Morning Report: The current LEI report illustrates the demand versus supply issue in the economy

Vital Statistics:

 LastChange
S&P futures4,413-25.2
Oil (WTI)72.98-0.19
10 year government bond yield 1.44%
30 year fixed rate mortgage 3.07%

Stocks are lower this morning on overseas weakness. Bonds and MBS are down.

Home equity rose 29% in the second quarter to $2.9 trillion, according to CoreLogic. This works out to be a $51,500 gain per homeowner. The number of homes with negative equity (surprised they still exist anymore) fell to 1.2 million homes.

New Home Sales rose 1.5% MOM to a seasonally-adjusted annual rate of 740,000. This is down big (24%) compared to a year ago. This was above expectations, however.

The Conference Board Index for Leading Economic Indicators rose in August.

“The U.S. LEI rose sharply in August and remains on a rapidly rising trajectory,” said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. “While the Delta variant—alongside rising
inflation fears—could create headwinds for labor markets and the consumer spending outlook in the near term, the trend in the LEI is consistent with robust economic growth in the reminder of the year. Real GDP growth for 2021 is expected to reach nearly 6.0 percent year-over-year, before easing to a still-robust 4.0 percent for 2022.”

This is interesting since the GDP forecasts are falling, at least if you look at the 2020 forecasts from the FOMC meeting this week. The Atlanta Fed’s GDP Now index has been trending downward for some time, and Street strategists have been taking down growth estimates. Given what we have heard out of FedEx and Nike, third quarter earnings will be soggy for a lot of companies. So what the heck is going on?

I think the issue is that the Conference Board’s LEI inputs are mainly measuring demand, and the issue for the economy right now is supply. Demand is strong for cars, however chip shortages have reduced inventories. Lots of people want to eat out at a restaurant, but restaurants are short-staffed.

Since GDP is a function of actual transactions, you need both supply and demand. For much of the post-bubble period demand was the issue. People lost a lot of their net worth in the housing market, and they used any extra cash to pay off debt. Since spending is the biggest portion of GDP, the policy levers were used to encourage spending. Today, the issue isn’t demand, it is supply. Unfortunately for DC politicians, they are still fighting the last war.

Ultimately the question becomes whether this is a short-term phenomenon or something longer term. If it is short term, it will work itself out and be forgotten in a year or two. If it is long term, then we will start seeing persistent inflation. And the lesson from the 1970s is that inflationary expectations are hard to control once they start.

Author: Brent Nyitray

In the physical sciences, knowledge is cumulative. In the financial markets, it is cyclical

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