All Things in Moderation

Vital Statistics:

Stocks are higher this morning on no real news. Bonds and MBS are down small.

Manufacturing expanded in May, according to the ISM Manufacturing Report. This is the second-lowest reading since September, 2020. New Orders and production improved, while prices inflation is moderating. Employment is falling. “The U.S. manufacturing sector remains in a demand-driven, supply chain-constrained environment. Despite the Employment Index contracting in May, companies improved their progress on addressing moderate-term labor shortages at all tiers of the supply chain, according to Business Survey Committee respondents’ comments. Panelists reported slightly lower rates of quits compared to April. May was a second straight month of slight easing of prices expansion, but instability in global energy markets continues. Surcharge increase activity appears to be stabilizing across all industry sectors. Sentiment remained strongly optimistic regarding demand, with five positive growth comments for every cautious comment. Panelists continue to note supply chain and pricing issues as their biggest concerns.

Janet Yellen admitted she was wrong about inflation over the past couple of years. “Well, look, I think I was wrong then about the path that inflation would take,” the Treasury secretary said when asked about her previous comments. “As I mentioned, there have been unanticipated and large shocks to the economy that have boosted energy and food prices and supply bottlenecks that have affected our economy badly that I didn’t — at the time didn’t fully understand. But we recognize that now.”

When discussing inflation, it pays to look at how some inputs affect each other. For example, here is a chart of natural gas:

Natural gas is a big component of electricity generation, and energy-intensive industries will have to pass on that increased costs to consumers.

Know what else is reliant on natural gas? Food. This is because natgas is a big input into fertilizer, which makes growing food more expensive. The US is a net exporter of natural gas, so world markets are not driving this. This is a capacity issue in the US, which ironically is the Saudi Arabia of natural gas. ESG (environmental and social justice funds) have declared war on fracking and made difficult for energy companies to raise funds for exploration and production. Of course as prices rise, we might see some members of the Climate Action 100 break ranks, however this is going to be a constraint on new production. It is the elephant in the room with the business press but realistically there is no lever that Washington can push. Additional drilling permits will do nothing if the energy companies can’t get financing.

Refining capacity has fallen over the past several years, and in order to maintain production of gasoline, diesel fuel refining has taken the hit, driving up diesel (and therefore transportation costs). Of course this gets passed onto consumers in the form of higher prices. Regulations could help here, especially suspending the Jones Act which requires American-flagged ships to transport goods from one US port to another. Shortages of diesel, particularly on the East Coast) could be addressed with supply elsewhere in the US.

Mortgage applications fell 2.3% last week as purchases fell 1% and refis fell 5%. Mortgage applications are at the lowest level since 2018. “Concerns of weaker economic growth and the recent stock market sell-off drove Treasury yields lower,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “The purchase market continues to struggle with supply and affordability challenges. With the 30-year fixed rate at 5.33 percent, the refinance market continues to shrink, led by larger decreases last week for FHA and VA refinance applications. The refinance index was 75 percent below last year’s level, when rates were more than 200 basis points lower.”

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