Month: August 2023

Note: I am travelling for another week, impacting frequency and depth.

Slower Hiring This Summer Could Take Heat Off the Fed Unemployment rate falls to 3.5%, near a half-century low, and wage growth holds steady at elevated level

The U.S. economy added 187,000 jobs in July, a still solid increase nearly matching June’s downwardly revised 185,000 gain, the Labor Department said Friday. Those figures are down significantly from a year earlier and below last year’s average employment growth of about 400,000 a month. (…)

Wages continued to rise briskly, with average hourly earnings growing 4.4% in July from a year earlier, the same rate as in June—down from last year but well above the prepandemic pace. (…)

Adding to signs of cooling labor demand, Americans also worked less in July, with average weekly hours ticking down slightly to match the lowest level since April 2020.

Job openings decreased in June and workers quit jobs at a slower rate, suggesting lower confidence they could land new positions. (…)

This stacked aggregate payrolls chart illustrates that monthly labor income growth has stabilized around +0.5% but that wages are taking a larger share of the growth while actual employment and hours works are slowing.

America’s Truckers, Cargo Pilots and Package Carriers Are Fed Up Inflation and resentment are stoking heightened labor activism, with FedEx pilots rejecting a union-brokered deal.

The Teamsters, which represents drivers at trucking company Yellow, threatened a strike shortly before the company shut down July 30. FedEx pilots recently rejected a new labor contract promising a roughly 30% raise. Port workers in Canada staged walkouts earlier this year and dockworkers at West Coast ports slowed work at container terminals. (…)

Transportation workers said they are entitled to a larger share of the corporate profit generated during the pandemic and better pay and recognition for showing up through the health crisis when other staff was able to work remotely.

“We know what we’ve sacrificed to make certain that goods and services are provided,” Teamsters General President Sean O’Brien said at a rally in Atlanta on July 22, days before a tentative agreement with United Parcel Service was reached and amid the Yellow threats. “Now is our time to be rewarded.” (…)

Employers say they are offering outsize wage increases and changing their operations to improve conditions for workers. UPS got rid of a lower-paid weekend driver role and agreed to ensure that delivery vehicles have adequate cooling equipment for drivers. Railroads are promising more predictable work schedules so workers can plan and attend family activities on their days off. (…)

Pilots at FedEx recently surprised industry observers by voting down a union-brokered deal that would have raised their wages about 30% by 2028. Some pilots said that they saw their counterparts at passenger airlines get higher wages in recent weeks, and that they were also worried about insufficient job protections. (…)

• UAW seeks 40% pay boost in talks with Detroit automakers. (WSJ)
• Workers to Employers: We’re Just Not That Into You In the postpandemic economy, we’re living more and working less

Employees still love remote work, but recent studies find no boost to productivity and a decline for fully remote work. 

And yet most employers have given up on prodding staff to return to the office full time. According to the Society for Human Resource Management (SHRM), 62% of employers offer the option to work remotely at least some time. The Census Bureau finds that 39% of workers are teleworking from home, half of them five days a week. (…)

Employees think they’re 7.4% more productive working from home, according to surveys conducted by Nicholas Bloom of Stanford University and two co-authors. Their managers think the opposite, estimating workers are 3.5% less productive at home. The reason, according to the economists’ review of recent research, is that communicating with an employee at home is more cumbersome and time-consuming, while reduced social interaction and feedback diminish creativity and learning. (…)

And even if productivity suffers, that might be more than made up for by cost savings. Remote employees might need less office space, live in cheaper places and accept lower pay: The authors found employees value working from home two or three days a week as equivalent to an 8% pay increase. It will take more than the threat of unemployment to undo this shift in values.

Labor productivity is up 5.0% since Q4’19 but Employment Costs are up 13.6%. Corporate profits jumped 60% during the first 2 pandemic years but have declined in each of the past 4 quarters, though still well above their pre-pandemic levels.

Business sales significantly outpaced inflation through mid-2022 but are down 2.6% since while inflation is up 3.5%.

So profit margins spiked up post pandemic but will be under pressure from slowing demand (the Fed’s main objective) and rising labor costs. Add now higher financing costs and possibly rising energy costs to challenge margins even more. Note how margins don’t always need a recession to decline.

• Earnings Season Threatens Lofty Stocks Investors say optimism in markets could evaporate if profits get squeezed further

(…) Companies in the S&P 500 are set to log a roughly 7% year-over-year decline in earnings for the second quarter, according to a FactSet blend of reported results and consensus analyst estimates. That would mark the largest quarterly earnings decline for the index since the second quarter of 2020 and a third consecutive quarter of declining profits.

Earnings expectations for the third and fourth quarters have dropped, too. At the beginning of the year, Wall Street analysts expected profits to grow nearly 5% in the third quarter and almost 10% in the fourth quarter, according to FactSet. Now, they see increases of roughly 0.2% and 7.4%. (…)

Net profit margins among companies in the S&P 500 are poised to fall to 11.4% for the second quarter, according to a FactSet blend of reported results and consensus analyst estimates, below the previous quarter’s 11.5% and the year-earlier’s 12.2%.

Consumer-products maker Procter & Gamble raised prices by 7% across its brands in the June quarter from a year earlier, propping up earnings. But sales volumes fell 1%, signaling some resistance from inflation-weary customers.

“At a certain point, consumers will balk. Something at some point will give. You can’t indefinitely increase prices,” said George Cipolloni, portfolio manager at Penn Mutual Asset Management. (…)

The fact is that increasingly higher interest rates eventually bite harder and wider…

• Corporate defaults this year are running at their fastest rate in over a decade — outstripping the surge we saw in the 2020 pandemic/lockdown recession. S&P is tracking more than 200 companies falling into “severe stress” because of the sharp rise in interest rates (and, incredibly, we have people at the Fed who somehow believe all the effects of what the Fed has done is in the rear-view mirror). (…) A recent paper by the Fed itself shows that 37% of publicly-traded firms are likely to struggle as they attempt to roll over their debt and concluded that the knock-on effects could be “stronger than in most tightening episodes since the late 1970s.”(D. Rosenberg)

A Real-Estate Haven Turns Perilous With $1 Trillion Coming Due Apartment buildings rose in value for years, but surging interest rates loom over the sector’s property owners now.

(…) The apartment sector’s main problem isn’t a lack of demand—rents have soared since 2020—it is interest rates.

The sudden surge in debt costs last year now threatens to wipe out many multifamily owners across the country. Apartment-building values fell 14% for the year ended in June after rising 25% the previous year, according to data company CoStar. That drop is roughly the same as the fall in office values. (…)

Mortgage delinquencies in the multifamily category are low but increasing. Borrowing costs have doubled, rent growth is slowing and building expenses are rising. (…

Outstanding multifamily mortgages more than doubled over the past decade to about $2 trillion, according to the Mortgage Bankers Association. That is nearly twice the amount of office debt, according to Trepp. The data provider adds that $980.7 billion in multifamily debt is set to come due between 2023 and 2027. (…)

Multifamily-building owners in Los Angeles, Houston and San Francisco have defaulted on loans against thousands of apartments. Blackstone, the world’s largest alternative-asset manager, has defaulted on mortgages on 11 Manhattan apartment buildings, according to a person familiar with the matter. A spokeswoman for Blackstone said the buildings have unique issues and are “not representative of the strength we’re seeing in our broader rental-housing portfolio.” (…)

Apartment-building owners often borrowed more than 80% of the building value from bond markets. Most apartment loans are fixed-rate, long-term mortgages. During the pandemic, however, investors took out more shorter-term, floating-rate loans. (…)

But few anticipated that interest rates could rise so quickly, pushing down building values and forcing landlords to refinance at much higher rates. Regional banks, a crucial source of funding, are lending far less today, making it harder to refinance mortgages. Rent growth has slowed sharply in many U.S. cities, while inflation and growing insurance premiums have raised the cost of running buildings. (…)

The unusually high number of new apartment buildings opening this year and next, especially on the higher end of the rental market, poses a supply concern. (…)

Note: I am travelling for another week, impacting frequency and depth.

PMIs

• S&P Globals’s Services PMI: Business activity growth eases as demand conditions soften in July

The seasonally adjusted final S&P Global US Services PMI Business Activity Index posted 52.3 at the start of the third quarter, down from 54.4 in June. The latest data signalled a modest and slower expansion in business activity at service providers. The rate of growth was the softest since February and weaker than the long-run series average. Nonetheless, greater output was attributed to a sustained increase in new orders and continued demand from existing customers.

New business at service sector firms grew for the fifth month running in July, and at a marginal pace. The expansion was linked to a larger customer base and accommodative demand conditions. That said, the pace of increase slowed notably from that seen in June and was well below the series trend rate. Firms often stated that high interest rates dragged on domestic customer spending.

New export orders rose at a sharper pace, however. New business from abroad increased for the third successive month and at a solid pace amid reports of stronger demand from foreign customers.

On the price front, input costs at service providers increased at a further marked pace during July.The rise was historically elevated and driven by higher wage bills and supplier prices. Although substantial, the rate of increase was weaker than seen in June and much slower than those seen through 2021 and 2022. Following a brief acceleration in pace during June, the rate of increase eased to the second-slowest since October 2020.

Similarly, selling prices continued to rise at a pace that was faster than the series trend in July. That said, the rate of selling price inflation accelerated from that seen in June and was marked overall. Companies often noted that higher charges stemmed from the pass-through of higher costs to customers, notably relating to wages.

Pressure from rising wages and challenges finding suitable candidates dampened employment growth during July. Service sector firms recorded a further rise in staffing numbers, but the rate of job creation was the slowest since January. Workforce numbers have increased in successive months for three years, however, with companies attributing hiring to greater new orders.

Despite a slower uptick in employment, service providers were able to manage their workloads, as backlogs fell in July. The decrease in outstanding business was only marginal but was the second decline in the last three months.

The outlook for activity over the coming year at service providers was upbeat overall in July. Planned increases in marketing spending, alongside hopes of greater client demand and stabilization in interest rates, reportedly underpinned optimism. The degree of confidence slipped sharply to the lowest since December 2022, however, amid concerns regarding future demand conditions.

• The ISM Services PMI:

In July, the Services PMI^® registered 52.7 percent, 1.2 percentage points lower than June’s reading of 53.9 percent. The composite index indicated growth in July for the seventh consecutive month after a reading of 49.2 percent in December, which was the first contraction since June 2020 (45.4 percent). The Business Activity Index registered 57.1 percent, a 2.1-percentage point decrease compared to the reading of 59.2 percent in June. The New Orders Index expanded in July for the seventh consecutive month after contracting in December for the first time since May 2020; the figure of 55 percent is 0.5 percentage point lower than the June reading of 55.5 percent. (…)

The Prices Index was up 2.7 percentage points in July, to 56.8 percent. (…)

There has been a slight pullback in the rate of growth for the services sector. This is due mostly to the decrease in the rate of growth for business activity, new orders and employment, as well as ongoing faster delivery times. The majority of respondents are cautiously optimistic about business conditions and the overall economy.

WHAT RESPONDENTS ARE SAYING

• “Pricing in food sectors has come down incrementally, but in very small, almost minute percentages. IT labor pricing is still inflated.” [Accommodation & Food Services]
• “Sales have been steady.” [Construction]
• “Continuing to see improved case volume in 2023, although July and summer months have flattened a bit as usual. Still scratching and clawing to find savings with economic inflationary pressures.” [Health Care & Social Assistance]
• “Business remains steady.” [Information]
• “We are maintaining a cautious approach, although inflation seems to be easing. The overall business environment has stabilized, but tight labor markets are creating ongoing issues.” [Management of Companies & Support Services]
• “Hiring of employees, temporary workers and consultants continues to be slow as companies remain cautious about increasing fixed and variable expenses during uncertain economic times.” [Professional, Scientific & Technical Services]
• “Although capacity in transportation services has improved, there are still some industries with lagging lead times for their products.” [Public Administration]
• “Overall economy is good. Supply chain market is stable. Commodity prices are increasing but at a slower rate. Lead times and deliveries are ideal, and inventories are lower than last quarter. The unemployment rate is at its lowest point in 70 years. Wages continue to grow.” [Retail Trade]
• “We are still having issues with getting certain materials based on chips, though not nearly as imposing as they were a year ago. Lead times from Europe and in general seem to be improving. There are challenges with suppliers who made changes during the pandemic to spread workloads — they are not as responsive, and this affects lead times.” [Transportation & Warehousing]
• “Steady, slower growth.” [Finance & Insurance]
• “High operational expenses continue to put pressure on the business and limit hiring. Supplier costs (are) not coming down as much as expected. Service levels from suppliers continue to improve. Trucking metrics improved.” [Wholesale Trade]

Recent key economic news

Q2 real GDP growth came in above expectations at a +2.4% annual rate, beating the +1.8% consensus estimate and accelerating from +2.0% in Q1, weakening the recession case. Adding to the encouraging news was the sharp slowing in inflation, as the GDP price deflator eased to a +2.2% annual rate (lowest number since 2020Q2!) from +4.1% in Q1 and considerably below the +3.0% consensus forecast.

The core PCE deflator also undercut expectations at +3.8% annualized (consensus was +4.0% and the lowest reading since the first quarter of 2021) and also sliced below the +4.9% first-quarter reading.

David Rosenberg remains an economy bear, reminding us

that over the past six recessions (before the pandemic) dating back to the early 1970s, that real GDP growth on average was +2.0% at an annual rate the quarter the recession began? (…) When the Global Financial Crisis began in 2007Q4, real GDP growth came in at a +2.2% annual rate. [In] the first quarter of the 1981-82 recession, real GDP growth printed +4.3% at an annual rate. Or just as the 1973-75 recession was just getting started, real GDP was a perky +4.0% pace. These were all head fakes because GDP is a coincident indicator at best.

David added

after stripping out shelter (rent, utilities) and medical care — both of which are essentials — consumer spending barely expanded in the second quarter (+1.4% annualized). We came off the month of June with industrial production (-0.5% for the second month in a row), real retail sales (flat), housing starts (-8.0%), building permits (-3.7%), new home sales (-2.5%), existing home sales (-3.3%), exports (-0.2% and down three straight months) and real core capex shipments (-0.1%) either declining or stagnating.

Last Friday we got the income and spending data for June. This table summarizes:

• Spending rose +0.5% in nominal terms and May was also taken higher to +0.2% from +0.1% initially.
• The real or inflation-adjusted gain was +0.4% (after a +0.1% reading in May). We head into Q3 with a slowish +1.1% (annualized) momentum in real consumer spending.
• Core PCE inflation slowed to +0.17%, nicely down from +0.4% and +0.3% in the previous 2 months.
• The Powell super-core service sector price index came in at +0.2% for the second month in a row.
• Real goods consumption rose 0.9% with durables up 1.7% MoM after -0.3% in May and +0.9% in April. Still very strong.
• Real spending on services, supposed to offset the expected softening in goods (!), rose only 0.1% in June after +0.2% and +0.1% in May and April respectively. Last 3 months annualized: +1.6%

So while just about everybody now adopts the soft landing scenario, it is important to hear the few remaining naysayers, particularly those who do good in-depth analysis. Like him or not, Rosie is one of them:

We have to keep in mind that the policy lags are long and variable:
• Fed tightening cycles have generated recessions 80% of the time in the post-WWII era. In the periods when we saw a recession, the average lag from the first hike to the recession is 15 months (not 15 weeks!) and the range is from as low as 0 to 30 months. From the final hike, the lag is 6 months on average (and the range from 0 months to 18 months).
• The 20% of the time when recession was avoided, the Fed stopped short of inverting the yield curve. The average lag from the time of inversion to the start of recession is 10 months; with a wide band of a minimum of 0 months to a maximum of 18 months.
• The Conference Board’s leading economic indicator leads — that is the point. It is riding an epic 15 month losing streak. The average lag from its peak to the onset of recession is 13 months (and a historical range of 8 months to 21 months).
• The New York Fed’s modified three-yield curve recession model pegs the odds of seeing a downturn in the next twelve months at 96%. When the Fed first started hiking in March 2022, these recession odds for the year ahead were barely 1%. So why would anyone have thought we would be in recession by March 2023? The cutoff in the past for this metric was 70% — at that point, not once in history did the recession fail to ensue. That is the trigger point — you don’t have to wait for it to hit 100%. And the index here crossed above 70% for the first time last November. The average lag from the time the recession indicator touches or crosses the 70% threshold to when the recession commences is 10 months; and a range of 6 months to 17 months.
• There is the old refrain of how the stock market has called 9 of the past 15 recessions. But it is the bond market that has the terrific track record — peaks in the 10-year Treasury note yield have led recessions, on average, by 7 months (over the past six decades). The yield peaked last October, as an aside. The range is wide, mind you — from as low as 0 months (contemporaneous) to as long as 17 months.
All of these indicators LEAD and it can easily be argued that even if the recession call has proven to have been early, to suggest that it is not going to happen at all in the coming quarters flies too much in the face of the historical record, to say the least. It reminds me a lot of what the pundits were saying in the opening months of 2002 and again in late 2007 and early 2008.

Jay Powell at his presser last week:

• the Fed staff “are no longer forecasting a recession”. Interestingly, Powell never mentioned that the Fed staff was forecasting a recession in his previous pressers.
• The overall resilience of the economy, the fact that we’ve been able to achieve disinflation so far without any meaningful negative impact on the labor market, the strength of the economy, overall that’s a good thing. It’s good to see that, of course. It’s also you see consumer confidence coming up and things like that, that will support activity going forward.
• We’ve covered a lot of ground and the full effects of our tightening have yet to be felt.
• So I guess I would put it this way. We — I’d say it this way, it’s really a question of how do you balance the two risks, the risk of doing too much or doing too little, and, you know, I would say that we’re coming to a place where there really are risks on both sides. It’s hard to say exactly whether they’re in balance or not. But as our stances become more restrictive and inflation moderates, we do increasingly face that risk.
• I mentioned that the inflation report was actually a little better than expected, but you know, we’re going to be careful about taking too much signal from a single reading. [Well, June was not a single reading. In fact, the Powell super-core service sector CPI has slowed to a +1.4% annual rate over the past three months. This was his focus data point which he did not even mention on Wednesday, focusing on the conventional core inflation.]
• And core inflation is still pretty elevated. You know, there’s reason to think it can come down now, but it’s still quite elevated. And so we think we need to stay on task. And we think we’re going to need to hold—certainly hold policy at restrictive levels for some time. And we need to be prepared to raise further if that—if we think that’s appropriate.
• “it is certainly possible that we would raise funds again at the September meeting if the data warranted. And I would also say it’s possible that we would choose to hold steady at that meeting.”
• The real federal-funds rate is now in meaningfully positive territory. If you take the nominal federal-funds rate, subtract a mainstream estimate of near-term inflation expectations, you get a real federal funds rate that is well above most estimates of the longer term neutral rate. So I would say monetary policy is restrictive, more so after today’s decision, meaning that it is putting downward pressure on economic activity and inflation. We’ll keep monetary policy restrictive until we think it’s not appropriate to do so. So that’s how I think about it.

Things are going the Fed’s way:

• We’ve seen softening through, you know, job openings coming down part of the way back to more normal levels; the quits rate, so people are not quitting as much. We’ve seen participation, people coming in. And so labor supply has improved, which has lowered the temperature in the labor market, which was quite overheated, you know, going back a year or so. So we’re seeing that kind of cooling and that’s very healthy and, you know, we hope it continues.
• As I mentioned, nominal wages have been coming down gradually, and that’s what we want to see, we expect to see more of that. That’s just more of what’s consistent over a longer period of time.

And here’s the recipe of this “data-dependent Fed” (my emphasis):

• But that’s the way I would think about it, is you’d start, you’d stop raising long before you got to 2 percent inflation, and you’d start cutting before you got to 2 percent inflation too, because we don’t see ourselves getting to 2 percent inflation until—you know, all the way back to 2, until 2025 or so.
• So the idea that we would keep hiking until inflation gets to 2 percent, it would be a prescription of going way past the target. That’s clearly not the appropriate way to think about it. So—and, in fact, if you look at our forecasts, we—the median participant—and again, these are forecasting out years, so taken with a grain of salt. But people are cutting rates next year because, you know, the Federal-Funds rate is at a restrictive level now. So if we see inflation coming down credibly, sustainably, then we don’t need to be at a restrictive level anymore, we can you know, we can move back to a neutral level and then below a neutral level at a certain.

BTW, NYT (Big Consumer Companies Keep Raising Prices, Complicating Fed’s Job)