Month: October 2023

Note: I am travelling this month. Posting will be sporadic and shorter due to limited time and equipment.

RENT RANT #4

Slicing & Dicing Inflation

I love Ed Yardeni, even when he has me rant on rent again…

Here he is discussing what many see as the most important data to watch these days:

Most economists, including Debbie and me, believe that if the data don’t support our forecasts, then there must be something wrong with the data and that they will be revised to show we were right after all. Most economists, including yours truly, also often dismiss components of headline indicators that don’t support our story and look to the remaining “core” indicators for conformity to our outlook and therefore confirmation of it. (…)

Another major economic indicator that is invariably sliced and diced by the brotherhood and sisterhood of economists is the CPI. September’s number was released along with all its components last week on Thursday. Some economists (such as us) claimed that it confirmed that inflation is still moderating and is turning out to be relatively transitory. Others looked at the report and concluded that inflation is stalling at a pace well above the Fed’s 2.0% inflation target. A few economists found evidence that inflation may be accelerating again, so it remains a persistent problem.

So who is right? We all are right all the time because there’s plenty of data to support all of our stories. Nonconforming data are dismissed as preliminary estimates that undoubtedly will be revised or simply are flawed. Future revisions no doubt will show that we are on the right track after all; if not, different data do so. We may not all be Keynesians or monetarists, but we are all prescient based on the data we choose to support our outlook!

Now let’s slice and dice the latest CPI and see what’s left: (…)

Before we go any further, here’s our punch line: The headline and core CPI inflation rates excluding shelter were both 2.0% y/y during September (Fig. 3 below). So to the question of when we’re going to get to the Fed’s inflation target, the answer is that we’re there now excluding shelter, at least based on the CPI measure!

Rent of shelter accounts for a whopping 34.7% and 43.6% of the headline and core CPI measures. Its inflation rate jumped from a low of 1.5% during February 2021 to a peak of 8.2% during March 2023 (Fig. 4). It was down in September but only to 7.2%.

In his speech, Powell observed: “Because leases turn over slowly, it takes time for a decline in market rent growth to work its way into the overall inflation measure. The market rent slowdown has only recently begun to show through to that measure. The slowing growth in rents for new leases over roughly the past year can be thought of as ‘in the pipeline’ and will affect measured housing services inflation over the coming year.”

Also, Powell acknowledged in his speech that “market rent” inflation (i.e., for new leases) has declined “steadily” this year. The Zillow rent index was down to 3.2% y/y during September. Using that reading rather than the CPI’s rent of shelter reading of 7.2%, Debbie found that the headline CPI is up just 2.3% versus 3.7% for the actual headline CPI!

Based on our analysis so far, the latest bout of inflation is turning out to be transitory rather than persistent after all, in our opinion. The Fed might achieve its 2.0% target for the core PCED inflation rate well ahead of schedule, i.e., in 2024 rather than 2025.

The chart below plots the Zillow Rent Index with CPI-Rent, both indexed at Jan. 2017=100 (Zillow data starts in 2015).

The series diverge starting in 2021 when Zillow rent (“market rent” per Powell and Yardeni) takes off reflecting the pandemic effect on new leases, while the BLS more gradual method takes time to reflect how all leases, including renewals which typically account for 90%+ of all leases, adjust to the “market”.

True, Zillow data show that new leases have flatlined since spring …

…but

• they are still rising MoM and are up 2.2% annualized this year (this is the seasonally adjusted data) and
• importantly, Zillow’s “market rent” remains 9.2% above CPI-Rent, suggesting that the BLS data needs to rise further, for a while, before it truly reflects the “reality”.

Ed is thus unknowingly right writing:

• “the data don’t support the forecasts”
• rentflation “remains a persistent problem”

BTW, in today’s WSJ: There’s Never Been a Worse Time to Buy Instead of Rent It is now 52% more expensive to buy a home than to rent one because of climbing mortgage rates.

And because of climbing house prices, all boosting rental demand:

Why would rents deflate in such an environment?

Then on to this other “problem”:

Supercore inflation is persistent.

In his speech, Powell said: To understand the factors that will likely drive further progress [on lowering inflation], it is useful to separately examine the three broad components of core PCE inflation—inflation for goods, for housing services, and for all other services, sometimes referred to as nonhousing services.” That last category has also come to be known as the “supercore” inflation rate. It has been sticky, having been stuck around 4.5%-5.0% since October 2021. However, the CPI services less housing inflation rate was down to 2.8% in September from last year’s peak of 8.2%.

You can slice and dice the CPI as much as you want but, in reality, Powell’s “supercore index” behaves almost exactly like the larger CPI-Services. There was a slight transitory delinking due to the housing crisis and the GFC but services prices are naturally highly sensitive to wage and energy costs.

This time, the pandemic helped boost wages which are now dragging services prices upward.

Hourly wages are still rising 4.3% YoY but slowed to a 2.4% annualized rate in the last 2 months. Hopefully, that will shortly influence services prices which shot up 5.8% a.r. in the same months. More wishful thinking?

But the economy remains strong (the Atlanta Fed GDP Now is at 5.3% for Q3) and so is the labor market:

• Job postings on Indeed are pretty steady through mid-October
• Unemployment claims dropped 14% in the 3 weeks to October 14. At 9-month low!

  US crude oil production has risen substantially in recent weeks.

Who saw that coming? That’s 1M additional bbl/d, just like that!

Source: The Daily Shot

Cracks Emerge in Manufacturing Spending Boom Factories may be built with stone but the commitments to build them tend to be written in pencil, with plenty of wiggle room for delays.

(…) There is indeed a spending surge: Since the beginning of 2021, companies have announced $650 billion worth of megaprojects — defined as an investment greater than $1 billion — according to tabulations by Melius Research. These were not just grand ideas and suggestions; factories, hospitals and airports are getting built. Melius calculates that more than 50% of the megaprojects it’s tracking have already broken ground. Construction spending on manufacturing has doubled to an annualized rate of nearly $200 billion as of August, up from about $82 billion in the same period in 2019, according to Census Bureau data.

The problem is that markets that were recently booming are now looking less robust. Rising interest rates, inflation and a shortage of skilled workers have also made many projects materially more expensive than even just a few months ago. Factories may be built with stone but the commitments to build them tend to be written in pencil, with plenty of wiggle room for delays or for companies to change their minds entirely. As I’ve written before, the reality of reshoring is much more nebulous and nuanced than the narrative, and the timeline is subject to a high degree of variability.

Just this week, Tesla Inc. Chief Executive Officer Elon Musk said the company isn’t ready to go “full tilt” on construction of a vehicle factory in Monterrey, Mexico, and needs to first get a better sense of where the economy is headed and the impact of higher interest rates on car purchases.

That the factory was announced only in March shows just how quickly the economic winds can change — even for products that are considered high-growth government priorities. (…)

A significant percentage of the prominent and high-dollar US factory announcements post-pandemic is tied to electric vehicles. The capital spending plans for this industry factor heavily into bullish investor sentiment on electrical infrastructure and automation equipment manufacturers. So it’s concerning to see even incremental signs of a pullback. The knock-on effects could be painful for industrial companies with rich valuations, such as Eaton Corp. and nVent Electric Plc.

In inflation-adjusted terms, overall investment in structures in the US is trending 20% below pre-pandemic levels and manufacturing is the only category seeing higher levels of spending, according to a June report from Deloitte citing data from the US Bureau of Economic Analysis. Real investment in power plants, mining exploration and commercial office buildings has yet to recover. Weaker structure spending elsewhere in the economy counteracts much of the manufacturing boom, as Bloomberg Opinion’s Karl W. Smith writes.

To that end, elevator and escalator maker Schindler Holding AG this week lowered its outlook for new installations in the Americas in 2023 to a decline of more than 10% amid a “recent softening across all major construction sector indicators.” Overall orders grew 3.8% on a local currency basis in the most recent quarter, roughly half the pace of the previous period. Shares of crane and aerial lift-maker Terex Corp. fell by the most since 2020 after the company’s updated earnings guidance fell short of analysts’ estimates, fueling fears of a peak in demand.

Meanwhile, ABB Ltd. said orders declined 27% in its robotics and discrete automation business in the third quarter amid weak demand in China and a pullback in bookings from machine builders as they work through inventory accumulated during the post-pandemic supply chain disruptions. Discrete manufacturing deals with distinct, countable items such appliances or cars on a factory assembly line. These pressures are expected to persist for “the next couple of quarters,” Chief Financial Officer Timo Ihamuotila said on the company’s earnings call this week.

It’s not that demand is falling off a cliff, but slumping orders and shrinking backlogs don’t fit with the super-cycle narrative, and companies grappling with such a dynamic don’t tend to command particularly rich valuations. “While there is undoubtedly some resilience from project related activity (as these tend to involve a backlog, rather than just ‘book and ship’ activity), we caution that this clearly does not guarantee a strong share price performance, particularly in the context of a high degree of ‘crowding’ of the investment community consensus,” Barclays Plc analyst Julian Mitchell wrote in a note this month.

Reshoring, nearshoring, friendshoring have become investment themes and there is no doubt that this cycle is different, although new orders have flatlined recently:

Interestingly, the surge in manufacturing construction spending did not boost productive capacity anywhere close to previous peaks, at least just yet:

And capacity utilization rates have not improved.

TECHNICALS WATCH

From Longview Economics

(…) a wide variety of equity indices are now sitting at/close to key levels: The S&P500 is at the lower end of its uptrend channel (which has been in place since October last year). It’s also sitting on its 200-day moving average (4,255 – see chart); the NDX100 is below its 50-day moving average, and on multi month technical support; a broad European index is on its lows from earlier this month (and those from the March banking crisis).

Added to which, from a technical perspective, it looks like it’s entered into a downtrend (as does the DAX). Elsewhere in the US, the small and mid-cap indices (Russell 2000 and S&P600) are similarly sitting on major technical lows; while the Philly SOX is on its 200-day moving average.

Geopolitics are complicating an already complicated environment. Danger zone ahead! The S&P 500 equal weight index flashed negative on Oct. 2.

Note: I am travelling this month. Posting will be sporadic and shorter due to limited time and equipment.

HEARSAY!

Same meeting, same words, … but different accounts…

From the WSJ’s Nick Timiraos:

• Fed’s Jerome Powell Signals Extended Pause in Rate Rises Recent economic figures show “ongoing progress” toward the goals of lowering inflation while sustaining strong employment, the Federal Reserve chair said.

Federal Reserve Chair Jerome Powell suggested that he is pleased with inflation’s decline this summer and that the central bank is unlikely to raise interest rates again unless it sees clear evidence that stronger economic activity jeopardizes such progress.

“Given the uncertainties and risks, and how far we have come, the committee is proceeding carefully,” Powell said in prepared remarks for a Thursday lunchtime address in New York. “Incoming data over recent months show ongoing progress toward both” of the Fed’s goals to maintain stable inflation and strong employment.

Powell’s remarks closely tracked those of his colleagues in recent days who have suggested they are prepared to hold short-term interest rates steady at their next meeting on Oct. 31-Nov. 1. That is in part because a run-up in long-term interest rates over the past month could slow the economy, effectively substituting for rate rises if higher borrowing costs are sustained.

“We remain attentive to these developments because persistent changes in financial conditions can have implications for the path of monetary policy,” Powell said.

Coming decisions over whether to raise rates again and how long to hold them near current levels would depend “on the totality of the incoming data, the evolving outlook, and the balance of risks,” he said.

Firmer-than-expected economic activity has made it difficult for the Fed to declare an end to rate rises, and Powell stopped short of doing so Thursday.

A blowout September employment report from the Labor Department earlier this month and a strong retail-sales report from the Commerce Department on Tuesday have extended a run of surprisingly brisk data releases. (…)

Still, Powell didn’t suggest that such economic strength was yet generating the heat—in the form of higher inflation—that would justify raising rates further.

As he did in a speech this August, Powell twice used the word “could” instead of the more muscular “would” to describe whether the Fed would tighten again. Evidence of stronger growth “could put further progress at risk and could warrant further tightening of monetary policy,” he said. (…)

The Fed estimates that overall prices in September rose 3.5% from a year earlier—unchanged from August and down from a peak of 7.1% in June 2022—using its preferred inflation gauge, Powell said. Core prices, which exclude volatile food and energy items, likely rose 3.7% in September, down from 3.9% in August and a peak of 5.6% in February 2022, he added. (…)

Powell described the slowdown in inflation since June as a “very favorable development” while acknowledging that data for September were “somewhat less encouraging.”

The question going forward is whether strong consumer spending will continue to buoy hiring, boosting demand and stalling progress bringing down price growth. (…)

Notably, Powell suggested that wage growth, which had been a top concern of his and other officials over the past year, now appeared to be slowing toward levels that would be consistent with the Fed’s 2% target. Earlier this year, Powell described the labor market as overheated, risking a dangerous dynamic in which paychecks and prices rise in lockstep, fueling inflation. (…)

From Axios’ Neil Irwin:

• Fed’s Powell: Hot growth “could warrant further tightening” The Fed Chair said Thursday that robust economic growth could undermine the Fed’s fight against inflation and warrant more interest rate increases.

“We are attentive to recent data showing the resilience of economic growth and demand for labor,” Powell said at the Economic Club of New York.

“Additional evidence of persistently above-trend growth, or that tightness in the labor market is no longer easing, could put further progress on inflation at risk and could warrant further tightening of monetary policy.”

Powell also acknowledged that the runup in long-term interest rates in recent weeks — the 10 year Treasury as of late morning was inching close to 5%, a 16-year high — adds risk in the other direction.

“Financial conditions have tightened significantly in recent months, and longer-term bond yields have been an important driving factor in this tightening,” Powell said, adding that the Fed will “remain attentive to these developments.”

Powell repeats language that the Fed is “proceeding carefully” in its policy moves, which is a signal that there will be no additional rate hike in a meeting two weeks from now.

However, another interest rate increase in December looks to be very much in play in light of Powell’s comments about the risks turbo-charged growth will undermine the Fed’s inflation fight.

Goldman Sachs:

• Powell Stresses Progress on Inflation and Labor Market, Notes FOMC Is “Proceeding Carefully” in Light of Two-Sided Risks

In prepared remarks at an event at the Economic Club of New York today, Chair Powell emphasized that recent data “show ongoing progress” toward the Fed’s dual mandate goals of maximum employment and price stability and stressed that the FOMC “is proceeding carefully” in light of “uncertainties and risks, and how far we have come” in the tightening cycle.

Chair Powell highlighted that “declining inflation has not come at the cost of meaningfully higher unemployment,” a development he characterized as “welcome … but historically unusual.”

Chair Powell also noted that “a period of below-trend growth and some further softening in labor market conditions” would likely be required to return inflation to the FOMC’s 2% target.

As a result, Chair Powell stressed that “additional evidence of persistently above-trend growth, or that tightness in the labor market is no longer easing, could … warrant further tightening of monetary policy.”

In the Q&A session following the speech, Chair Powell noted that higher long-term bond yields could reduce the need for further tightening “at the margin,” though he emphasized that it “remains to be seen” whether higher yields would actually substitute for additional hikes.

I emphasized “at the margin” because only GS quoted these rather important words from Mr. Powell when characterizing the potential effect LT yields might have on the economy and monetary policy.

Bloomberg’s John Authers also has his own account of the event:

He’s leaving the possibility of another hike open in case of further signs of resilient economic growth, but as it stands it looks very likely that Powell and his colleagues will skip hiking rates for two consecutive meetings, for the first time in their 19-month tightening campaign. (…)

But he did very directly admit that the Fed and the bond markets are now in a state of interdependence, and put a perhaps dangerous amount of faith in bond traders to do the Fed’s work.

The key words to latch on to were that “persistent changes in financial conditions” — as has just been witnessed by the surge in longer bond yields — “can have implications for the path of monetary policy.” In other words, higher yields make it easier for the Fed to avoid making further hikes in overnight rates. (…)

All of this was taken as a broad hint that the Fed wouldn’t need to hike rates again, because the bond market was doing the work. (…)

Authers then discussed how readings of apparently tightening financial conditions can also differ considerably.

This is the Bloomberg FC index, very tight:

But…

Stephen Stanley of Santander described the Fed as “being willfully dovish at the moment,” and predicted that another hike would be needed by the end of the year. He added, in a note:

I’m puzzled by the sudden FOMC fascination with 10-year Treasury yields as the be-all, end-all indication of the economic outlook. For years, Chairman Powell has insisted that the Fed looks at financial conditions broadly rather than at a particular single measure.

Well, I am sure that it will snug in the coming weeks, but the Chicago Fed Financial Conditions Index, which is just what the Fed says that it likes (a broad index that includes both market measures and other indicators, such as from the Fed’s Senior Loan Officer survey) was, as of the end of last week, at its easiest reading since the FOMC began to raise rates. Yes, you read that right.

Powell, during the question-and-answer session with Westin, added: “I think the evidence is not that policy is too tight right now.”

(…) he said that policymakers would let the rise in yields “play out” and watch what happened.

Some evidence:

The U.S. Services PMI declined to the 50 no growth range.

September data indicated a continued decline in new business at service sector firms. The rate of contraction quickened to the sharpest since December 2022, albeit still modest overall. Lower new orders were reportedly linked to weak domestic and foreign client demand, with new export orders falling for the first time in five months. The decrease in new export sales was the steepest since February and was in stark contrast to the solid expansion seen in July.

Although slower than the series average, service providers saw a further rise in employment during September. Staffing numbers have risen in each month since July 2020, with the latest uptick the fastest for three months. Alongside efforts to clear backlogs, firms noted that greater workforce numbers on the month were often due to the replacement of previous voluntary leavers.

On the prices front, input costs rose at a further marked pace, with the rate of inflation similar to that seen in August. Panellists stated that higher energy, fuel, wage and food costs drove the latest increase in business expenses. The pace of cost inflation remained above the long-run series average.

In line with another substantial uptick in cost burdens, service providers hiked their selling prices in September. The pace of charge inflation accelerated to the fastest since July as firms sought to pass through greater costs to customers.

Among the G4, services inflation remains a problem but gradually less so:

“…by far the greatest upward pressure on selling prices for both goods and services continued to be coming from wages in August…”

In the USA, price pressures picked up as a result of growth in wages and higher costs for fuel and raw materials. That said, output charge inflation slowed amid efforts to boost sales.

The number of companies raising their selling prices due to stronger demand was the lowest since November 2020, signalling that a sales slowdown is helping to ease global inflationary pressures.

In the last 2 months U.S. wage growth came in at 0.2% MoM, 2.5% a.r., across the board, including services, bringing the YoY changes to the 4% range.

But the composition-adjusted Atlanta Fed wage tracker is still above 5%.

Housing is where conditions are the tightest:

Home Sales Fall to Lowest Rate in 13 Years Home sales fell 2% in September to the lowest rate since October 2010, the National Association of Realtors said, as high mortgage rates squeeze the market.

Existing home sales, which make up most of the housing market, decreased 2% in September from the prior month to a seasonally adjusted annual rate of 3.96 million, the lowest rate since October 2010, the National Association of Realtors said Thursday. September sales fell 15.4% from a year earlier.

The national median existing-home price rose 2.8% in September from a year earlier to $394,300, NAR said. That was the highest price for any September in data going back to 1999, said Lawrence Yun, NAR’s chief economist. (…)

Nationally, there were 1.13 million homes for sale or under contract at the end of September, up 2.7% from August and down 8.1% from September 2022, NAR said. That was the lowest inventory level for any September in data going back to 1999, Yun said. At the current sales pace, there was a 3.4-month supply of homes on the market at the end of September. (…)

The share of first-time buyers in the market was 27% in September, down from 29% a year earlier. About 29% of September existing-home sales were purchased in cash, up from 22% in the same month a year ago, NAR said.

A measure of U.S. home-builder confidence fell in October for the third straight month, the National Association of Home Builders said this week. (…)

But overall demand remains strong:

US Sales Managers Growth Indexes Rise to New Highs in October

The US Sales Managers Market Growth Index accelerated to a 54.9 reading in October, a 27 month high. The month-on-month Sales Growth Index also rose sharply to a similarly elevated level, and 8 month high. These indexes are currently reflecting buoyant growth over a wide spectrum of economic activity.