Month: October 2023

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

A band-aid is sticky. A tune can be sticky. Habits can be sticky.

But England’s Sticky Pudding is unexpectedly shurely shticky. The very first bite shticks in your mouth, you think forever.

Delichious but shticky!

Sho with shervices inflashion in the UShA.

And this rentflashion that refushes to do what it’sh shupposed to do. Bloody lagsh.

Gimme Less Shelter, or Inflation Won’t Fade Away The lag in bringing down housing costs may be more stubborn than thought, and could have unpleasant knock-on effects. (John Authers)

(…) Shelter inflation, on a year-on-year basis, is still above 7%. All of the other components of the CPI, aggregated together as an index, come to exactly 2%. That’s the Fed target. It’s also widely known that shelter inflation tends to be lagged, as it includes all leases currently in force, rather than only those that were signed in September. So the picture of a problem that was now essentially dominated by a lagging measure of the housing market appeared to be confirmed:

Exclude shelter costs and annual inflation is at the Fed’s 2% target.

For those who want to explore further, this is the breakdown of inflation into four components that will greet you on the Bloomberg terminal. Once dominated by food (in blue) and energy (red), it is now almost all driven by services (in yellow), which includes housing:

The more sophisticated statistical measures operated by different research groups within the Fed showed clear improvement. The “trimmed mean” compiled by the Cleveland Fed, which excludes the biggest outliers and takes the average of the rest, has dropped to 4.29% — still too high for the Fed to consider its job done, but emphatic progress after this number had peaked above 7%.

The Atlanta Fed’s “sticky price” CPI, which measures inflation for products whose price takes a long time to change and cannot easily be reduced, also improved to a level that is at least approaching something comfortable for the Fed, at 5.07%.

Once shelter is excluded, core sticky price inflation even dipped just below 3%, the upper end of the Fed’s target range. It’s hard to say that any of the numbers “under the hood” were bad enough to spark a selloff:

(…) So what was the problem? The clearest reason for disquiet, I think, comes from the “supercore” measure that Fed Chair Jerome Powell has emphasized in recent months — services excluding shelter. This category is heavily led by wage inflation, as labor is a large share of costs for such businesses.

If the tight labor market was causing price pressure, this is where it would be. In this context, the fact that September saw the highest month-on-month increase in the supercore since September of last year is distinctly disappointing:

(…) Digging into the property data can also be disconcerting. As is now widely understood, the official data don’t catch up with the latest trends because they look at all leases in effect, rather than only the most recent — a methodology that makes sense for setting cost of living adjustments for benefit payments, but doesn’t give an up-to-date take on price pressures.

Privately maintained rental indexes signaled that shelter inflation was going to rise well in advance, and they’ve now been signaling a coming fall for a while. (…)

Now comes the problem. The Zillow numbers are beginning to tick up a little. Despite everything that has been thrown at it in higher mortgage rates, there is still some life in the property market. As Gerard MacDonell of 22V Research put it, “The gap between these lagging government measures of average rent and the private measures of marginal rent has narrowed quite a bit over the past several months, both in level and rate of change terms.”

That makes the government data “less irrelevant,” in his words. He adds: “It makes sense to discount them as lagging and virtually fated to slow, but our confidence in that dismissal is somewhat less than it was.” (…)

For a few months now, the feeling has been: “Don’t worry about the inflation numbers, we know that rents are coming down, so we know inflation is coming down too.” In broad outline that is still plainly true. But anything that chips away at the weight we can put on those private rental indexes is going to chip away at confidence in other asset classes. And so it has proved…

Those private measures of rents only measure new leases. The Census Bureau estimates that only 8.4% of Americans move in a given year (last data point in 2021). The proportion of “new leases” is thus very small against “renewals” which represent 90%+ of the market.

Actually, new leases per Apartment List have really only levelled off in the past year:

After Q2, public rental companies told us that their renewals were at +6.5% (Tricon Residential), +9.1% (Invitation Homes) and +7.5% (American Homes), the latter in spite of a 28.5% turnover rate.

All 3 companies operate in the Sun Belt where the bulk of new apartments are being built owing to strong population and job growth and above average income levels.

Maybe, just maybe, economists, analysts and strategists, including FOMC voters, all unlikely renters, are too distanced from this reality: the median American household would need to spend 46.4% of their income to afford payments on a median-priced home in the US, the highest % on record with data going back to 2006. So they have to rent.

It could be useful if some of the numerous monthly surveys out there would query Americans about their rental costs.

But wait, that’s what the BLS does, doesn’t it?

Here’s the monthly trend:

Yes, the BLS method is not perfect and includes some lags. But these lags should by now be taking effect.

What is really lagging now is the recognition that rents may not be behaving like most pundits expected, and are still expecting.

• Services inflation, on the other hand, has been slower to improve. Core services prices rose 0.6% in September. Notably, owners’ equivalent rent—the largest single component in the CPI—rebounded to 0.6% from 0.4% the prior month. This is at odds with private sector measures of housing inflation that lead the CPI, so we expect the jump to reverse over the next couple of months. (Wells Fargo)
• We expect continued moderation in shelter inflation. (Goldman Sachs)
• The report also showed a 0.6% rise in rents, which appears on track to fall in coming months based on real-time private sector measures of the rental markets. (Axios)
• Still well off the 2.0% mark is the CPI shelter inflation rate, which was 7.2% in September. However, we know that the rent inflation rate on new leases was down to 3.2% in September according to Zillow and -1.2% in August according to ApartmentList. So shelter inflation should continue to fall in coming months. (Ed Yardeni)
• Housing is still running hot, rising 0.6% MoM, but we know that the relationship with housing rents data means this will slow meaningfully in coming months. (ING)

In reality,

• since WWII, CPI-Rent has never been negative on a YoY basis except for 2 months after the GFC (and only barely).
• people need living spaces and generally buy or lease what they can reasonably afford. CPI-Rent is 99.8% correlated with wages since 1985.

• Since February 2020, wages are up 19.5% while CPI-Rent is up 18.7% even with all the lags.
• The Atlanta Fed wage growth tracker adjusts for compositional biases. Its 3-month moving average ticked up to 5.2% in September.

BTW, we can look at rent from the receiving side of the ledger. The BEA publishes Rental Income of Persons which I matched with CPI-Rent below.

Here’s the YoY trend to be compared with the CPI-Rent chart 3 charts above.

The other bummer in this CPI report is that, even if rent price growth recedes as anticipated, prices for services excluding rent have accelerated over the last three months, +0.2% in July, +0.5% in August and +0.6% in September.

From Wells Fargo:

Energy played a smaller role in September’s gain compared to August, advancing 1.5%. However, prices over the past three months are still up at an annualized rate of 33%, as this category has swung from a significant source of help in reducing inflation since last summer to more recently a hindrance.

The sharp retreat in retail gasoline prices since the end of September should offer some relief to consumers in the near term, but the drag on annual inflation from energy has nonetheless eased considerably. Meanwhile, the disinflationary force from food has also steadied, with food prices up 0.2% for a third consecutive month. Over the past year, food costs have increased 3.7%, a marked improvement from 11.2% last September, but still more than double the pace of the 2010s as consumers continue to contend with elevated inflation for everyday necessities.

My measure of CPI-Essentials is at +5.4% YoY from 4.1% in June:

Wells Fargo hopefully continues:

September’s CPI demonstrates that, while the trend in inflation has downshifted since the spring, driving all the way back to the Fed’s target in a timely manner remains challenging. Improvement over the coming months is likely to be slower than over the past few months.

In the goods space, the recent rate of decline in vehicle prices is unlikely to be sustained, with the UAW strike impeding production and used vehicle auction prices rising since July.

Among services, the summer’s declines in travel prices will be hard to match, while medical services inflation looks set to rebound next month with the incorporation of the most recent health insurance source data.

Nevertheless, the downward trend in inflation remains in place, in our view. In addition to shelter disinflation likely to resume, easing supply chain pressures, slower wage growth and more price-sensitive consumers should help inflation continue to settle down.

Between the September PPI and CPI data, core PCE looks set for a 0.3% monthly gain in September. If realized, that would leave the Fed’s preferred measure of inflation rising at a 2.8% annualized rate over the past three months—still above target but much better than the 5.0% pace from the same period last year. While there remains further ground to cover in returning inflation to 2% on a sustained base, we believe recent realized progress will be enough to keep the FOMC on hold in November, and as the Committee awaits further data, to determine if policy is sufficiently restrictive to reduce inflation in a timely manner.

Funnily, there is no sticky pudding in Portugal, but Portuguese pronounce vowels followed by a “s” like “sh”. So Denis is Denish. Very shticky!

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

NFIB Small Business Optimism Index Declines Again in September

The NFIB Small Business Optimism Index fell to 90.8 in September from 91.3 in August. Optimism is up a bit from the low of 89 hit in April 2023, however over the past few months, the index has been hovering around levels not experienced since 2012 in the aftermath of the Great Recession.

Ongoing pessimism on the part of small firms reflects a long list of challenges which include inflation, labor shortages, higher financing costs and reduced credit access. Although some of these macroeconomic factors have improved this year, small firms do not appear to be convinced that the road ahead is clear of obstacles.

The share of firms expecting the economy to improve over the next six months, which is still near a record low even after turning up in the summer, deteriorated for the second consecutive month in September. (…)

• The business outlook deteriorated for the second straight month in September. The net percent of respondents expecting the economy to improve over the next six months fell to -43% from -37%. This is the lowest share since May and is an about-face from the more optimistic survey results seen in June and July.
• Deteriorating credit conditions weighed on sentiment in September. A net 8% of owners reported it was harder to get a loan compared to three months ago—the highest reading since the March survey conducted in the wake of multiple bank failures. The outlook was equally pessimistic as a net 10% of owners expect credit conditions to worsen in the next three months, the highest reading since December 2012.
• (…) Small businesses are clearly feeling the effects of higher interest rates, however. A net 26% reported paying a higher interest rate compared to three months ago, the highest since 2006. The average rate paid on these loans was 9.8%, up from 9.0% in July.
• Hiring plans ticked up slightly in September. The slight upturn coincides with September’s surprisingly robust nonfarm payrolls report and August’s increase in job openings. Small business continue to have difficulty filling positions, however, with 43% of owners reporting they were unable to fill a job opening in September, up from 40% in August.
• Wage pressures continue to ease. The net share of owners raising compensation held steady at 36% during September, while the share planning to raise compensation dipped to 23% in September from 26% in August.
• Although wage pressures appear to be abating, a higher share of small firms reported raising selling prices during the month. The net share of owners raising prices increased two percentage points to 29%, the highest since June 2023.
• Inflation and labor quality remained the chief concerns of business owners in September. Although inflation concerns are down on an annual basis, the measure is still above its pre-pandemic trend.

Bloomberg’s Joe Weisenthal (@TheStalwart) tweeted (Xed?) “Such a striking chart from the NFIB Small Business Optimism survey. Huge gap between the hard and the soft data.”

Wage Growth Tracker Was 5.2 Percent in September

The Atlanta Fed’s Wage Growth Tracker was 5.2 percent in September, down slightly from the 5.3 percent reading for August. For people who changed jobs, the Tracker in September was 5.6 percent, the same as in August. For those not changing jobs, the Tracker was 5.0 percent, down from 5.2 percent in August.

Composition-adjusted wage growth rates are all converging around the 5.0% range.

• 420,000 workers are now on strike in the United States, according to Bank of America. Estimates show that up to 545,000 workers are likely to be on strike by the end of 2023. This would be the most workers on strike since 1983, which also happens to be the last time inflation was an issue. Meanwhile, a record 447,000 people now hold 2 full-time jobs in the US. Consumers are feeling the pain of inflation. (@KobeissiLetter)

China’s Country Garden Wilts The troubles of China’s largest private property developer still standing won’t be enough to spark a broader Chinese debt crisis but it could undermine Beijing’s attempts to put a floor under the housing market.

Mounting damage to banks’ balance sheets from the property meltdown could also make stabilizing other parts of the economy more difficult.

Country Garden, the largest Chinese developer by contracted sales last year, warned Tuesday that it doesn’t expect to be able to repay all its U.S. dollar bonds and other offshore debts—after missing a 470 million Hong Kong dollar loan repayment, equivalent to around $60 million. The company has flagged liquidity issues for months but managed to make payments on past-due dollar debts last month within its 30-day grace period. (…)

And, as was the case at Evergrande before it, the firm’s financial troubles have plunged it into a vicious cycle as home buyers stay away, further draining it of cash needed to repay debts. Country Garden’s contracted sales were down a shocking 81% year on year in September.

Country Garden’s downfall is significant as it was considered one of the financially healthier developers not too long ago. While it had similar revenue to Evergrande in 2019, it has much less debt. As of June, it had a net debt, including bonds and bank loans, of 146 billion yuan, the equivalent to $20 billion, compared with Evergrande’s 618 billion yuan, according to S&P Global Market Intelligence.

That could cause jitters in debt markets, especially since Evergrande scrapped its own plan to restructure its offshore debt just last month. But more important, the apparent implosion of a seemingly solid big developer deals another blow to already fragile sentiment in the housing market and makes other private developers’ debt woes harder to solve.

Property sales have remained sluggish despite easing policies rolled out by many Chinese cities since late August. Country Garden also has around 603 billion yuan of contract liabilities, which are mostly apartments that have already been sold but not yet delivered to buyers. (…)

Chinese property developers had 5.3 trillion yuan, equivalent to $726 billion, of domestic bank loans as of June—about 6% of Chinese banks’ books. Country Garden’s darkening outlook, on top of Evergrande’s failure, substantially raises the probability that a big chunk of that debt will eventually need to be written off. And it comes as commercial banks’ net interest margin is near an all-time low.

Another potential ripple effect is on suppliers. As sales dry up, developers are finding it harder to pay construction and material companies. Country Garden had around 202 billion yuan of trade payable as of June and China’s listed developers together owed 3.4 trillion yuan in trade payables to their suppliers, according to research firm Gavekal.

That has already caused delays in payments to sectors such as steel and cement and tied up around 1 trillion yuan in working capital for those sectors, says Gavekal. For now, Chinese heavy industry still seems to be getting by: Profits at key property-related heavy industrial sectors were about six times interest payments in mid-2023. But deepening financial troubles at another big developer such as Country Garden could chip away at that too.

The Country Garden mess is another reminder that China’s housing meltdown is a long way from over. Banks, households and the economy writ large will be footing the bill for years.

US PPI

The producer price index (PPI) increased by 0.5% in September, above expectations for a smaller increase. This reflected an increase in energy prices (+3.3%), an increase in food prices (+0.9%), and an increase in core producer prices (+0.3%). The PPI excluding food, energy, and trade services increased by 0.2%. Retail margins increased 0.5%. The “old methodology” core PPI—finished goods excluding food and energy—increased by 0.2%. Core intermediate producer prices were unchanged, and the prices of crude materials less food and energy decreased by 0.8%. (Goldman Sachs)