In this conversation, Alex Chausovsky and guest Joseph Politano provide expert context on the current commodity market conditions, discuss other input prices and what the latest developments mean for your business.
Politano is the founder of the Apricitas Economics, a newsletter that specializes in the intersection of finance, macroeconomics, labor economics and public policy. Previously, Politano was a financial analyst, assisting in the administration of economic surveys across the U.S. He also worked as an economic development volunteer in Uganda where he assisted with agribusiness and youth development efforts.
Alex Chausovsky: There is a great deal of debate going on right now about whether the economy is in a recession and what lies ahead. When you look at the economic landscape, what factors or data sets do you consider to be a good gauge of economic conditions for distributors?
Joseph Politano: It’s a topic I have written extensively on. There are two ways to think of a recession. Most people tend to view a recession as something bad, and consumers, businesses and investors feel bad about the economy right now. We’ve had massive price increases and inflation is running at almost 9%. We also had negative GDP growth for the last two quarters. From that, many people conclude outputs are declining.
Alternatively, there is the “Poindexter Economist” way of thinking. “It’s not really that bad, what’s the chance of a recession?”
I do think the GDP oversells how bad things are. When you look at gross domestic income instead of GDP, that looks good. Job growth is robust over the last six months. It’s an unprecedented moment in American history to have a recession in which jobs were added. That’s just not how recessions work.
On the flip side, if you were to look at the unemployment rate or non-farm payrolls, that probably overestimates how good the labor market is.
But looking forward, what’s the chance of a recession? Those numbers look better than they did three or four months ago, but there appears to be a medium-sized risk of recession.
The part that’s relevant to this audience is what the Federal Reserve wants. They’re setting interest rates because they want to get inflation under control. They don’t want to cause a recession. They don’t want people to lose their jobs. They want “immaculate disinflation.”
For forward-looking indicators, I like to look at credit spreads. So, you ask yourself, “What do the markets think about the chances of really risky businesses failing and going under? Or, can companies borrow money?” Those metrics have been rising and are at 2018 levels.
Housing growth is another important metric to watch.
I also like to watch more targeted business-to-business metrics like non-defense capital goods, industrial production and heavy truck sales. If you look at heavy truck sales, they almost always precede a recession by about six months, and those are falling right now though not at a catastrophic level.
One of my favorite indicators to watch is U-Haul prices. They’ll charge more if you want to leave a city that many are exiting and go to one where the economy is doing well. If you look at those indicators right now, U-Haul prices are coming down. If people don’t feel confident in moving, that’s a worrying sign to me.
Chausovsky: You brought up several interesting points. One is that trucking is in decline despite online purchasing and a shortage of drivers. What do you think is driving the decline and is this a long-term or short-term issue?
Politano: It’s hard to say precisely. I think trucking falls into one of the industries that were overextended. People buying a lot more goods online peaked in the early pandemic, they are buying less and less online now. That online buying peaked several quarters ago and is trending downward along with trucking. Trans-Pacific cargo rates just dropped 14%. If rates on trans-shipping are declining, that means demand for trans-shipping is declining. This is worrisome for trucking companies because demand is fickle. Will they buy a truck with everything going on in the economy or will they wait?
Chausovsky: Do you expect any trend to increase productivity through automation, digitization of industry or other innovations?
Politano: Yes, I think when you have this high-demand economy, especially high labor demand, functionally there’s a fixed rate of worker growth. In the U.S., it’s not like suddenly you are going to have millions of people immigrating, turning 18 or returning to the workforce from retirement at the same time. When there is a severe labor shortage, the answer is usually to invest in making the workers they do have more productive. We’ve seen that in a big way with companies in the service sector. They say, “Now everyone is working from home. Here’s how we are going to automate processes. Here’s how we are going to cut back on costs.”
I think we’ve seen this with labor in the warehousing and transportation sector. That has gotten a lot more efficient, even as that sector chewed up a bigger share of the U.S. labor pool. I fully expect that whenever there is a labor shortage, companies will find ways to get the best out of the workers they have. Usually, that’s good for workers in the average economy because that productivity trickles down into real wage growth and bigger investment. I am bullish on that.
The one thing I would say is when the Fed raises rates, they want companies to be colder toward that idea and reconsider hiring workers or investing due to uncertainty in the coming months. That will pull down overall demand, which is necessary to get inflation down. They would also love to see the labor shortage weaken. The Fed would love if that came from higher labor supply and people reentering the workforce. I think they fear that it’s likely going to have to come partially from reduced labor demand, which is also going to mean reduced demand for automating processes and fixed investment productivity.
Chausovsky: I would like to address the inflation element, and there’s no better way to do that than talking about the input prices that businesses, particularly distributors, must contend with. You mentioned gasoline prices earlier. We’ve seen that surge when the national average briefly topped $5 a gallon; we’ve now seen a significant pullback and based on what I’m seeing out of refineries, downside pressure on gasoline should persist in the foreseeable future. That’s because they’re incentivized to produce more of the other non-gasoline stuff like jet fuel, diesel and heating oil. Those inventories are still suppressed relative to pre-pandemic levels.
What are you observing in the commodity markets, particularly when you think about oil and gas or energy costs in general?
Politano: It’s been a crazy six months. We have seen crazy developments and the U.S. is in a lucky position. It’s a fortunate position that was part luck and part planning compared to economies in Europe that are much more reliant on energy imports. We have a much better domestic supply, and we’re not reliant on natural gas connections from Russia, in particular.
When you look at the spreads between oil and gas, those have come back down to a level similar to that in 2019. For gas, in particular, we’ve really shaken off the refinery shortage.
A refinery’s job is to convert crude oil into gasoline, and they charge a cost for that. The spread is a representation of that cost. If a spread is high, you’re expecting more refinery capacity to come online. If it’s very low, you’re basically saying refineries have plenty of capacity. It’s really easy for them to convert, so they charge low prices. It’s a supply-demand relationship. We reached a point in the middle of this year where there was no capacity. The only place on planet earth where there was capacity was in China. China was experiencing these massive lockdowns, and they were not trying to refine anything. That has since abated.
At the peak of the pandemic, gas spreads were like $50 a barrel. Now it’s closer to $15-$20 a barrel, which is at the high end of the normal range. Supply and demand caught up a bit. We’re not in a critical acute global refinery shortage. Oil has also come down pretty significantly. Though, it’s really hard to forecast, as we’re in this moment where energy markets are fragile.
I do think we’re in a good place now. And if you were looking at futures for like the next couple months, people expect to stay in a good place and prices to come down even a little bit more. But there’s still this underlying fragility. If the geopolitical landscape changes, you could see big rises in gas prices again.
Chausovsky: When you think about all the things that have been driving prices, they’re seemingly outside of the macro landscape. It’s the COVID shutdowns in China; it’s the war in Ukraine. It’s things that are considered black swan events. If we were to just look at the economic impetus of what’s going on in the face of a slowing economy and ask what do energy oil and natural gas prices tend to do: How would you answer that?
Politano: Usually, you’re not going to see big effects. We mentioned at the beginning of our discussion that if gasoline prices go up, people still buy. They have to buy, it’s a basic tenant of their work, their life and their business. You would have to see economic collapse for people to say I’m not driving anymore. If you look back to the 2008 recession, it took about halfway through before gas prices started falling off the cliff, as people lost their jobs.
Chausovsky: What is your opinion and where do you see yourself perhaps disagreeing with some of the consensus opinions in terms of commodities and input prices as we look to the rest of this year into 2023 and beyond?
Politano: China is exporting deflation. The domestic choices they’re making are pulling down a lot of commodity prices in the U.S.
If you’re looking at base metals, what you’re really looking at in a lot of ways is the Chinese housing market and Chinese infrastructure investment. That’s the real economic crater. We talk about how bad the U.S. housing market is when we’ve seen a 25% drop in housing starts. The Chinese housing market is seeing a 50%-60% drop in total housing starts inclusive of multifamily, which is a much bigger deal there. That’s a crazy driver. I think that the collapse in demand is the big reason you’re seeing aluminum, zinc and steel (to a lesser extent) dropping in price so significantly. You also have demand for metal softening in the U.S., but not to the same degree.
It’s hard to gauge how sustainable it is.
Labor is the one thing you can very easily point to and say this is the thing that the Federal Reserve controls demand for. They control aggregate demand for labor and through aggregate demand for labor, they control consumer demand and that passes through to inflation.
The frustrating part for them is if there’s 9% inflation, plausibly 3%-4% of it is supply chain stuff, gas, oil, food, and other things that they can’t control. And then another 3% of that’s labor-driven or core services driven from demand that they can’t control.
It’s really early to tell, but I think the data we’ve seen over the last few months is consistent with this idea that people are re-entering the workforce who left during the pandemic: parents with small kids, older people who retired and students. The labor supply and employment growth are improving and, at the same time, wage growth is slowing a bit.
Chausovsky: I think about the implications of what you just said as far as planning from a cost basis on the part of distributors and the part of manufacturers. They’re going to be facing more pressure on the bottom line, at least from the labor component. It’s going to be more expensive for them to maintain their existing workforce. It’s very competitive to attract new people into their organization. That’s going to keep the pressure on. It sounds like there may be some offset in some of the other input prices that we were talking about.
If I’m a distributor looking at increasing costs in labor, I’m looking at flat to potentially increasing costs on the material side. That probably means that I need to figure out a way how to have a conversation with my clients about ongoing price increases. They might not be as painful as what we went through in 2021 and 2022, but it’s still going to be a part of the conversation.
Politano: That’s pretty consistent with the data we have. One of my favorite tools is something the Atlanta Fed does. They survey businesses and ask questions like, “What do you expect unit cost growth to be over the next year?”
And recently, we’ve seen the first declines in that forecast. Normally they forecast about 2%/unit cost growth; that’s 2% inflation. That’s the target, that’s the goal. They were forecasting almost 4%. Now it’s back down to like 3.75%. On the one hand, 3.75% is going in the right direction. On the other hand, 3.75% is still a lot bigger than what it would be pre-pandemic. That’s still rising costs.
The problem for the Fed is that if you have this “immaculate disinflation” where the supply chain is improved without having to crush demand, that still wouldn’t get inflation back down to target. The other problem is that the Fed wants to have a strong labor market and a strong economy, and they need to get prices down. They are committed to getting prices back down. And, if there are costs associated with doing that, they are willing to pay those costs.
Chausovsky: If you were going to give distributors advice based on the economic landscape for 2023, what would you say to them?
Politano: The best advice I can give anyone is that the only people who have been right are the people willing to admit they were wrong. It’s been a messy two to three years for everyone. The best thing you can do is try to stay nimble and question the assumptions, the plans, and the decisions you are making. That’s the way you continually improve.