOJ for the privilege of parking reserves at the BOJ. According to the new policy, commercial banks can obtain zero-interest loans from the BOJ and can be exempted from the negative interest rate policy if they lend money for climate projects. The hope is that this will stimulate more investments that have the effect of reducing carbon emissions. This policy is likely to be welcomed by banks. Around the world, financial institutions are already increasingly focused on climate. Many are assessing and pricing risk and allocating portfolios partly on the basis of climate risk.
Germany’s parliament took dramatic action in June meant to compel German companies not only to abide by high standards of human and labor rights, but to ensure that their global suppliers do the same. Specifically, the new German law, which will go into effect in 2023, compels German companies of a certain size to monitor, assess, and report on human and labor rights across their supply chains. They must ensure that there is no child or forced labor and they must create processes to assure compliance. Failure to comply with the law will lead to large fines. Germany’s labor minister said, “Article 1 of the German constitution states that human dignity shall be inviolable, not German dignity.” Germany’s law is seen as a potential precursor to a European-wide law that might be passed by the EU.
Supporters of the law hope that it will help to reduce human- and labor-rights violations in many emerging countries. There will likely be a focus on China, especially Xinjiang Province, which has been a source of controversy given claims of severe human rights violations. In fact, the US Congress is considering legislation to ban imports from Xinjiang unless importers can demonstrate that products were not produced with forced labor. A recent study conducted by the German Parliament found that many German companies have indirectly benefitted from forced labor in Xinjiang.
Many critics of Germany’s legislation argue that other countries, especially China, might retaliate by limiting imports from Germany. That could be onerous given the German economy’s heavy reliance on exports of capital goods to investment-intensive countries, such as China. Meanwhile, the EU and China recently signed a Comprehensive Agreement on Investment (CAI) that is meant to set clear rules regarding cross-border investment. Critics worry that Germany’s new law, and a potential EU rule, could complicate implementation of the CAI.
The new German law, as well as potential laws that might be passed by the EU, the US Congress, or others, demonstrates that ESG is increasingly a significant factor in supply chain design and operations. This trend suggests that global companies will increasingly be compelled to monitor their suppliers and attest to their suppliers’ compliance with global standards regarding human and labor rights. Such rules could also be extended to environmental and safety standards as well. Such might worsen relations between countries that could lead to restrictions on trade and investment.
Following the recent sharp rise in infections in the United Kingdom, several major European countries are now seeing a sharp rise as well. These are Spain, Portugal, Greece, Cyprus, and the Netherlands. Many others–such as Germany, France, Italy, and Belgium–have not yet seen an acceleration in infections. Spain and the Netherlands have the highest infection rates on the European continent. Last week, Germany and France urged citizens not to travel to Spain. This could have serious negative consequences for Spain’s economy, which is highly dependent on tourist travel from other parts of Europe during the summer months. Following the surge in infections, the Netherlands introduced restrictions on nightlife last week. The infection rate in Cyprus is, by far, the highest in all of Europe. Cyprus, too, is dependent on tourism, yet its government has introduced restrictions on hospitality and entertainment venues. Portugal has introduced restrictions on who can enter the country, which could retard the recovery of the tourist sector.
The current surge is mainly due to the delta variant and comes at a time when most European governments have eased restrictions, leading to an acceleration in mobility and spending. The risk now is that a further surge in infections will, at the least, scare some people from engaging in social interaction, thereby suppressing service activity. More worrisome from an economic perspective would be the introduction of further economic restrictions by multiple governments.
Nonetheless, it should be noted that the preponderance of new infections has been among relatively younger people. Consequently, the rates of hospitalization and death have not increased significantly. This could mean that, without government restrictions, there might not be a significant scaling back of mobility and interaction. Also, the daily rate of vaccination in most of Europe is now high after a slow start.
Meanwhile, finance ministers of the G20 nations intend to issue a statement saying that the recovery is characterized by great divergences across and within countries and remains exposed to downside risks, in particular the spread of new variants of the COVID-19 virus and different paces of vaccination. This is especially true of Europe. Thus, the economic outlook for Europe remains highly uncertain in the coming months. As such, the continuation of an easy monetary policy by the European Central Bank appears to be warranted.
The latest report from the US government on the consumer price index is unambiguous. Inflation is up sharply. And yet, once again the bond market more or less yawned. Bond yields increased only slightly, evidence that bond traders were not the least bit alarmed by the latest inflation report. It is evident that investors continue to accept the Federal Reserve’s view that high inflation is transitory and driven by one-off factors that are likely to abate over time. It is also notable that, although annual and monthly inflation rates hit the highest level since 2008, the years that followed the 2008 high were characterized by very low inflation. Thus, there is precedent for a temporary surge in inflation to be followed by a reversion to low inflation.
In any event, let’s look at the numbers. In June, consumer prices were up 5.4% from a year earlier, the biggest increase since August 2008 and a considerable gain since the 5.0% increase in May. Prices were up 0.9% from May to June, the biggest increase since June 2008. When volatile food and energy prices are excluded, core prices were up 4.5% from a year earlier, the biggest increase since November 1991, and core prices were up 0.9% from the previous month.
The gap between the headline number and the core inflation rate reflected a big increase in energy prices, which were up 24.5% from a year earlier and up 1.5% from the previous month. The category with the biggest price increase continued to be used cars, with prices up 45.2% from a year earlier and up a staggering 10.5% from the previous month. Thus, although used cars only account for 3.2% of the consumer price index, used car prices accounted for a third of the monthly increase in the consumer price index. Moreover, as previously noted, the surge in used car prices is not related to growth in the money supply. Rather, it reflects unique conditions in the market for used cars that are driven by the semiconductor shortage and strong demand by rental car companies. US Federal Reserve Chair Powell recently stated, “Used car prices are going up because of sort of a perfect storm of very strong demand and limited supply. It’s going up at just an amazing annual rate. But we do think that it makes sense that would stop, and that in fact it would reverse over time.”
Notably, the price of renting a car was up 87.7% from a year earlier and up 5.2% from the previous month. This reflects a shortage of rental cars after companies sold a substantial share of their fleets at the height of the pandemic. Another category that saw a big price increase was airline fares, up 24.6% from a year earlier and up 2.7% from the previous month. This reflects a sudden surge in demand that the airlines have been slow to accommodate, in part because of regulatory requirements. It is worth noting, however, that the index of airline fares remains below the prepandemic level. Thus, although fares are up sharply, they have not yet made up for the decline during the pandemic. The cost of staying at a hotel was up 17% from a year earlier and up 7.9% from the previous month. A surge in demand fueled by the perception that the pandemic is ending is the likely culprit.
That being said, there were significant decreases in the prices of many merchandise and service categories, including electricity, some types of furnishings, nonelectric cookware, household cleaning products, men’s apparel, girls’ apparel, jewelry, medicine, audio equipment, pet supplies, sports equipment, books and magazines, toys, computer software, tobacco products, domestic services, health insurance, sporting events, and internet services. In other words, very large increases in a small number of categories were partially offset by moderate decreases in the prices of many other categories. This pattern is not indicative of a general inflationary trend. It is no wonder, then, that investors remain relatively sanguine.
As noted above, the prices of some manufactured goods sold in the United States actually declined in June despite an overall acceleration in inflation. This could be due to an easing of supply chain constraints. It was reported that exports from China surged in June, indicating that Chinese exporters were able to function despite recent disruptions at ports due to virus outbreaks. The troubles at the Yantian port near Shenzhen have largely ended, thereby allowing for a return to normal operations. Specifically, June exports (measured in US dollars) were up 32.2% from a year earlier, far faster than many observers had anticipated. The rise reflects both a global surge in demand as well as increasing ability to meet that demand. There was strong growth in shipments of technology products, home appliances, and automotive parts.
At the same time, Chinese imports were up 36.7% in June versus a year earlier. A significant share of China’s imports are inputs and commodities used to produce final goods for export. Thus, it appears that supply chains are functioning better than previously. For example, there was an increase in imports of semiconductors, which lately have been in short supply. Despite the good news, prices of imported goods were up significantly, due in part to a surge in commodity prices, raising fears of importing inflation. On the other hand, some analysts have expressed concern that, as the impact of government stimulus abates in the US and Europe, demand for Asian exports could decelerate later this year. Moreover, recent strong demand by US-based retailers for Asian exports reflected a need to quickly replenish inventories after a surge in spending. This process is likely to lessen in the months ahead.
In much of the world, governments are easing restrictions, people are becoming more mobile, and a strong economic recovery is under way. One would be forgiven for thinking that the pandemic is over. It is not. New variants continue to emerge. For example, there is concern about the lambda variant—that was first detected in Peru—making its presence felt in the United Kingdom. The delta variant is now the dominant source of infection in the United States. Health officials have expressed concern about the potential for new variants that could be resistant to current vaccines. While most major countries are now seeing relatively low infection rates, there are important exceptions. The United Kingdom, for example, has seen a sharp rise in infections in recent weeks, hitting a rate not seen since late January and a rate that is roughly 10 times that of the United States. A senior UK cabinet minister warned that, when restrictions are fully lifted later this month, the number of infections could soar. This certainly gives one pause. Although the United Kingdom has not yet seen a sizable spike in deaths and hospitalizations, a rise in infections could hamper economic recovery. What is happening in the United Kingdom could easily happen elsewhere.
Meanwhile, although the infection rate has remained low in the United States, in part due to a high vaccination rate, the number of people getting vaccinated each day has fallen sharply, down about 75% from mid-April. The United States now has the lowest daily vaccination rate of major economies—lower than in the United Kingdom, Canada, Eurozone, Japan, and India. Some US states have very low vaccination rates, putting them at greater risk should new variants become problematic. Interestingly, one of the biggest determinants of whether a person gets vaccinated is politics. People self-identifying as Democrats are far more likely to be vaccinated than those self-identifying as Republicans. The 20 states with the highest vaccination rates were won by Joe Biden in last year’s election, while 19 of the 20 states with the lowest rates of vaccination were won by Donald Trump. Consequently, Republican governors in several states are now making a new effort to encourage people to get vaccinated, evidently fearful of the consequences of yet another outbreak in the coming weeks or months.
Also, there has been slow distribution of vaccines in emerging countries. Obtaining adequate supplies, undertaking distribution, and encouraging people to get vaccinated are all problems and obstacles. Although the leading affluent economies have pledged to transfer a large number of dosages to emerging countries, the numbers are likely inadequate. Meanwhile, high risk of infection in these countries has left borders partially or fully closed. Laurence Boone, chief economist of the OECD, said that “the global economic and social cost of maintaining closed borders dwarfs the costs of making vaccines, tests, and health supplies more widely available to these countries.” She urged the rich countries to do more, suggesting that it is not simply a moral imperative but is in their self-interest.
The biggest source of trouble in the global economy during the pandemic has been the sharp decline in activity in many service industries. The ability of the global economy to bounce back to normal will depend, in part, on whether consumer-facing service industries are able to attract strong support from consumers. That, in turn, will depend on perceptions about the pandemic. If consumers remain fearful of the virus, many will choose to avoid interacting with service enterprises, thereby suppressing activity, employment, and growth. If, on the other hand, a high rate of vaccination and low rate of infection provide sufficient confidence, then service enterprises will experience strong demand.
Currently, the broad services industry is experiencing a sharp rebound in the United States and Europe but not in Asia. Of the three largest economies in Asia, two continue to experience a decline in activity (India, Japan). This conclusion is based on the latest purchasing managers’ indices (PMIs) for services published by IHS Markit. PMIs are forward-looking indicators meant to signal the direction of activity in the broad services industry. Services include retailing, wholesaling, transportation, telecoms, finance, professional services, leisure, and hospitality. PMIs are based on sub-indices such as output, new orders, export orders, employment, pricing, and sentiment. A reading above 50 indicates growing activity; the higher the number, the faster the growth.
In the United States, the services PMI fell from 70.4 in May to 64.6 in June—a level that indicates very rapid growth in activity. This was driven, in part, by very strong growth of new orders. Interestingly, input price inflation abated somewhat in June, although it remained high. Labor shortages continued to create obstacles to meeting consumer demand.
In Europe, the services PMI for the United Kingdom fell slightly to 62.4 in June, a level indicating rapid growth. Markit noted a surge in demand for consumer services combined with a further easing of economic restrictions by the government. In addition, it said that in the hospitality and leisure sectors, there continued to be a shortage of labor and capacity constraints. In the Eurozone, the services PMI increased from 55.1 in May to 58.3 in June, the highest level since July 2007. This reflected a further easing of government restrictions. The PMI increased significantly in most European markets, but especially in Spain where it hit 62.5, the highest level since 2000. The hospitality sector saw a big increase in activity. Throughout Europe, employment in services increased rapidly. However, labor shortages remained. This led to an acceleration in wages. Higher wages, combined with higher costs of inputs, led businesses to boost output prices by the biggest amount since 2000.
In Asia, the situation was quite different. In India, the services PMI fell from 46.4 in May to 41.2 in June, a level indicating a rapid decline in activity. This was related to the constraints imposed due to the latest severe outbreak of the virus. In China, the services PMI dropped sharply from 55.1 in May to 50.3 in June, a level indicating almost no growth in activity. Output and new orders grew at the slowest pace in 14 months. The transport sector, especially, saw a decline in activity. The weakness was mainly attributed to the latest outbreak of the virus and the restrictions imposed to combat the outbreak. The weakness of the sector led to a decline in services employment. Finally, Japan’s services PMI increased from 46.5 in May to 48.0 in June, a level indicating a continued decline in activity. There was a decline in output and new orders associated with new measures meant to avert another outbreak of the virus.
When the European Central Bank (ECB) was created over 20 years ago, there was a need to assuage Germany’s concerns around its previous success in fighting inflation being undermined by the creation of a common currency. Hence, it was agreed that, like Germany’s Bundesbank, the ECB would focus on an inflation target and that, unlike the US Federal Reserve, it would not target unemployment. The goal was for the ECB to mimic the success of Germany’s Bundesbank in maintaining low inflation and creating a stable economic environment. At the time of the ECB’s creation, there was a strong memory of the relatively high inflation that had infected many European countries in the last quarter of the 20th century.
Last week, however, the ECB announced a new strategy, the first change in strategy since 2003. In recent years, Europe has worried not about excessive inflation, but instead about very low or no inflation. Even as inflation rises as the pandemic abates, the ECB expects the increase to be transitory. It expects that inflation will revert to a low level. Consequently, the ECB says that it will target an inflation rate of 2.0%, with an expectation that inflation can periodically move above the target for sustained periods of time. This is somewhat similar to the new targeting strategy of the US Federal Reserve. This is different from the past ECB strategy of targeting inflation “close to, but below, 2.0%.” The ECB evidently believes that, when inflation is too low, real (inflation-adjusted) borrowing costs are too high. The result is weak business investment. In practice, the new strategy will likely mean keeping short-term interest rates very low for a prolonged period. It will also likely mean continuing to engage in asset purchases for a prolonged period. It is not clear, however, whether this strategy will be successful in bringing inflation to a sustained higher level. The ECB provided no details about specific changes in policy. In response to the announcement, European bond yields fell. This reflects an expectation that ECB monetary policy will remain easier for longer. Moreover, it reflects an expectation of continued ECB bond purchases which have the effect of suppressing yields.
The US Federal Reserve released the minutes of the mid-June meeting of the Federal Open Market Committee (FOMC), which is the principal policymaking body of the Fed. The minutes are a useful guide to the thinking of the Fed and offer insight into when and what it will decide regarding policy in the months to come. This is important from a global perspective given the massive footprint of the Fed and the US economy in the global economy. Here are some highlights from the minutes:
Comments by business leaders about a shortage of available workers in many markets may prompt one to imagine that that there are jobs waiting to be filled. But this is not the case. The OECD says that, in member countries, 22 million fewer people are working now than before the pandemic. Of these, eight million cannot find work and 14 million are not actively looking for work. In addition, it predicts that, postpandemic, there will be many people unable to find work and that employment levels in affluent countries will remain below the prepandemic level. It says that structural changes in the global economy will render a skills mismatch in which many lower skilled workers will be unable to fill the positions that are available. Indeed, it notes that, for higher paid workers, employment is already back to the prepandemic level in rich countries. Yet among lower paid workers, employment remains far below the prepandemic level. This is due to the permanent loss of jobs in many consumer-facing services.
The OECD also says that, by the end of 2020, the number of long-term unemployed had increased dramatically from the prepandemic period. In other words, unemployment for many lower skilled workers was not simply due to the temporary closure of businesses. Rather, it reflected the permanent loss of jobs as the global economy shifted toward more online interaction. Of course, even before the pandemic, businesses were shifting toward automation and online interaction which was having a negative impact on the number of low-skill jobs available. The pandemic simply accelerated this process.
Should we be worried about the surge in housing prices in affluent countries? In the past year, relatively affluent consumers in rich countries have significantly increased their saving, especially when there were limited opportunities to spend money on consumer-facing services such as restaurants, theaters, airlines, and hotels. Instead, people stashed much of their income in their bank accounts and purchased assets, such as equities, commodities, crypto-currencies, and property. The case for property was helped by central bank policies that kept borrowing rates historically low, and also by people’s desire to find larger homes from which to work remotely. Moreover, in the United States, the Federal Reserve bought, and continues to buy, assets backed by mortgages. In fact, such purchases have accounted for one third of the Fed’s asset purchasing program during the pandemic.
The rise in house prices is global. It has taken place in North America, much of Western Europe, many parts of East Asia, and even Latin America and southern Africa. In the United States, the median sales price of an existing home was up 23.6% in May versus a year earlier, a stunning and historically unusual number. In the United Kingdom, house prices were up 13.4% in June versus a year earlier. This was the largest increase since November 2004. Activity in the housing market has been helpful to economic activity, driving construction, demand for lumber and other commodities, as well as demand for home appliances, home electronics, and furniture. And yet some people are worried. One leading economist, Adam Posen of the Peterson Institute and formerly of the Bank of England, said, “I’m not happy about house price increases because real estate is the surest indicator, the most compelling indicator, for a crash.” Indeed, the housing price crash of 2008-2009—the crash nearly brought down the entire global financial system—followed a massive surge in house prices in the United States.
Still, this time is somewhat different in that home buyers are mostly relatively affluent, have good credit, are putting equity into new homes, and are actually buying homes rather than cashing out the added value of existing homes. In the period leading up to the 2008 crisis, many home buyers were relatively low income, had bad credit, did not make significant down payments, and often borrowed to extract cash from existing homes. In fact, much of the increase in US consumer spending in the 2001-2008 period was attributable to the cash people extracted from their homes through home equity loans. Finally, banks did not often hold adequate capital against the risk of a decline in home prices. Hence, many were ill-prepared for what happened. Since that crisis, bank capitalization has improved and bank standards for mortgage lending have improved.
Although it is likely that the financial system is better protected this time, it does not mean that a decline of home prices would be easy to absorb. If the current situation is a bubble that ultimately bursts, the global economy will feel the consequences. A sharp decline in house prices would wipe out wealth, thereby having a negative impact on consumer spending. It would reduce demand for new homes, thereby reducing construction activity and some commodity prices. It would reduce overall activity in the housing market, thereby reducing demand for home-related products such as appliances and furniture. And, although it would likely not bring down the global financial system, it would have a negative impact on the banking system, thereby affecting the overall availability of credit. The bursting of bubbles is usually precipitated by a tightening of central bank monetary policy. For now, this does not appear to be imminent in most major markets. Still, once economies fully recover and inflation appears to be a risk, then central banks will likely reduce or stop asset purchases and raise interest rates. At that point, we might have to worry about the housing market.
Meanwhile, central banks are starting to talk about things they can do to limit the frothiness of the housing market, if only to soften the blow when the bubble bursts. In the US, some Fed officials are talking about reducing purchases of mortgage-backed securities. The central banks of Norway and New Zealand are talking about tightening monetary policy. Christine Lagarde, President of the European Central Bank (ECB), said that “the disconnect between housing prices and broader economic developments during the pandemic entails the risk of price corrections.” She said that policy should be “designed carefully to address country-specific risks.” Still, she said that the ECB is not ready to change overall monetary policy.
With respect to the US housing market, the S&P CoreLogic Case Shiller index of home prices in the top 20 US markets was up 14.9% in April versus a year earlier. This was up from 13.4% in the previous month. It was the biggest increase since December 2005. The largest increases were in Phoenix (up 22.3%), San Diego (up 21.6%), and Seattle (up 20.2%).
This situation might have the characteristics of a speculative bubble. One way to judge whether price movements are inconsistent with market fundamentals is to look at the price to rent ratio in the housing market. This is similar to the price-earnings ratio in the equity market. That ratio is often a good indicator as to whether prices are unhinged from fundamentals and set to decline. The price-to-rent ratio, having fallen sharply during the financial crisis a decade ago, was gradually rising over the past decade. However, this ratio suddenly accelerated sharply during the pandemic as house prices soared. This sharp increase is consistent with a bubble. Still, as I wrote recently, bubbles usually only pop when the central bank starts to raise interest rates. Currently, the Federal Reserve says that it will not likely raise rates until late 2022 or later. This implies that the surge in house prices could persist.
It should be noted that the Federal Reserve has so far purchased US$982 billion in mortgage backed securities and continues to purchase US$40 billion per month. The president of the Federal Reserve Bank of Dallas, Robert Kaplan, has noted that “there are some unintended consequences and side effects of these purchases that we are seeing play out.” This includes upward pressure on home prices. In addition, James Bullard, president of the Federal Reserve Bank of St. Louis, said, “I’m leaning a little bit toward the idea that maybe we don’t need to be in mortgage-backed securities with a booming housing market and even a threatening housing bubble here, according to some people.” And Eric Rosengren, president of the Boston Fed, said that “the mortgage market probably doesn’t need as much support now.” While the purchases are meant to suppress borrowing costs, the more likely impact is on prices. These recent statements by Fed officials suggest the possibility of a slowdown in purchases of mortgage backed securities.
Meanwhile, one could make the argument that changes in household and business behavior are propelling an increase in ownership of suburban homes. That is, if a large number of workers are going to work remotely in the future, then this is reflected in the current increased demand for large, suburban homes. Given that supply is not keeping up with demand, the rise in prices might make sense and might not be indicative of a bubble. Time will tell.
The US government released data on the job market in June and it was well received by investors. The report indicated stronger-than-expected job growth in June, although employment remained significantly below the prepandemic level. In addition, the report indicated that wages continued to rise, but not at a rate that will likely spur much higher inflation. Thus, many investors saw the report as being in a sweet spot—indicative of strong economic growth but not necessarily indicative of rising inflationary pressure. As such, equity prices were up modestly while bond yields were down. Let’s look at the details.
The US government releases two reports: one based on a survey of establishments, and the other based on a survey of households. The establishment survey found that, in June, 850,000 new jobs were created, the biggest number since August 2020. This means that there are now 15.6 million more people employed than in April 2020 at the peak of the pandemic. However, employment remains 6.8 million, or 4.4%, below the prepandemic level of February 2020. This reflects both unemployment among those participating in the labor force as well as a decline in the number of people participating in the labor force.
By category, employment growth was muted in goods-producing sectors, likely due to supply chain issues. Manufacturing employment was up only 15,000 while the automotive component of this was down 12,300. Auto manufacturers are currently struggling with a shortage of semiconductors and have been forced to shut down some production. Construction employment fell 7,000, largely due to weakness in civil engineering. This could change, however, if the Congress passes an infrastructure bill in the near future.
In the services arena, retail employment was up 67,100 with strong growth at clothing and general merchandise stores and a decline in employment at grocery stores. There were 72,000 new jobs in professional and business services (such as Deloitte) and 59,000 new jobs in education and health services. Yet the biggest gain in employment was in leisure and hospitality, which was up 343,000. This included 194,300 new jobs at restaurants and 75,100 at hotels. In addition, government employment was up by 188,000, which included 155,200 new jobs at local public schools.
Average hourly earnings of private-sector workers were up 3.7% from a year earlier, although the monthly gains decelerated in June, suggesting that the shortage of labor could be abating. Interestingly, in the leisure and hospitality sector, which saw massive job growth, average hourly earnings were up a staggering 11.2% from a year earlier. This indicates that companies were willing to pay more to attract workers. On the other hand, hourly earnings were up only 2.4% in the retail sector and up 3.6% in the manufacturing sector versus a year earlier.
The separate survey of households found that the labor force grew at a moderate pace in line with the increase in the working age population. As a result, the labor force participation rate remained steady. The unemployment rate increased from 5.8% in May to 5.9% in June. We believe this is a statistically insignificant change in the unemployment rate.
Overall, this was a very favorable report and indicates that, at least to some extent, the imbalances in the labor market are starting to be addressed. Still, participation in the labor force remains relatively low, which explains the difficulty in attracting workers to lower paid professions. It also explains why many businesses are willing to pay more to attract workers. Still, the fact that monthly increases in wages are decelerating suggests that the labor market problems are not getting worse and might be getting better. Meanwhile, it is reasonable to expect that, in the coming months, labor force participation will rise as children return to school and daycare. Also, participation could be helped if a high vaccination rate makes workers feel more confident about interacting with other people. On the other hand, new variants threaten to revive outbreaks, thereby stymying labor market renewal.
The global manufacturing industry continues to grow at a robust pace, driven by a strong rebound in demand as much of the world emerges from the pandemic. However, supply-chain constraints are having a negative impact on the growth of output and new orders. This is according to the latest purchasing managers’ indices (PMIs) published by IHS Markit. PMIs are forward-looking indicators meant to signal the direction of activity in the broad manufacturing sector. They are based on sub-indices, such as output, new orders, export orders, employment, pipelines, inventories, pricing, and sentiment. A reading above 50 indicates growing activity; the higher the number, the faster the growth—and vice versa. The global PMI fell from 56.0 in May to 55.5 in June, still a level indicating strong growth. Yet the deceleration was attributed to supply-chain difficulties that, in turn, drove up costs. Interestingly, although the global sub-indices for output and new orders declined, the sub-index for sentiment increased. Evidently many business leaders are experiencing some constraints, but are becoming more optimistic about the future. Strength in manufacturing can be found in the United States, Western Europe, and Taiwan. Weak growth is found in China, Japan, and South Korea with a decline in activity in Southeast Asia and India. Here are some details.
In the United States, the manufacturing PMI held steady at 62.1, indicating very rapid growth in activity. Strong demand is reflected in very high sub-indices for new orders and export orders. This is placing unusual stress on the industry. Supplier delivery times have increased to the greatest extent on record. Input costs are rising at the fastest pace on record, leading to a record rise in output prices. Survey respondents report a serious shortage of available labor. This, along with supply chain disruption, is suppressing the ability of companies to satisfy demand. Still, employment in the industry increased rapidly in June. Finally, respondents reported that rising infection rates in Asia will affect the ability to source components from Asian countries. Meanwhile, neighboring Mexico continued to experience a decline in manufacturing activity, despite strong US demand. Mexico has been adversely affected by the virus outbreak and the consequent restrictions on economic activity. However, Mexico could be turning the corner. The rate of decline lessened in June.
In the United Kingdom, the PMI for manufacturing fell from 65.6 in May to 63.9 in June, a number still indicating blistering growth. Output, new orders, and employment grew swiftly amid easing of restrictions and further reopening of the economy. Export orders performed well due to strong global demand and an easing of Brexit-related disruption. Yet input costs increased at the fastest pace on record leading to a record increase in output prices. Supply-chain constraints and shortages held back growth. Companies purchased inputs preemptively, leading to a surge in inventories of raw materials. Meanwhile, inventories of finished goods fell precipitously as companies struggled to meet extraordinary demand.
Meanwhile, Eurozone activity also grew at a rapid pace. The Eurozone PMI for manufacturing increased from 63.1 in May to 63.4 in June. PMIs were at near record levels in Germany, the Netherlands, France, Italy, and Spain. Strong demand was driven by easing of restrictions, reopening, increased vaccination, and continued easy monetary policy. Yet, as elsewhere, capacity and transport constraints have conspired to limit output growth and boost input and output prices. Markit noted, however, that several indicators suggest the likelihood that the surge in prices will prove to be transitory. It noted that “widespread issues such as port congestion and a lack of shipping containers should soon fade as the initial rebound from the pandemic passes. Similarly, recent months have seen safety stock building as companies seek to protect themselves against potential future supply-chain disruptions, which has exacerbated the imbalance of demand and supply in the short-term. Once sufficient stocks are built, this effect should likewise fade.” In addition, it said that rapid rehiring and investment in new capacity and new technologies will ultimately help to alleviate imbalances. Indeed, the EU reported that the unemployment rate continues to decline in the Eurozone and that the number of unemployed declined sharply in May.
Unlike the United States and Europe, the PMIs in East Asia do not indicate strong growth in activity—with the exception of Taiwan. In China, the manufacturing PMI fell from 52.0 in May to 51.3 in June. China was adversely affected by a rise in infections, resulting shortages of labor and constraints on output, and power outages in southern China. Unlike in the West, Chinese manufacturers experienced an easing of input price inflation as shortages were partly resolved. Output price increases, consequently, eased as well. Likewise, Japan’s manufacturing sector also experienced a decline in its PMI from 53.0 in May to 52.4 in June. This means that growth was moderate. Virus-related economic restrictions and supply-chain disruption contributed to the easing of growth. Still, manufacturers continued to contend with rising input costs. Sentiment was strong and consistent with the latest Tankan Survey which increased sharply in the latest month.
Finally, many of the smaller manufacturing powerhouses of East Asia, which are heavily reliant on Chinese supply chains, experienced modest or no manufacturing growth in June. In ASEAN, the PMI slipped into negative territory at 49.0 in June. There were contractions in economic activity in several Southeast Asian countries, mostly driven by the virus. A sharp decline in Myanmar was related to political unrest. Vietnam and Singapore experienced a sharp decline in activity. In addition, South Korea saw a deceleration in growth in June, although growth remained at a reasonably healthy level. Finally, Taiwan saw a deceleration, but continued rapid growth with a June PMI of 57.6, down from 62.0 in May. Taiwan is a powerhouse for semiconductors and other products that have been in strong demand throughout the pandemic. Still, the sharp deceleration likely reflects the negative impact of a recent surge in infections and the resulting restrictions imposed by the government.