Recovery Gaining Momentum; for Now

Markets are reacting positively to a rare concerted intervention in the currency markets by the world’s biggest economies, known as the G7, to stem the damaging rise in the value of the yen as well as from news that Libya’s government announced an immediate cease-fire and end to all military operations across the country. A strong yen makes Japanese exports much more expensive on world markets. As a primary part of Japan’s economy, exports will be crucial to the re-building of their economy. Additionally, Japan’s decade-long struggle with deflation will be made even worse by a strong yen. 

As mentioned last week, the interruption in the Japanese supply chain will undoubtedly have an impact on the global economy. Companies are busy assessing the extent of dependence on Japanese parts as well as potential alternatives. General Motors has already closed a plant in Shreveport, Louisiana plant that builds small pickup trucks due to the lack of a Japanese part it did not specify. Any company that uses semiconductors (most) will be impacted as Japan supplies over 20% of the world’s supply of silicon wafers used to make semiconductors. According to the Wall Street Journal, nearly one-third of the company’s new 787 Dreamliner as well as parts for all of Boeing’s other in-production commercial airplanes, come from dozens of Japanese suppliers. An article in yesterday’s WSJ pointed out that “even companies that said they were unaffected by Japan’s crisis qualified their statements with ‘so far,’ ‘yet,’ and ‘if the situation lasts longer.’

It will likely be May before the government-released data in this country reflect the extent of damage caused by the interruption of critical supplies from Japan. But for now, US manufacturing is on an absolute tear. The Empire State Manufacturing survey rose more than two points in the March report to 17.50 for a reading well above the breakeven of zero. Growth is strong and accelerating. Another regional Fed survey released by the Philadelphia Fed showed sharp acceleration in new orders by more than 16-1/2 points in the March reading to 40.3 above zero.

The manufacturing component of the Industrial Production report showed 0.4% gain following a 0.9% gain in January. Within the manufacturing component, output of motor vehicles and parts was up a sharp 4.2%, following a 4.5% jump in January. Excluding autos, manufacturing rose 0.2% in January after a 0.7% jump the prior month.

Yesterday, the government reported its index of leading economic indicators which rose 0.8% in February which compared favorably to January’s 0.1%. The big contributor to the index remains the spread between short and long term interest rates, but declines in unemployment were a welcome addition to the strength column of the index. Building permits were the index’s biggest detractor.

The weekly report of jobless claims resumed its positive trend after an interruption last week with a 16,000 decline in the March 12th week to 385,000. The four-week average is down 7,000 to 386,250 for its best reading of the recovery, according to Bloomberg News. Continuing claims in data for the March 5th week fell 80,000 to 3.706 million in another recovery best. Month-to-month reveals a more than 200,000 improvement.

Prices of essentials are rising as a result of the sudden increase in oil and gasoline, but the Fed, other economists, and I argue that we are not in for high inflation any time soon. The primary reason is that inflation in this country is generally fueled by the cost of rising wages. We will likely not experience price pressures from wages for years to come. That said, prices where we live, gasoline, heating and cooling as well as food are going up.

The government reported that prices on imports jumped 1.4% in February, continuing a long string of increases. Excluding petroleum increases of 3.7%, import prices were up 0.6%. Consumer goods and capital goods both showed a 0.2% gain in the month, modest, yet above trend. The disruptions already mentioned from Japan will undoubtedly add to the negative trend in imports.

Headline prices at the producer level were up an attention-grabbing 1.6% in February well above analysts’ estimates of 0.7%. Both food and energy components were exceptionally strong at 3.9% and 3.3% respectively. The core number, which removes volatile food and energy prices slowed to a much more reasonable 0.2% following a 0.5% increase in January.

Prices at the consumer level are rising at both levels; headline and core. The CPI jumped 0.5% in February, following a 0.4% jump in January. Excluding food and energy, the core increased by 0.2%, matching last month’s rise. Energy was up 3.4%, with gasoline surging by 4.7%. Food price inflation was up 0.6% with five of six major grocery store food groups showing increases. The fresh vegetables index was up a surprising 6.7%.

Price increases of this magnitude would normally put pressure on interest rates (increasing them), but there remains in place a strong flight to safety with increasing instability in the Middle East and the devastation in Japan. There is also the missing component of rising labor costs which is a near requirement for inflation in the US.

On the ides of March the Fed announced it was leaving its target at the range of 0 – 0.25% and retained the language of “extended period” for retaining its low rates. The following statement summed well their views on their joint mandate of employment and inflation. “Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate remains elevated, and measures of underlying inflation continue to be somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. The recent increases in the prices of energy and other commodities are currently putting upward pressure on inflation. The Committee expects these effects to be transitory, but it will pay close attention to the evolution of inflation and inflation expectations. The Committee continues to anticipate a gradual return to higher levels of resource utilization in a context of price stability.”

The Fed noted that the recovery “is on firmer footing” with the labor market “improving gradually.” Bloomberg reported that the Federal Open Market Committee sees the recent impact of higher oil prices on inflation as likely transitory. There were no dissenting votes. Also, there was no specific mention of recent events in Japan.

The impact of Japan’s weakened economy and higher energy prices coming out of the Middle East will undoubtedly have an impact on the world’s recovery, but momentum was increasing before the events. It will be weeks or months before the full impact is felt. There is no way of knowing what will happen in the Middle East, but history is a guide for Japan. At the end of WWII, the Japanese people demonstrated remarkable resilience and spirit as they re-built their economy better than before, with the help of the allies and American management experts like Peter Drucker. They will rebuild again, and likely better than before.

Sam Bass
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