Supply Chain Hit By Coronavirus

Bullard Talks Down March Fed Decision

Fed did an emergency cut on Tuesday. Questions are now being asked about the March 18th meeting as we only have a couple more days before the Fed’s quiet period starts (Friday). When asked about future Fed action Bullard stated, “We certainly can keep our options open there, but since we kind of pulled that decision forward, I'm not sure you should put a lot of weight on the March meeting right now." 

It makes sense for Bullard to say this because the Fed is running out of ammo. He wants to caution the market about pricing in another 2 cuts. This caution doesn’t mean the Fed won’t cut once.

Fed is very likely to cut at least 25 basis points. However, the market has been trending towards expecting more cuts, so he wants to make sure the market doesn’t get too excited. JP Morgan sees a 50% chance the Fed funds rate goes to zero. That might occur, but we’d probably need to see more tightness in financial conditions and the virus spread further before such action is taken. 

Fed rate cuts aren’t as important as the Fed joining with Congress to come up with a way to support businesses who are dealing with temporary weakness. We don’t want thousands of small businesses to go bust because of a virus that hurts the economy for 6 months. This would mitigate the impact of the virus more than a rate cut ever could. Congress needs to put all hands on deck when appropriating money to deal with the situation.

February ISM Manufacturing PMI

Past couple weeks have had a lot of news as the market has been reacting to the 2020 Democrat primary, the coronavirus, and the Fed’s emergency rate cut. Basic summary of the reports from Monday to Wednesday is that the American economy was in good shape before the assumed negatives caused by the coronavirus will impact it this spring. It’s possible the impact isn’t as bad as expected, but currently the base case is 0% S&P 500 EPS growth and 1.3% GDP growth.

ISM manufacturing PMI was slightly weaker than expected as it fell from 50.9 to 50.1 as the chart below shows. Estimates were for 50.4. In the midst of the volatility in the economic data hurt by the coronavirus, this was a very benign miss. It's not surprising that the PMI stayed above 50 because the regional Fed reports were strong. 

That being said, the details were worse than the headline reading. Let's see how the March regional Fed reports come in. This ISM PMI was in the 28th percentile for all months since 1950. Usually, weaker PMIs are good for the stock market, but we only expect a recovery from this correction, not new record highs.  

This report is consistent with 2.1% GDP growth. That’s slightly below most estimates that use only the data that has come out (the nowcasts). Those making predictions expect weaker growth because they correctly assume the economy took a hit starting somewhere in either February or March. 

Interestingly, the Redbook same store sales reading showed yearly growth rose from 5.4% to 5.9%. Maybe this is from the influx of consumers flooding supermarkets to buy non-perishables. Within the ISM report, new orders fell from 52 to 49.8 and production fell 4 points to 50.3.

ISM report is worse than the headline reading indicates because inventories fell 2.3 points to 46.5 and backlogs rose 4.6 points to 50.3 because of supply chain disruptions, not because demand is rising. When you take that into account, it’s clear the impacts started being felt in the manufacturing sector in February. Imports index fell 8.7 points as China’s economy shut down. The prices index fell 7.4 points to 45.9.

Many Comments On The Virus

Within the comment section of this report, it’s no surprise there were many mentions of the coronavirus and supply chain issues. 6 of the 10 comments mentioned the supply chain or the coronavirus. Only comments that didn’t mention these terms were very brief ones.

A computer and electronics firm stated, “There are always supply chain challenges with Lunar New Year shutdowns, and this year is no different. Coronavirus is wreaking havoc on the electronics industry. Companies are delayed in starting up production, which is resulting in longer lead times, constraints and increased pricing. It's a mad dash to dual source stateside in case China isn't back online soon.” 

China is improving slowly, while countries such as South Korea, Iran, and Italy are headed in the opposite direction. It will be interesting to see how badly the global economy is hurt as these comments mainly refer to China.

Strong January Construction Spending

January construction spending report was very strong as the economy was in great shape before the virus hit. Monthly spending growth was 1.8% which beat estimates for 0.6%. Previous report was revised higher by 0.4% to 0.2%. As you can see from the chart below, yearly growth increased from 6.4% to 6.8% which is the highest growth since February 2017.

Housing market has been on fire because of the decline in rates and the warm weather. Yearly private residential construction spending growth was 9% which was the highest rate since February 2018. While mortgage rates will hit a record low in March, it will be interesting to see how the coronavirus impacts sales. The spring selling season won’t be as strong as expected. 

Private non-residential construction wasn’t as strong as yearly growth fell from 2.9% to 0.5%. This report was driven by private sector housing and the public sector as public construction spending exploded higher. Yearly growth was 12.6% which was the highest rate since November 2007. There’s little doubt all these readings will come down in February and March. The main question is how far they will fall.

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