Economic Rundown: Volume 64, Number 8

Dear Clients and Friends,

McVean Trading will be participating in a Global Interdependence Center conference in Buenos Aires, Argentina on November 1st.  The conference, co-sponsored by the Argentinean stock exchange, was planned to examine what lessons the European periphery might glean from Argentina’s default and subsequent experience without access to global credit markets.  Given the recent turn of events in Argentina with nationalization of their oil industry and fears of pesification of their economy, we expect a vibrant discussion.  Add in the recent parabolic price movements for  corn and soybeans and the discussion on the outlook for next year’s South American crops will be center stage.

We hope that your travel plans allow you to attend.  Registration and a preliminary agenda are available at GIC’s website:


Michael Drury
Chief Economist
McVean Trading & Investments, LLC
Incoming Program Director
The Global Interdependence Center


As another week of data rolls in, the United States is looking a little better while Europe and China look worse.  The pressure is mounting for more fiscal action in Europe, as the weakness is spreading into the core.  Despite the Bundesbank’s wailing and gnashing of teeth, more ECB bond buying seems likely relatively soon.  Current Bundesbank President Weidmann’s threats of resignation are unlikely to carry any more weight than Axel Webber’s departure, or ECB Chief Economist Jurgen Stark’s leaving close behind.  We expect Greece to receive its money, the German Court to approve ESM and the drumbeat of previously unthinkable German concessions to go on – and on.  Bottom line, Germany’s industrialists are now in control of policy, not the monetary authorities – and like the Chinese leadership, they are currently far more worried about growth than inflation.  Chancellor Merkel is carrying out an ongoing retreat, trying to exact as much reform from the periphery as possible before it becomes clear that Germany will ultimately cave in.  Sustaining growth is tantamount in that process, since a slide into German recession condemns her government to exile and the Euro experiment becomes even more incredibly messy.  No one wants that – even Finish industrialists are more vocal now about the bad old days when the Markka was dominated by the Dollar, Ruble, and Deutschemark.  When the core of the most conservative Austerians (my new word) is calling for compromise and extension, where can their supporters go?   We woke up Monday morning to a Bloomberg article about Chancellor Merkel’s latest speech to her party faithful in which she condemned markets for making a few rich and the rest indebted.  Sounds more like something Obama or Hollande would say.  Merkel is moving to the center (which is far left of her in Europe) as her election approaches next year.

The collapse in European import demand has exacerbated the slowdown in China, which was inevitable after the surge in stimulus in 2009.  Now, China is returning to multi-year infrastructure projects, which will lift their economy in 2013, but are likely to be even less efficient than those that went before simply because the most needed projects typically go first.  Even in a country growing as fast as China, the need for substantial new infrastructure does not pop up three years immediately after a wave of stimulus incented projects.  Still, employment is their primary concern, as inflation is currently under control, and the new leaders will be named shortly.  As long as China remains uncertain about European recovery – and Premier Wen was quite vocal this week during Chancellor Merkel’s visit about Europe’s need to do more – China will have to go to the whip hand on its own domestic policy.  Lower interest rates and reserve requirements are likely in coming months, but still with strong restrictions on high end residential real estate, which remains in the Party’s doghouse.

In the US the muddle through now appears a couple of tenths of a percent better than just a week ago.  Revisions to the second quarter real GDP data lifted growth in the rear view mirror from 1.5% to 1.7% at an annualized rate.  Meanwhile, a stronger than expected 0.4% increase in real consumer spending has put a better tone into third quarter real GDP.  With back to school sales doing well estimates of third quarter real GDP are now back above the 2% stall speed.  The improvement in personal spending mirrors the rise in retail sales, but added information on service sector spending was upbeat as well.  It appear that as in last year’s back to school and Christmas seasons, consumers are waiting for sales around holidays when they know they are going to spend – while remaining frugal in between.  This suggest a solid back to school period followed by lower activity until Black Friday and then another four weeks of quiet until the big finish just before Christmas.  We focus now on this potential see-saw on-off pattern so that we won’t be surprised or dissuaded from a more optimistic view when sales slow again in October.  Of course by the time that data is reported, the election will be over and politics, not economics, will be driving markets.

The most upbeat data released this week was the Chicago Purchasing Manager’s report.  Yes, we know that the headline fell to 53.0 from 53.7.  However, the more important new orders index picked up nicely to 54.8, well above the 52.9 in July and following the pattern of a breakout after three depressed months that we have seen in a lot of other data.  Production and employment also rebounded and are both healthy above 57.  It was faster vendor deliveries and a plunge in the order backlog that held the index back.  These suggest that businesses were confident enough in the strength in new orders to ramp up production and fill existing orders at a faster rate – and to hire as well.  Business purchasing managers have far better insight as to their future order flow than economists, and they react to upbeat data with far more caution than financial markets.  We read their optimism on production in August as a sign that their outlook is improving as we exit the payback period that followed the fast start to the year.

Will the Federal Reserve start another round of bond buying – perhaps an open ended round?  There was much sound and fury at the Jackson Hole summit with many speakers sounding solidly for and others solidly against such a move.  That is to be expected when policies are unconventional and there is limited experience with their consequences.  However, as strongly as Chairman Bernanke made his case for their success in forestalling deflation and disaster in the past, he did not make an overt call for their use in the future.  He merely reiterated the FOMC’s latest views, with a bit more spin toward his own apparently pro-QE stance.  Whether the FOMC gives him the green light will depend heavily on data – so if employment matches last month’s 150,000 gain, and/or the outlook for the third quarter remains above 2%, and/or core inflation remains at the top of its range, and/or the anti-Fed statements of the Republicans gain traction with a lead in the polls, we suspect the Fed will remain on the sidelines jawboning rather than doing.  More likely the ECB and Bank of Japan will be buying assets before the Fed – but equity markets like liquidity no matter where it comes from.

With the transition now on from the Republican Convention to the Democrat Jamboree, we are fielding a lot more questions and input from both sides on the possible election outcome.  I begin with the disclaimer that I was raised a Democrat in Boston during Camelot.  I will also point out that during my childhood Massachusetts’ Governor was always a Republican (Volpe and Sargent) except for two years under Endicott Peabody.  I left for school in 1973 and missed most of the Dukakis years, and when I returned in 1988, Bill Weld was elected in 1990.  (His successors until Patrick was elected in 2006 were all Republicans as well.)  I have long believed that Romney would be the toughest test for Obama as a Northeastern Republican would put many recently Democrat states in play while risking little of Bush 43’s base.  That appears to be the case with the election in my view still Romney’s to lose.  He passed the Convention test and earned a modest bounce which has him even to leading slightly.  Now the Democrats get their bounce, then on to the debates.

Our approach to the election has always been based on the Electoral College.  If you give Obama all of the states that he, Gore and Kerry won (Democrat base), Obama needs only 28 more electoral votes to win.  Add NM, NH and NV, his strongest leads in the polls among toss ups and he needs only 13 (a tie goes against Obama in the House of Representatives).   Eliminating toss ups, RCP has Obama winning a sizable electoral victory as he still leads in every state he won in 2008 except Indiana and North Carolina.  However, his lead in seven of these states (IA, VA, FL, MI, OH, WI, and CO in order of lowest margin) is less than 1.6%.  The weakness in Michigan and Wisconsin is most telling as these states were won in each of the past three elections by the Democrats – and by double digits in 2008.  Losing either state is likely fatal to Obama’s re-election.  Thus, the Romney-Ryan ticket strikes at Obama’s soft underbelly.  CO by itself is not enough even assuming MI and WI stay Democrat.  That is why so much pressure is on OH, a state with 18 electoral votes.  A FL win moves Obama over the top, but even then a loss in MI and WI would require a CO win.  Bottom line, the race is currently too close to call.

In the national polls, Real Clear Politics has it a virtual dead heat with Obama up the thinnest possible 0.1%.  Polls generally move against the incumbent as the election nears and undecided voters break toward the lesser known candidate as they gain confidence they understand him.  Obama is already fighting the perception that he will not do as well this time as in 2008, in comparison to Bush who won a close re-election but was climbing in the polls at the end.  By this time in 2008 it was clear that McCain was behind, even before the Lehman crisis.  At this time in 2010, it was clear that there was a Republican wave election building.  It appears the undecided are still largely undecided in the current election, so the debates loom far larger than the Democrat’s convention, as the critical question for undecided voters is getting to know Romney’s policies and personality.  Obama’s plusses and minuses are well known.


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