Outlook for North America
Recession, Inflation and Rates – OH MY! As a good Kansas lad, I can’t resist the occasional Oz reference but this one seems somewhat apt. The media has been alive with doom and gloom, economists and analysts filling the airwaves with dire forecasts. How real are these? Should we be jumping off the ledge? There is certainly a great deal to contend with and these challenges are real enough but there are also solid indicators and promises of better days ahead (assuming some solutions emerge to the current collection of stressors).
A few points of clarification as we listen to the latest commentary. Are we facing imminent recession? No. Recession is two straight quarters of negative growth. The last quarter of 2021 featured rapid growth of 6.9% but first quarter of 2022 saw a decline of 1.4%. If the second quarter numbers are also down the recession call can be made. The revised first quarter numbers will be released soon. Are we facing stagflation? No. To be in a stagflation situation the economy has to be facing both double-digit inflation AND double-digit unemployment. Inflation is at 6.1% according to the Personal Consumption Expenditure data and the PCE is what the Fed looks at. The more volatile Consumer Price Index is at 8.5%. The unemployment rate is at 3.6% and that is close to record lows. The quit rate is as high as it has been in decades. There is no sign of impending stagflation. Will the Fed react to high inflation numbers and jack rates up? Not likely. The Fed has repeatedly reminded people that inflation is being driven by factors out of their control – energy prices and the supply chain breakdown. They will hike rates but still insist that these will be between 2.5% and 3.5% by year’s end – certainly higher than they have been but not near record levels.
Meanwhile the industrial numbers are still trending positively. The Purchasing Managers’ Index is still solidly in expansion territory with a reading of 55.4 (although it was down from the 57.1 noted the month before). Capacity utilization is still not in the “normal” range between 80% and 85% but it is closer than it has been at 78.9. The latest data from Armada’s Strategic Intelligence System shows a small dip in the industrial outlook but the curve is still at a three-year peak.
A great deal of attention is always focused on the housing sector and for the most obvious reasons. For the last several years there have been any number of dire predictions regarding the imminent demise of the sector. The price of housing has been escalating for years and that had been expected to slow demand but low mortgage rates managed to sustain the sector. Now that interest rates are starting to climb there is another round of doom and gloom. It is still a little early to determine whether rates will climb radically (most predictions have rates between 2.5% and 3.5% by the end of the year) and it is early to say what will happen to mortgages. For the moment the demand is still strong – the fact is that there is still a deficit of some 5 million homes in the US. There has been an 18.2% growth in residential housing year over year even as the sector has come off the peak. Construction in the commercial sector is also growing (by 8.2% year over year). This has been driven by warehousing and inventory management but even office buildings seem to making a comeback.
The Canadian economy is surging and commodity growth is the driver. The first quarter gains were impressive - 5.6%. the nation’s GDP gained by 1.1% in February and that beat the estimate of 0.8%. The flash estimate for March showed another 0.5% gain and that marks the ninth month in a row for growth. The motivation for these gains will come as no shock to anyone who has been following events globally. The energy crisis and the food crisis have made Canada’s commodity-based economy surge and this trend is likely to extend through the remainder of the year.
While this is good news on one level it also creates a problem for the Bank of Canada. While the US is arguably hitting a downturn the Canadian economy is on the edge of overheating and that has prompted a discussion of significantly higher interest rates in order to cool things down. This means taking rates out of the neutral zone (2.0% to 3.0%) for a quarter or two and maybe longer. With per barrel oil prices expected to stay above $100 to $110 the impact on the Canadian economy will be positive but almost too positive. The manufacturing sector is not enjoying this surge as much. Their costs are rising as logistics becomes more expensive and commodities rise. Those that are focused on the energy sector or food production are doing well enough but automotive has taken a major hit (just like in the US). The unemployment rate has fallen again and to a new low of 5.2%. Inflation rates are close to 6.0% and that is a major leap from the 1.5% level struck in 2020.
Construction expansion has been taking place in Canada as well. Transportation and warehousing has been booming and will be further encouraged by the decision by Canadian Pacific to buy Kansas City Southern. This is expected to involve an additional 800,000 to 1.5 million additional containers making their way to the middle of the US, Canada and Mexico. Housing has also been an issue in Canada – shortages rival that in the US.
As the US goes, so goes Mexico. This has long been the case and nothing in the last few years has changed that situation. The Mexican economy managed a bit of growth in the first quarter – growing by 0.9%. Nearly all of this gain can be attributed to the demand for commodities (oil and food). The other three key sectors of the Mexican economy are moribund. The level of remittances from the US have been declining for years as pressure remains on immigration. The tourism business crashed during the pandemic and has shown little recovery since. Manufacturing was competing with oil as the main driver for the system but this is tightly connected to the US and has not been growing as fast as would be preferred. Much of Mexican manufacturing is geared to the struggling automotive sector.
The policies of the AMLO (President Andres Manuel Lopez Obrador) continue to inhibit the recovery. Covid still rages in Mexico and cooperation with the US is at a minimum. A recent high-level conference was supposed to bring the US and Latin states together to work on trade issues but Mexico refused to engage unless the US invited Cuba, Venezuela and Nicaragua to participate. The US refused and AMLO backed out. The official unemployment rate is 4.7% but most analysts assert that the real rate is close o three times that high at between 15% and 20%. The inflation rate stands at around 7.8% and has been getting worse. It is a far cry from the record of 179% set in 1988.
Chris Kuehl, PhD., is an economist and Managing Director of Armada Corporate Intelligence. Visit www.armada-intel.com for more information.