Friday, August 5, 2016

Chemical activity hits a new high

For almost 100 years, The American Chemistry Council has been publishing their "Chemical Activity Barometer." The index rose 3% in the year ending a few days ago, and reached a new all-time high in the process. As the charts below show, this index has reliably tracked the performance of the overall economy and, in particular, it has been a good leading indicator of industrial production, which has been noticebly weak for the past 18 months. (See more details in my June '16 post on the subject here.)

This close-up look at the performance of the index highlights its strength in the past several months, and the fact that it finally exceeded its 2007 peak, which occurred six months before the economy entered the Great Recession.

The chart above gives you a longer-term perspective on the behavior of the index, which invariably turns down in recessions (often in advance of recessions), and invariably rises during recoveries. It would appear that the recent behavior of the index points to stronger growth than is widely perceived to be the case.

The chart above compares the year over year change in the 3-mo. moving average of the Chemical Activity Index with the equivalent change in the level of Industrial Production. The Chemical index invariably moves in advance of moves in Industrial Production. If this relationship holds, the market is going to be surprised at the new-found strength in Industrial Production in the months to come. We've been waiting for evidence that sharply lower energy prices will result in a boost in non-energy sectors of the economy, and this suggests that the evidence should be forthcoming before too long.

To be conservative, the strength in the Chemical Activity Index suggests that at the very least, a recession is not on the near-term horizon, and that the economy should prove to be at least a bit stronger, in the months to come, than the market is expecting. 

Truck tonnage in June was a bit weaker than in May, but as the chart below suggests, it remains on an upward trend. Both chemical activity and truck tonnage are good measures of the physical size and growth of the economy, and both suggest the economy continues to make progress.


Benjamin Cole said...

Great charts.
The US economy still gets but a "gentleman's C" from me.

Rob said...

Scott, do you think the sudden rise in Japanese bond yields could be the start of a global bond trend change ? Thanks.

Scott Grannis said...

I'd like to think so but I have the wrong about bonds for many years so I'm suitably humble.

Benjamin Cole said...

Some idle speculation: Okay, the Fed wants to raise rates, and talks about raising rates at every opportunity. It is rare to see true happiness in this world, but the look on a central banker's face when a rate hike is announced is close.

Now, of course, the Fed pays 0.50% on excess reserves to banks. The banks are getting paid to not do anything, and not make loans.

This is different from pre-2009, when a commercial bank (in general) could only make money by extending loans (and associated fees etc).

So a commercial real estate developer goes to a bank today, hat-in-hand, and wants a loan. The bank is making money without extending the loan. They have a USDA-style program in effect (getting paid for not farming) or not extending loans. And no risk. And the Fed is hankering to raise IOER to 0.75%.

And remember, when a commercial bank extends 4.00% property loan, that is not a 400 basis point spread of profit. The bank has staff, overhead, its own borrowing costs.

Maybe this is one reason why commercial real estate loan volume only reached 2007 levels again in late 2015. Actually, 2016 has been a decent year for commercial real estate loan volume, but if the Fed raises IOER again, perhaps the IOER will be higher than the spread on a commercial property loan. The banks can go golfing on the 0.75% they make for keeping money in the vault.

This question is doubly important, as many say it is banks that expand the money supply, when they extend a loan. Before QE, the main creation of new money was through bank lending, and banks primarily lend on on real estate.

This gets into the whole exogenous v. endogenous expansion of the money supply dispute, which can put any sane person into knots for days.

But suffice it to say, I think the Fed is following a reckless and suppressive course with its view towards higher IOER.

Paying banks to do nothing is dangerous precedent, and of course, only banks will closely monitor and lobby this issue going forward. Like any federal dope, it will quickly become addictive.

Anonymous said...

do you know Kyle Bass' opinion on the Japanese Bond bubble? IIRC if they would rise only 200 BP Japanes interest payments on its debt would already exceed all taxes - Japan would be finished.
I believe rising rates without inflation going higher, is the last thing the Japanese establishmend wants.
Why aren't you concerned about raising rates in Japan?

Scott Grannis said...

I'm mainly concerned about negative interest rates that are used in lieu of more traditional methods of monetary stimulus.

Benjamin Cole said...

Endzeit14 and Scott--
On the other hand, I have read that within two years the bank of Japan will own nearly all the Japanese government bonds on the market.

So taxpayers will pay taxes to pay interest on government bonds, which will flow back into government coffers.

Unknown said...

Endzeit14, I'm not sure if this article from a few years ago contains anything new to you...anything "Japan" is all very confusing to me, but here you go:

"The Japanese situation is all about policy rates, expected future policy rates, expected inflation and currency depreciation.

It’s not about bond vigilantes forcing a sovereign currency issuer to pay extortionate rates on its own currency obligations.

Currency revulsion? As I have said time and again, the currency is the release valve. And we are seeing that with Japan as I predicted. The Yen is getting crushed and rates are falling. In Japan, the 5-year is down 10 basis points, the 10-year is down 44 basis points and the 30-year is down 56 bps points in the last year alone! Where’s the stress that Bass points to? He is totally out of paradigm. It’s about policy rates, expected policy rates and inflation."


More on the Yen here:

Anonymous said...

an excellent argument. I already had forgotten that fact. Tx.

Grechster said...

Put aside the idea that the Fed wants to RAISE the rate of IOER. Why is there IOER at all? This has never made any sense to me (from a policy perspective). That is, if you want the banks to actually lend why would you incent them, via IOER, to not lend?

Since we've had this policy for a long time now, the answer must lie somewhere else. Could it be that the Fed grew frustrated at being able to control only short term interest rates (whereby the actual money supply was determined by the powerful whim of the banks' willingness to lend)? The Fed, under this line of thinking, wanted a much better hammerlock on the total money supply. So, using the IOER, the Fed is now able to influence the actual willingness of the banks to lend. Now, the Fed controls short term interest rates and also heavily influences the lending (velocity) function. Could this be the most powerful form of government control in the history of our (fallen) Republic? (And please save your Fed-is-independent nonsense.)

Btw, Scott, I loved your charts on chemical usage.

Benjamin Cole said...


I think the Fed has a large degree of independence. The Reaganauts went after Volcker hammer-and-tong, but could not get him to ease up much. Reagan appointed three members to the FOMC who famously outvoted Volcker once in favor of easing--and Volcker threatened to resign. They backed down, and Volcker prevailed.

Obama is worse---he appears clueless about Fed policy, and so the Fed is effectively independent.

I am not sure an independent central bank is a good idea.

I would prefer what was proposed by Reaganaut Treasury Secy Don Regan: That the Fed be placed into the Treasury Department.

The President should formulate monetary and fiscal policy, and then voters can vote based on the results.

Now, how does one vote their preference for an easier or tighter monetary policy? The situation is even worse in the Europe.

This leads to monetary policy being a non-issue. Trump and Hillary have scarcely addressed the topic, which is way more important than transsexual bathrooms or Melanie Trump's speech.

If Trump or Hillary has a monetary policy position, please advise me.

Benjamin Cole said...

Add on:

Many observers say central banks have little control over longer-term interest rates. Japanese 10-year and 20-year bonds are selling for negative rates or right on the line.

In this case, the Bank of Japan is not dictating negative rates; it is the market that is settling on negative rates.

In the US, the 10-year US Treasuries are still positive, but will probably go negative in the next downturn. The 30-year secular trend in interest rates is lower. Central bankers are not exactly growth-friendly, so this trend is likely to continue,

Unknown said...

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