The faltering US economy and emerging market contagion
Today, we got a pretty shaky US jobs report. Non-Farm Payrolls were up only 142,000, well below the 190-203,000 range of median expectations I have seen quoted. But the previous month was also revised down to 136,000 from 173,000 and July was revised down from 245,000 to 223,000. That’s a net addition of 83,000 jobs. As I indicated in my last piece I am actually concerned about the US labor market. But I think the angst about emerging market contagion is overdone. More specific thoughts below
What I wrote last week specifically about my labour market concerns was this:
“One last thing, US growth was upgraded recently to 3.9% annualized in Q2. I think this is well above trend. Gross domestic income is lagging that number, and the Atlanta Fed’s GDPNow forecast for Q3 is tracking 1.4% at present. These two data points both suggest the 2%ish growth I have been calling. Increasingly though, numbers are soft and I am actually starting to become concerned about the employment situation. We should look to jobless claims as the best real-time indicator regarding continued health of the US economy.”
The gist is that, while the US economy is slowing, it is still in the 2%ish growth phase. 3.9% was overdone and the now 0.9% projection from the Atlanta Fed’s GDPNow model for Q3 is a one-off as well. But, my concern is that the trend is down and that the Atlanta Fed Q3 projection is more in line with the coming quarters of growth in the US i.e. sub 2%. I am not talking recession yet, but I am talking about anemic growth levels inconsistent with a tightening monetary policy response.
The question here is about cause and effect because a lot of people are talking about the emerging market and global growth slowdown as triggers. Mohamed El-Erian is one. Christopher Wood at CLSA is another. And while I do believe the things that have caused EM to slow down have also caused developed markets to slow down, I do not believe that an EM slowdown translates into a DM slowdown. What is the transmission mechanism for contagion from EM to DM? Shale oil capex, junk bonds, 100%. And the lower capital expenditure, lower job growth and lower, output there are slowing growth in the US. These are areas I have mentioned for months as likely negative for growth (see here from February for example).
But if suffering EM’s add incremental growth to world economy but are net EXporters, how does a domestic demand downshift there impact DM real economy growth negatively? I don’t see it. One outcome of the downshift in domestic demand of EM net exporters could be lower global growth but LIMITED real economy contagion to DM. The REAL contagion will be via credit and financial sources once the US and DM economies hit stall speed.
Let’s take Canada as an example. If you saw the Q2 house price numbers, credit growth in Canada is still going gangbusters despite recession. House prices rose at the 4th fastest pace in the world. But we do know that the oil sands and mining slowdown has crushed the economy in Alberta. And that has left the overall economy in recession, making the economy as a whole vulnerable to an exogenous shock. Today, it was revealed National Bank is cutting hundreds of jobs due to both the slowdown and a bad investment related to the VW situation. That’s the kind of thing that one can consider contagion from VW and a hit to an already enfeebled economy. It doesn’t take a lot of these kinds of shocks to add up to further economic pain.
If you take Europe or the U.S. into the sub 2% growth range, those economies would be at stall speed and recession could become a real outcome. I would expect for the U.S. however it would be the capex numbers combining with further problems in student loans, auto subprime and general financial economy weakness that would be the trigger. EM per se would have nothing to do with any of this.
The bottom line here is that it is clear that US job growth is now slowing enough to be a concern. Yesterday JPMorgan was saying they expected 225,000 jobs in September, adding that “likely the August payroll figure will be revised up by about 35,000”. What we actually got is significantly worse than that on all counts. Over the past 3 months, payrolls are now up a scant 167,000 versus 198,000 year-to-date and 238,000 at this time last year. This speaks to a decelerating economy. And the culprit is weakness in energy in particular. I expect this weakness to continue and get worse. That is Treasury-bullish but equities and junk-bond bearish.