"Kee" Points with Jim Kee, Ph.D.


  • Possible New NAFTA
  • Why Markets Like This
  • More Yield Curve Stuff
  • Texas Doing Well


Possible New NAFTA

The US and Mexico have reached a partial or preliminary agreement with respect to a North American Free Trade Agreement (NAFTA) rewrite (WSJ). “Were going to call it the United States/Mexico Trade Agreement,” said President Donald Trump of the “new NAFTA” deal, which rewrites portions of the original trade agreement that was signed into law by President Clinton in 1993. Key parts of the rewrite include ensuring that a greater portion of motor vehicles (75% versus current 62.5%) are built within the region (including locally sourced steel and other materials), and raising Mexican wages.



Why Markets Like This

My understanding is that this means Mexico will accept demands for 75% of car components coming from US rather than 62.5%. Also, a certain proportion of auto components must be made by workers earning at least $16 per hour (WSJ). However, Canada is not in yet, and Trump still has to sell the agreement to Congress. Markets are responding positively to this not because it represents dramatic change from the old agreement, but because it conveys cooperation rather than fighting on the part of President Trump, who had threatened on numerous prior occasions to pull out of NAFTA altogether. Markets are hoping that this might signal a cooperative or conciliatory attitude toward European and Chinese trading partners as well.



More Yield Curve Stuff

Moving a little closer to home, I attended the San Antonio Small Business Roundtable last week, an event hosted by the San Antonio Branch of the Federal Reserve Bank of Dallas. Fed economist Keith Brown discussed the yield curve, and why he wasn’t as concerned with a flattening this time around. Importantly, he pointed out that the reasoning of why an inverted yield curve would signal a recession is rarely provided in yield curve discussions.


As I have mentioned, part of this reasoning is the notion that short-term interest rates reflect economic growth, and longer-term rate in a sense contain an expectation of future short-rates, i.e. future growth. So an expected recession would, other things equal, cause long rates to fall. That means a flatter or inverted yield curve. Blake Hastings of the Fed also pointed out that a flat yield curve makes it harder for banks and financial intermediaries to make money on loans, because they tend to borrow short (i.e. paying depositors short-term rates) and lend long (i.e. earning longer-term rates). The idea is that when long rates are low relative to short-rates, bank lending is less profitable and less is done. Less lending in-turn means less growth. So those are two explanations of why an inverted yield curve might signal recession. In my opinion there are just too many international factors influencing long-rates right now (e.g. excess global liquidity, differential central bank policies) to read too much into yield curve slopes.


It was also mentioned that until the curve actually inverts, it is not a signal, meaning the levels don’t really matter that much. That led Hastings to comment that the yield curve is more like a light switch than a dial, meaning that it is the actual inversions – long rates below short – that historically have had implications for future growth. I found this discussion particularly enlightening. Brown also noted that the press seems to be focused upon things like the 2-year/10-year spread less because it has any significance, but rather because they can get more of a story out of it right now. “Exactly!” I thought. Economists have typically watched the 10-year Treasury yield versus the 3-month T-bill yield, not the 10-year/2-year. In fact, the Federal Reserve Bank of San Francisco just released a report today stating, “The difference between 10-year and 3-month Treasury rates is the most useful term spread for forecasting recessions.” Most of this stuff is just media over-hyping, and I cannot recall ever coming across a theoretical case as to why one should care about the spread between 2-year and 10-year bond yields with respect to recession forecasting.


 

Texas Doing Well 

Brown also pointed out that national employment growth among small firms year-to-date is rising pretty dramatically, while employment growth among large firms is flat to negative. His point was that many hiring surveys, which focus more on larger firms, are missing the job growth that is actually taking place. Texas job growth has almost doubled national job growth this year, and unemployment rates between the two have largely converged (3.9%ish). Texas continues to be a magnet for immigrants from other states because of its business friendly climate, with the strongest growth being in Houston and Dallas, and the weakest being Corpus Christi/Coastal areas. NAFTA is a big deal to Texas because it ranks 4th highest in the nation as measured by share of jobs tied to exports. Oil prices remain strong and the Dallas Fed’s survey expects oil at $68 per barrel at year-end (so little change). We export a lot of natural gas to Mexico, and Diesel fuel to Latin America in general.