Note: I am travelling this month. Posting will be sporadic and shorter due to limited time and equipment.
The U.S. and European Economies Are Diverging With eurozone economic activity weakening and inflation tumbling, rate rises appear to be having greater traction
The European Union’s statistics agency Tuesday said the combined gross domestic product of the eurozone’s 20 members fell by an annualized 0.4% in the three months through September, having increased by 0.6% in the previous quarter.
This is a stark contrast with the 4.9% rate of annualized growth recorded by the U.S. during the same period, more than double the pace of growth in the previous quarter.
Added to this are signs that consumer-price inflation is easing in Europe’s single currency area while it has increased recently in the U.S. Figures also released by Eurostat showed prices were 2.9% higher in October than a year earlier, the lowest rate of inflation since July 2021. The core rate of inflation, which excludes energy and food prices, fell to 4.2% from 4.5% in September. (…)
The widening growth gap and the narrowing inflation gap between the eurozone and the U.S. suggest that the European Central Bank’s rate rises are having a greater impact on an economy that already faced stronger headwinds.
“Our past interest rate increases continue to be transmitted forcefully into financing conditions,” said ECB President Christine Lagarde in a news conference last week. “This is increasingly dampening demand.”
Some critics of the ECB argue that by almost matching the Federal Reserve’s rate rises while confronting stronger headwinds to growth from other sources, eurozone policy makers will make the growth gap even wider. (…)
Meanwhile, the eurozone’s weakness is holding back other parts of the world economy. The EU’s imports from China in the first eight months of this year were down 15.4% on the same period of 2022, while imports from the U.K. were down 13.7%. Imports from the U.S. were little changed as Europe looked to the world’s largest economy to replace natural gas that it no longer buys from Russia.
In the wake of the invasion, energy and food prices have risen more sharply in Europe than in the U.S. since the invasion, reducing the ability of households to spend on other goods and services.
Households around the world have cut back on their spending on goods after splurging during the Covid-19 pandemic and instead have focused on the services they were denied during lockdowns. But that swing has been particularly pronounced in Europe: By August, retail sales in the eurozone were 7.5% lower than in January 2022, compared with a 1.8% drop in the U.S.
Total consumer spending in Germany was 0.5% lower than a year earlier in the three months through June, while in the U.S. it was 1.8% higher. In the third quarter, U.S. consumer spending surged again, while consumer spending fell in Germany.
The second blow for Germany and the rest of Europe has come through higher costs for energy-intensive factories. Output cuts in Germany’s large chemicals industry, among other sectors, meant industrial production in August was 2.2% lower than the month before Russia’s invasion of its neighbor, while in the U.S. production was up 2.3%.
There are few signs that economic growth in the eurozone is set to pick up over the coming months. October surveys of eurozone businesses released by S&P Global last week pointed to the largest decline in activity since November 2020, with new orders falling sharply and purchasing managers reporting the first reduction in employment since January 2021. By contrast, a similar survey of U.S. businesses pointed to a pickup in activity during October. (…)
On top of those headwinds, the ECB has raised its key interest rate to a record high, and to a level that policy makers believe is cooling demand. The central bank Thursday ended a historic run of 10 consecutive rate increases, but said they would continue to weigh on the economy through the first quarter of next year, if not for longer.
The consumer price index, which measures how fast prices are rising in the 20-member euro area, stood at 2.9% in October, dropping sharply from 4.3% the month before and below economists’ expectations for a reading of 3.3%, according to a poll compiled by The Wall Street Journal.
Inflation was brought lower notably by energy prices, which were some 11% lower in October compared with last year, when price spikes from the Russia-Ukraine crisis resulted in natural-gas supply shortages. In September, energy prices were 4.6% lower on year.
Food inflation also continued to ease, reaching 7.5% in October from 8.8% the month before.
Core inflation, a measure stripping out volatile food and energy prices, meanwhile eased to 4.2% from 4.5%, in line with economists’ expectations. (…)
Inflation cooled across most of the zone’s major economies in October. In Germany, the eurozone’s powerhouse, harmonized price rises eased to 3.0%, while in France they cooled to 4.5% and in Italy to 1.8%, bringing the latter country in line with European Central Bank targets. In Spain, where inflation had cooled more quickly, prices rises ticked up again in October, reaching 3.5%.
Canadian economy stalls as higher interest rates weigh on growth GDP on track to fall by 0.1% annualized in the third quarter, following a 0.2% drop in the second quarter, according to preliminary Statscan data
Real gross domestic product was essentially unchanged in September, according to a preliminary estimate that Statistics Canada published Tuesday. While the numbers will be revised on Nov. 30, GDP is on track to fall by 0.1 per cent annualized in the third quarter, after a 0.2-per-cent drop in the second quarter.
If those figures hold, Canada would post two consecutive quarters of declining GDP – what some economists refer to as a “technical recession.” Output would also be considerably weaker than the Bank of Canada’s most recent projection, published last week, which expected 0.8-per-cent growth in the third quarter. (…)
“We’re expecting growth below 1 per cent for the next three, four quarters,” Bank of Canada Governor Tiff Macklem explained at a press conference last week. “Is that a recession? No, it’s not a recession. It’s low positive growth.”
Mr. Macklem said “some small negative numbers” couldn’t be ruled out in the near future – although this wouldn’t necessarily qualify as a recession.
“When people say the word ‘recession,’ I think what they have in mind is a steep contraction in output and a large rise in unemployment. That’s not what we’re forecasting.” (…)
MANUFACTURING PMIs
China: Manufacturing production falls slightly in October
At 49.5 in October, the headline seasonally adjusted Purchasing Managers’ Index™ (PMI®) fell from 50.6 in September and below the neutral 50.0 threshold to signal a fresh deterioration in manufacturing conditions. Though only marginal, it was the first time that a deterioration has been recorded since July.
Weighing on the headline index was a renewed fall in manufacturing production during October. Though only slight, the decline contrasted with modest expansions in the prior two months. Companies that cut output levels often linked this to relatively muted sales, particularly from abroad.
Overall new business expanded for the third straight month, but the rate of growth eased to one that was only marginal. Panel members often noted that sluggish global economic conditions and high prices had dampened sales. Notably, new export business declined for the fourth straight month in October, albeit slightly.
Lower production and relatively muted client demand weighed on purchasing activity, which fell for the first time since July. Firms also made greater usage of current stocks, partly to help control costs, which led to a moderate decline in inventories of inputs. On the other hand, weaker-than-expected sales and the delayed shipment of goods led to the strongest rise in inventories of postproduction items since September 2015.
Turning to supply chains, average delivery times for purchased inputs improved slightly in October. There were some reports that requests for expedited shipments had supported the slight shortening of lead times.
Manufacturers trimmed their staffing levels for the second straight month in October, with the rate of job shedding the quickest seen since May. There was evidence that softer customer demand and efforts to cut costs had led firms to readjust their workforce numbers. At the same time, backlogs of work continued to expand slightly, with some firms linking this to recent increases in new work and pressure on capacity.
Average input prices faced by Chinese manufacturers increased further in October. Though modest, the rate of inflation was the quickest recorded since January, with firms often citing higher prices for raw materials and oil. Greater operating expenses were partly passed on to clients in the form of higher selling prices, which likewise rose at a modest rate.
Business confidence regarding the 12-month outlook for production softened again in October, reaching its lowest since September 2022. While some companies were hopeful that new product launches and improved client demand both at home and overseas would support growth, others expressed concerns over the sluggish global economic climate.
Japan: Manufacturing conditions continue to deteriorate inOctober
The headline au Jibun Bank Japan Manufacturing Purchasing Managers’ Index™ (PMI®) was little-changed in October but remained marooned below the crucial 50.0 no-change mark for a fifth successive month. After accounting for seasonal factors, the index recorded 48.7, up from 48.5 and a reading indicative of a modest deterioration in operating conditions.
Output and new orders remained on downward trajectories during October. Both have now fallen for five months in a row since some marginal growth was registered in May.
Panellists commented that sales demand was weak regardless of whether it emanated from domestic or international markets. Indeed, new export orders declined for a fifth successive month in October, and at a solid rate that was the steepest since June.
High prices were in some cases reported to have weighed on sales.
China was notably reported to be a key source of reduced international sales, although Europe and the US were also mentioned. (…)
Meanwhile, firms continue to report some modest delays in the delivery of inputs to their plants, and this helped to explain in part why input price inflation remained elevated during October. According to the latest anecdotal evidence, a wide plethora of inputs increased in cost, including steel, energy, wood, food and semiconductors. Firms sought to pass on higher costs again to their clients, and subsequently increased their own charges in October. (…)
S&P 500 Companies With More International Exposure Reporting An Earnings Decline of -5%
(…) For this analysis, the index was divided into two groups: companies that generate more than 50% of sales inside the U.S. (more domestic exposure) and companies that generate more than 50% of sales outside the U.S. (more international exposure [41% of S%P 500 companies]). Aggregate earnings and revenue growth rates were then calculated based on these two groups.
The blended (combines actual results for companies that have reported and estimated results for companies that have yet to report) earnings growth rate for the S&P 500 for Q3 2023 is 2.7%. For companies that generate more than 50% of sales inside the U.S., the blended earnings growth rate is 6.8%. For companies that generate more than 50% of sales outside the U.S., the blended earnings decline is -4.7%.
The blended revenue growth rate for the S&P 500 for Q3 2023 is 2.1%. For companies that generate more than 50% of sales inside the U.S., the blended revenue growth rate is 3.6%. For companies that generate more than 50% of sales outside the U.S., the blended revenue decline is -2.0%.
Q3 ECI: Labor Cost Growth Slowing Gradually
The slowly improving balance between supply and demand for labor is helping to gradually reduce cost pressures stemming from the labor market. The Employment Cost Index rose 1.1% in the third quarter, a touch higher than the consensus and our own expectation for a 1.0% gain. Yet the “low” 1.1% reading (1.07% before rounding) was enough to nudge down the year-over-year rate to nearly a two-year low of 4.3% (not seasonally adjusted).
The ECI is the preferred gauge of labor costs among the FOMC and most economists as it provides a more comprehensive look at compensation growth. Compared to the more timely average hourly earnings data from the monthly jobs report, the ECI includes public sector workers and benefit costs, in addition to controlling for compositional shifts in jobs that can at times muddy the trend in pay pressures.
Helping to drive the stronger-than-expected ECI print in Q3 was a 1.5% increase for government workers, whose pay growth typically lags the private sector. Private sector compensation rose 1.0% over the quarter, consistent with an annualized rate of 4.1% and on par with the 4.2% annualized increase in average hourly earnings growth for the private sector in Q3. Total benefit costs growth was unchanged in Q3 at 0.9%, which slowed the one-year change to 4.1%. (…)
Source: U.S. Department of Labor and Wells Fargo Economics
Since the onset of the pandemic, employment cost growth for unionized workers has trailed behind that of non-unionized workers by a total of 3.8 percentage points, suggesting that at least some of the recent push by unions is to catch up to the lofty rates of compensation growth for non-unionized workers amid the exceptionally tight labor market of the past few years.
We doubt the significant extractions of recent union deals will be enough to reverse the downward trend in labor cost growth over the coming year, although they may slow its progress.
First, only a small fraction of the private sector workforce is represented by a union (6.8% in 2022). Second, compensation pressures are broadly receding as demand for workers cools and more workers join the labor force. The quits rate has returned to 2019 levels, signaling less pressure for companies to raise pay in order to retain workers. Meantime, the share of small businesses raising pay has fallen alongside hiring plans.
Factoring in the recent trend in productivity, labor cost growth remains too high to be consistent with the FOMC’s 2% inflation goal. Moreover, we believe Fed officials will need to see labor cost growth reach the ~3.0-3.5% range consistently before feeling confident that inflation can return to 2% on a sustained basis.
Therefore, any policy easing remains distant in our view. That said, the moderating trend in labor cost growth alongside signs of a further slowdown to come over the next few quarters suggests little need for the Fed to tighten policy further from here, and we continue to believe that the current hiking cycle has come to an end.
Source: U.S. Department of Labor and Wells Fargo Economics
Druckenmiller Says He Has ‘Massive’ Bullish Bets on 2-Year Notes ‘I started to get really nervous’ about the economy recently
Billionaire investor Stan Druckenmiller said he’s bought “massive” bullish positions in two-year notes, as he’s become more worried about the economy.
In recent weeks, “I started to get really nervous,” Druckenmiller, founder of Duquesne Family Office, said in an interview with hedge fund manager Paul Tudor Jones at a conference last week. “So I bought massive leveraged positions” in the short-term notes, he said.
Druckenmiller has joined a number of prominent investors, including Bill Ackman and Bill Gross, in sounding the alarm about the economy lately. Ackman, founder of Pershing Square Capital Management, said this month that he’s unwound bearish bets on 30-year Treasuries, because “there is too much risk in the world.”
Unlike Ackman, Druckenmiller said he’s keeping bearish wagers on longer-term bonds because he’s concerned about swelling government-debt issuance. But with the new bullish bets on two-year notes, overall he is long fixed income for the first time since 2020, he said at a Robin Hood Foundation event in New York. A video of the interview surfaced on social media this week. (…)
In the interview with Tudor Jones, Druckenmiller said he’s observed anecdotal evidence that “on the margin, things are getting softer” as pandemic stimulus is “running down rapidly.” Historically, the simultaneous increases in interest rates, oil and the dollar have been negative for the economy, he added. (…)
If he’s right about the economy, Druckenmiller said two-year yields could fall to 3%, while 10-and 30-year yields remain at the current levels of roughly 5%.
“I am confident the yield curve will normalize,” he said. “That’s a trade I expect to have for some time.” (…)
In the interview, Druckenmiller blasted Treasury Secretary Janet Yellen for not taking advantage of near-zero interest rates during the pandemic by selling more longer-term bonds, calling it “the biggest blunder in the history” of the department.
“When rates were practically zero, every Tom, Dick, Harry, and Mary in the United States refinanced their mortgage,” Druckenmiller said. “Unfortunately, we had one entity that did not, and that was the US Treasury.”
Druckenmiller reiterated his concern about the growing government-debt burden. If rates stay where they are, the government’s interest expense will amount to 7% of GDP by 2043 — equivalent to 144% of annual discretionary spending today, he said. (…)
WeWork is expected to file for Chapter 11 bankruptcy protection as early as next week. (WSJ)
