Year: 2023

Income, spending and inflation remain too strong for the Fed to ignore

The April US personal income and spending report is a fair bit stronger than expected across the board, which will fuel talk of another Federal Reserve rate hike at either the June or July meetings. Incomes rose 0.4% month-on-month as expected, with wages and salaries up by 0.5% MoM, but spending rose by 0.8%MoM versus the 0.5% consensus with March revised higher. Consequently, we find real consumer spending came in at 0.5% MoM versus the 0.3% expected. This will inevitably lead to upward revisions of second-quarter GDP expectations given consumer spending is two-thirds of economic activity as measured by GDP.

We then turn to inflation, and the core PCE deflator has come in at 0.4%/4.7% rather than the 0.3%/4.6% expected. This move higher will inevitably boost the case of the Fed hawks such as James Bullard and Neel Kashkari that policy needs to move tighter to ensure inflation returns to the 2% target in a timely manner. (…)

• Wages and salaries rose 0.5% in April from 0.2% and 0.3% in the previous 2 months. YtD after 4 months: +5.8% a.r..
• Disposable income was up 0.4% in April and is up 10.5% a.r. YtD as effective tax rates dropped in January.
• The effective tax rate (black line, right scale) is gradually heading back to its 11.75% pre-pandemic rate (April: 12.8%)
• Lower cash taxes and excess savings are keeping consumers busy: expenditures jumped 0.8% in April, +9.0% a.r. YtD.

• In real terms, spending rose 0.5% in April, continuing a very erratic behavior since November:

• Compared with pre-pandemic levels, real expenditures are up 8.2% even though real income is up only 2.2%. The savings rate went from 9.3% to 4.1% during the period.

• Fed tightening has been totally disregarded by a flush consumer: excess savings, steady labor markets, declining taxes and low gas prices are keeping YOLO spending spirits high after tough pandemic years.
• The problem for the Fed is that core inflation is sticky at a monthly 0.4% rate for both total PCE and services inflation:

• The Fed says it will not tolerate 5% inflation. Services prices are the target but demand for services does not react much to higher interest rates, if at all. Services inflation stems from wages which are 19.1% above their pre-pandemic level against 14.0% for services prices.

• Wage growth seemed to be slowing in January but is now back to its 0.4% (5.0% a.r.) monthly growth pace:

• Wages have been increased in spite of sharp gains in productivity during the pandemic years but Q1’23 productivity fell below Q4’19 levels. Wage increases of 3.5% would be consistent with 2% inflation if productivity resumes the 1.5% annual growth achieved between 2016 and 2019.

The Fed was clamoring its data dependency until SVB. It then invoked monetary lags and the widely expected credit crunch post SVB to justify a pause. The lags may still be there, though pretty slow showing up, but the credit crunch is not materializing, even at smaller banks (through May 26):

One positive view of core PCE inflation is that the 3-month change is now 4.2% a.r., down from 4.9% in March. But that was because January’s MoM print was 0.55%. The last 4 months comes in at 4.8% a.r., up from 4.2% between September and December.

Goldman Sachs calculates that “48% of core services categories excluding shelter increased by at least 4% (annualized) over the past six months (vs. 47% in March and 66% at the peak).”

BTW, the Cleveland Fed’s Inflation Nowcast, spot on for the April numbers, is showing core CPI at +0.45% and core PCE at +0.38% for May. The YoY prints would be +5.3% and +4.7% respectively.

The inflation mission is not accomplished just yet.

• “I think everyone should be prepared for rates going higher from here. That 5% is not enough in Fed funds, if I — and I’ve been advising this to clients and banks, you should be prepared for 6, 7…there’s still too much liquidity in the system, which is why stocks are high, bond spreads are still…So I think there’s a chance you’re going to have rates ticking up and not to 3.78. I’m talking about 4.25, 4.5, 5, 6, maybe even 7.” – JPMorgan Chase (JPM ) CEO Jamie Dimon

Goods demand is weak:

• What Costco’s Baskets Reveal About Consumer Finances The upper middle class is feeling the economic squeeze too

(…) The retailer on Thursday said comparable sales excluding fuel in constant currency rose 3.5% in the quarter ended May 7 compared with a year earlier—lower than the 4.2% growth Wall Street analysts expected. It was also the weakest comparable sales growth Costco has seen since 2017. This follows Dollar Tree reporting more business from shoppers who earn annual incomes of $80,000 or more in its stores. Those shoppers weren’t looking for party favors or tchotchkes; they were putting everyday necessities in their basket. Likewise, Walmart last week said that it continues to gain grocery market share among higher-income shoppers.

While shoppers still love going to Costco—traffic at its stores rose 4.8% globally and memberships grew 7%—they are walking out with smaller receipts. The average daily transaction declined 4.2% as shoppers bought fewer big-ticket discretionary items. (…)

Chief Financial Officer Richard Galanti said on Thursday’s earnings call that sales have shifted from beef to poultry and pork, a trend the company historically sees during recessions. Some are even switching to canned products such as chicken and tuna. The share of sales that came from its Kirkland Signature private brand rose 1.2 percentage points last quarter—much faster than the pace of private label share growth it has seen historically. Interestingly, Galanti said customers bought apparel “in a big way,” which could mean more higher-income consumers are trading down from department stores. (…)

• “…our top line comp ran down 6%” – Williams-Sonoma (WSM ) CEO Laura Alber
• “Net sales decreased 3.3%, and comparable sales were down 4.3%. …we continue to see softness in the home category” – Kohls (KSS ) CEO Thomas Kingsbury
• “…what we’re seeing is pressure across big-ticket discretionary purchases primarily. We’re seeing some pressure in small ticket, but it’s more pronounced in big-ticket and is almost exclusively discretionary DIY.” – Lowe’s (LOW ) EVP-US Stores, Home Depot Marvin Ellison
• “We are seeing subdued demand in our furniture business with customers demonstrating more caution on high ticket considered purchases.” – Williams-Sonoma (WSM ) CEO Laura Alber
• “And so we’ve got, I think, a very clean look at consumer intent. And I’ll tell you, it’s a healthy market right now, and it’s persisting into the second quarter. And we’re seeing strong demand signals.” – Cars.com (CARS ) CEO Alex Vetter “Our traffic is up 19% year-over-year, and our marketing expense is actually down.” – TrueCar (TRUE ) CEO Michael Darrow

Except for cars which are slowly coming back from their own covid recession

• “…pre-COVID, there were about 3.5 million to 4 million new cars in dealer inventory pre-COVID going at the end of 2019. In 2022 at its lowest point, it got under 1 million units. So it started to build back up. At the end of March, there was about 1.7 million new cars in dealer inventory, so it’s starting to rebuild” – TrueCar (TRUE ) CEO Michael Darrow

Services are using the remaining excess savings

• “We aren’t seeing any weakness in demand. We’re not seeing any fall-off, which is the uncertainty in the economy. So right now, our projections hold. We’re still expecting to have unit revenue full year kind of in that up low single-digit range.” – American Airlines (AAL ) CFO Devon May

Debt Deal to Hit a US Economy Already Facing Recession Risk

The cap on government spending in Washington’s deal to raise the federal debt limit adds a fresh headwind to a US economy already burdened by the highest interest rates in decades and reduced access to credit. (…)

Federal spending in recent quarters has helped support US growth in the face of headwinds including a slump in residential construction, and the debt-limit deal is likely to at least damp that impetus. (…)

“It’s an important development — it’s been more than a decade since monetary and fiscal policymakers were rowing in the same direction,” said Jack Ablin, chief investment officer at Cresset Capital Management. “Perhaps fiscal restraint will be another ingredient to weigh on inflation.” (…)

The Treasury has run down its cash balance to keep making payments since it hit the $31.4 trillion debt limit in January, and once the ceiling is suspended by the coming legislation, it will ramp up sales of Treasury bills in order to rebuild that stockpile to more normal levels.

That wave of newly issued T-bills will effectively drain liquidity from the financial system, although its exact impact could be challenging to assess. Treasury officials may also arrange their issuance to minimize disruptions. (…)

The International Monetary Fund last week said that the US would need to tighten its primary budget — that is, excluding debt-interest payments — by some 5 percentage points of GDP “to put public debt on a decisively downward path by the end of this decade.” (…)

• The spending deal looks likely to reduce spending by 0.1-0.2% of GDP yoy in 2024 and 2025, compared with a baseline in which funding grows with inflation. That said, the boost to funding Congress approved late last year for FY23 was so large (nearly 10% yoy) that overall discretionary spending is likely to be slightly higher in real terms next year despite the new caps. (GS)

European inflation

Markets expect German inflation to print at 0.2% MoM, which looks relatively fair but the scope for surprises on the low side is increasing to due pent-up weakness in input costs. The PPI has fallen off a cliff since late 2022 alongside lower electricity -and gas prices. (Stone Research)

• Spanish Inflation Slows More Than Expected, Nears 2-Year Low

May’s reading moderated to 2.9% — the least since July 2021 — as fuel costs fell and the growth in food prices eased. The result follows April’s uptick to 3.8% and is well below the 3.3% median estimate in a Bloomberg survey of economists.

There was good news, too, on underlying inflation as the gauge that excludes the costs of energy and some food items fell for a third straight month, though it remained elevated at 6.1%.

• USA?

PPI Final Demand vs CPI and PCE Deflator

• In the real world:

• “Inflation continues to abate somewhat. If you go back a year ago to the fourth quarter of ’22 last summer, we had estimated that year-over-year inflation at the time was up 8%. And by Q1 and Q2, it was down to 6% and 7% and then 5% and 6%. In this quarter, we’re estimating the year-over-year inflation in the 3% to 4% range” – Costco (COST ) CFO Richard Galanti

• “…we saw wage inflation moderate to approximately 4%. While the staffing environment has substantially improved versus this time last year, we don’t envision wage inflation pulling back much from these levels as there continues to be regulatory and market pressures.” – Autozone (AZO ) CEO William Rhodes

• “Coming into this year, in January, we saw something that for us was unprecedented, which was a steep decline year-over-year in the amount of hiring that companies were doing. And what was interesting about January is that it was no longer just SMBs, but it was also enterprises. So we shared the information that we had at that point, which was that effectively January was down 15% year-over-year. Q1 came in 19% down year-over-year. And then we also shared April data, which was down 27% year-over-year. So this is a macroeconomic economy-wide all job categories, all — companies of all sizes, slowed down in hiring.” – ZipRecruiter (ZIP ) CEO Ian Siegel

Why Are Markets So Calm? Quants Are Dominating Firms that use computers to determine buy and sell signals have been loading up while other investors sit back.

(…) Over recent months, stocks have handily overcome stress in the banking system, stubborn inflation and interest-rate hikes. Last year, those kinds of issues repeatedly torpedoed stocks. This year, markets have met such events with a shrug. (…)

One explanation: Quant funds, or those relying on computer models and automated trading, have been doubling down on equity markets as other investors have stepped back, citing high valuations and concerns about the likely course of the U.S. economy.

Quant-fund buying has pushed these funds’ net exposure to U.S. stocks to the highest level since December 2021, according to data from Deutsche Bank. Mainstream investors, in contrast, have been pulling cash from stock funds and pouring it into money markets.

The continuing demand from quants has provided a lifeline for the stock market. Combined with robust corporate buybacks, their buying has helped counteract selling pressure and led to placid moves. The S&P 500, for example, has moved less than 1% in either direction for 36 of the last 46 sessions, according to Dow Jones Market Data, the quietest 46-day stretch since December 2021.

(…) systematic and fundamental investors haven’t been this divergently positioned since 2019.

Driving the quant funds is a self-reinforcing dynamic. When market volatility drops, they pile in more. Big stock-market moves collapsed this spring after regulators rushed to stem the banking crisis, and the Federal Reserve signaled it might stop raising interest rates soon.

So-called vol-control and risk-parity funds, which tend to automatically load up on riskier assets during calmer periods, ramped up equity exposure, according to the Deutsche Bank data, available through May 18. Other quants, such as trend-following CTAs, or commodity trading advisers, have similarly piled in.

The dominance of quants has helped explain previous periods of calm trading, including long stretches in 2017 and 2018. Those periods were punctured by rapid selloffs, including the 2018 selloff dubbed “Volmageddon” when the dynamics exerting calm on the market suddenly went away. Some warn a repeat could be ahead.

“If you do have concentrated positioning, it does create the risk of unwinds in the case of a negative shock,” said Christian Mueller-Glissmann, head of asset allocation research at Goldman Sachs. “And the risk you face with them is not just that they might have bought some equities because volatility has gone down, they might have levered up.”

The market has started to see early signs of eroding tranquility. Last week, the Cboe Volatility Index—the VIX, or Wall Street’s fear gauge—on Wednesday briefly settled above 20 for the first time in about three weeks as simmering debt-ceiling anxieties surfaced. Typically, anything higher than 20 indicates fear is starting to rise. (…)

At the end of March, quant-focused hedge funds held about $1.13 trillion in assets, according to research firm HFR, hovering just below last year’s record high. That represents about 29% of all hedge-fund assets. (…)

Tech Stock Rally Leaves Small-Caps in the Dust One measure shows large-cap stocks beating smaller companies by the widest margin in 25 years.

The Russell 1000 index of large companies has gained 9.2% this year, beating the 0.7% advance of the small cap concentrated Russell 2000. That is the widest outperformance since 1997, when looking at years in which the Russell 1000 has been in positive territory through May 26, Dow Jones Market Data show. (…)

Some investors, though, are wary that the stock market’s rally is too narrow underneath the surface, leading to doubts about its sustainability if one or more of the market’s behemoths were to falter. (…)

Tech stocks emerged as haven play during the March banking crisis, with investors betting that the collapse of three regional banks would force the Fed to pause its bid to raise interest rates. Lower rates boost the appeal of growth companies, such as tech stocks, which have the potential to generate windfall profits many years in the future. (…)

Investors poured more than $2.6 billion into U.S. stocks on a net basis during the week ended May 19, the largest net inflow since October, Bank of America global research data show. About $2.2 billion of that sum went to large-caps, while small-caps logged net outflows of $42 million. (…)

The Russell 2000 is trading at 12.8 times expected earnings over the next 12 months, below its historical average of 15.8, based on FTSE Russell data going back to 1979, when the index was created.

In comparison, the Russell 1000 trades at about 18 times earnings, above its historical average of 15.8. Meta’s multiple is about 20, while Tesla’s and Nvidia’s are both around 47. (…)

QQQ/IWM

@carlquintanilla

(Yardeni Research)

• The S&P 600 index is still in a bear market at -23% from its recent peak, -2% YtD. The junkier Russell 2000 is off 28% from its peak, flat YtD.
• The S&P 500 Equal Weight is not keeping pace with the heavy weights:

MarketCharts @Callum_Thomas

@_rob_anderson

• But S&P 500 earnings are looking better:

Why You’re Losing More to Casinos on the Las Vegas Strip Casinos are making it costlier to play and harder to win. Blackjack players lost nearly $1 billion on the Strip last year, the second-highest loss on record, after 2007.

Some Las Vegas casinos cut back the number of blackjack tables with dealers, raised minimum bets during busy times and lifted their advantage over players in some games—doubling-down on a prepandemic practice of making subtle changes that favor the house, according to industry executives, researchers and gamblers.

These changes are part of a broader effort by companies to make Las Vegas more of an upscale destination.

“You’re bringing in higher value customers, and we’re already full,” Caesars Entertainment CZR 1.81%increase; green up pointing triangle Chief Executive Tom Reeg said on a call with Wall Street analysts this month. “So, you’re kicking out the lowest end. I see no reason that that needs to stop or would stop.” (…)

Las Vegas Strip casinos took in nearly $8.3 billion in gambling revenue last year, a record that exceeded prepandemic revenue by more than 25%, according to state regulators. In 2022 the number of visitors to Las Vegas fell short of 2019 levels, but tourists last year still spent money at record-setting levels, according to tourism officials. (…)

Blackjack, a fast-paced card game, historically paid out a ratio of 3:2 when a player hit 21 on the first two cards. That means a gambler wins $15 for every $10 bet. Now, many blackjack tables on the Strip pay out at 6:5, which means that same $10 yields only $12. (…)

Casino executives say labor costs make table games expensive to operate, making the lower-priced bets more difficult to offer. Casinos are also offering fewer opportunities to play at a table. Last year Strip casinos had about 1,090 blackjack tables, down about 19% from a decade ago, state records show. (…)

Gamblers playing the centuries-old game roulette must look closely from table to table to figure out their odds of winning. Triple-zero roulette, a version that leans in favor of the casino, is increasingly popping up on the Strip. Historically, American casinos more commonly used a wheel with 38 slots, including 18 black, 18 red, and two green slots numbered zero and double-zero. The triple-zero roulette adds another slot with three zeros, lifting the house’s advantage and making gamblers’ bets more difficult to win. (…)

According to Vegas Advantage’s survey, the triple-zero roulette tables have grown from a handful in 2016 to 78 last year, compared with 111 double-zero tables. (…)

FYI

• U.S. Still Spends More on Military Than Next Nine Countries Combined

Institute for Policy Studies

• More High-School Grads Forgo College in Hot Labor Market The share of young people seeking higher education slipped to 62% last year from 66.2% in 2019, before the pandemic began.

Note: special thanks to The Transcript for the quotes from corporate conference calls.

Emerging Debt Deal Would Raise Limit, Cap Spending for Two Years

Republican and White House negotiators are moving closer to an agreement to raise the debt limit and cap federal spending for two years, according to people familiar with the matter, as time grows short to avert a catastrophic US default.

The two sides have narrowed differences in talks over recent days, according to the people, though the details agreed to are tentative and a final accord is still not in hand. The two sides have yet to agree on the amount of the cap.

Under the terms of the emerging agreement, defense spending would be permitted to rise 3% next year in line with President Joe Biden’s budget request. (…)

May Vehicle Sales Forecast: 15.3 million SAAR, Up Sharply YoY

The Wards forecast of 15.3 million SAAR, would be down 3.9% from last month, and up 21.6% from a year ago.

Chicago Fed: Pickup in Economic Growth in April

The CFNAI rose to +0.07 in April from -0.37 in March. All four broad categories of indicators used to construct the index increased from March, but two of the four categories made negative contributions in April.

Pending Home Sales Unchanged in April

Recession?

The Fed tightening has had its normal impact on interest sensitive sectors but the highly unusual circumstances of

• 10 years of QE;
• a worldwide pandemic;
• government money showering and a very accommodative Fed;
• the war in Ukraine;
• a very mild winter;
• the return of protectionism;

have together created an economic and financial environment that has made previous playbooks ineffective.

The auto and housing cycles are now showing signs of bottoming without having had their usual effects on employment and wages. Services are gradually but surely recovering, helped in part by rising interest rates that are boosting savers’ incomes, particularly baby boomers’ who are increasingly dining out and travelling.

@Mike_Zaccardi

Apartment Landlords Bleeding Cash Imperil $47 Billion of Loans The US multifamily buying boom threatens to go bust for owners getting squeezed by higher interest rates and other surging costs.

Higher interest rates and surging expenses are erasing their profits, even as rents are still climbing in many places. Debt payments already exceed income from multifamily buildings financed with more than $47 billion of securitized loans, according to data from Trepp.

Making matters worse, property taxes are escalating swiftly and the destructive path of climate change is sending insurance costs skyward. And building values are falling, complicating owners’ efforts to sell or refinance their way out of trouble.

“The problem is, nobody expected expenses to rise as much as they did,” said Jay Parsons, chief economist for RealPage, a rental-data tracker. “In particular, investors with floating-rate loans resetting at significantly higher rates could be challenged to cover debt payments.”

For now, the fallout has been limited. That’s because investors often purchase rate caps that protect them from the worst effects of soaring interest costs. But those policies are likely to begin burning off at a rapid rate later this year, leaving a growing number of owners vulnerable. (…)

Prices have fallen by an estimated 15% to 20% since the Fed began raising interest rates last March, said Aaron Jodka, research director for US capital markets at Colliers. (…)

America’s Travel Resurgence Is Finally Here Would-be tourists have the money and the desire to hit the road this summer. Their increased spending could even help fend off a recession.

(…) In a Gallup poll last May, 40% of respondents said they had been avoiding travel by airplane, bus, subway or train. By this February—the most recent survey—that figure had fallen to 18%. With the U.S. this month ending the national emergency and public-health emergency declaration put in place when the pandemic hit, people are probably even less worried now. (…)

Traditional hotel chains have been more upbeat, with many, including Marriott International and Hilton Worldwide Holdings, upping sales forecasts for this year when they reported first-quarter results. The unlocking of overseas demand, particularly in countries such as China and Japan that had strict Covid mitigation measures in place last summer, is helping boost global demand for hotel rooms.

That reflects increased comfort with international travel and is having a spillover effect for the U.S. as a destination: Over the three months starting last June, international arrivals to the U.S. were 33% lower than in the comparable three months of 2019, according to the National Travel and Tourism Office. The most recent available data shows that in the first two months of this year that gap had narrowed to 18%. (…)

Ships have gone from not having enough passengers a year ago to packing them to the gunwales, and in some cases cruise lines are canceling people’s trip after overselling. (…)

• Hotels: Occupancy Rate Down 2.0% Year-over-year

Through May 13 per STR (via CalculatedRisk): Occupancy: 65.1% (-2.0%)

• On roads (Advisor Perspectives)

“Travel on all roads and streets changed by +1.9% (+4.5 billion vehicle miles) for February 2023 as compared with February 2022. Travel for the month is estimated to be 233.7 billion vehicle miles.” The 12-month moving average was up month-over-month (MoM) by 0.14% and was up 0.5% year-over-year (YoY). If we factor in population growth, the 12-month MA of the civilian population-adjusted data (age 16-and-over) was up 0.1% MoM and down 0.6% YoY.

Total miles traveled, however, is one of those metrics that should be adjusted for population growth to provide the most meaningful analysis, especially if we want to understand the historical context. (…)

In fact, there’s a good case for using the Census Bureau’s mid-month estimates of total population (POPTHM) rather than civilians age 16 and over for the population adjustment. The reason is that a portion of total miles traveled is specifically to support children’s needs (daycare, schools, children’s activities, etc.) and the needs of elders who might have licenses but no longer drive. Ultimately the division of miles traveled by either population group (CNP16OV or POPTHM), while not a perfect match with drivers, is a consistent and relevant metric for evaluating economic growth.

(…) In the total population-adjusted version, the latest data point is 5.65% off-peak. This population-adjusted version puts us at a level we first achieved in 1999.

• By air: TSA checkpoint travel numbers show passenger volumes up 12.2% YoY in May (through May 24) and +7.1% from the same period in 2019.

• A Barbecue Craze in China Shows Why Its Economy Is Undercooked The journey of Zibo from industrial backwater to meat-grilling vacation hot spot reflects the bitter reality of China’s postpandemic recovery

Thousands of tourists sip cheap lager in plastic cups and grill mutton skewers in the open air every night in this hardscrabble Chinese city. The revelers snap selfies with friends, many on their first vacations since China lifted Covid-19 restrictions.

Until recently, few Chinese could place Zibo on a map. Now it is one of the country’s top vacation hot spots. Its skyrocketing popularity captures a national mood that increasingly places fun and thriftiness over lavish spending—with consequences for China’s postpandemic recovery. (…)

Even as they indulge in parties with friends, many Chinese people are scrimping on bigger-ticket items such as furniture and appliances. The dim job prospects are also leading many young people to put off getting married and having children, which in turn will likely worsen China’s falling population in the years to come.

“Young people think differently now,” said 23-year-old Shao Xiaoru, who was visiting Zibo earlier this month. “They all want to go out and have fun instead of staying at home.”

Shao perused a popular bookstore in Zibo that is shaped like a giant pagoda. Few were buying books though and only three of its nine floors were operating. The throngs of tourists instead indulged in another pastime that doesn’t cost anything—taking selfies to put on social media.

Zibo’s emergence as a selfie-worthy destination reflects the pent-up demand for fun that Chinese leaders hope can revive the world’s second-largest economy. But turning that exuberance into sustainable economic growth is more complicated. (…)

While the number of domestic trips nationwide jumped 19% versus the last prepandemic year of 2019, total tourist spending only rose 0.7%, according to the Ministry of Culture and Tourism. (…)

Europe’s Economic Engine Is Breaking Down Germany is at risk of a long, slow decline — with consequences for the whole of the EU

Decades of flawed energy policy, the demise of combustion-engine cars and a sluggish transition to new technologies are converging to pose the most fundamental threat to the nation’s prosperity since reunification. But unlike in 1990, the political class lacks the leadership to tackle structural issues gnawing at the heart of the country’s competitiveness. (…)

While Berlin has shown a knack for overcoming crises in the past, the question now is whether it can pursue a sustained strategy. The prospect looks remote. Chancellor Olaf Scholz’s make-shift coalition has reverted to petty infighting over everything from debt and spending to heat pumps and speed limits as soon as the risks of energy shortfalls eased. (…)

Economists see German growth lagging behind the rest of the region for years to come, and the International Monetary Fund estimates Germany will be the worst-performing G-7 economy this year. (…)

Germany finds itself ill-suited to sustainably serve the energy needs of its industrial base; overly dependent on old-school engineering; and lacking the political and commercial agility to pivot to faster-growing sectors. The array of structural challenges points to a cold awakening for the center of European power, which has become accustomed to uninterrupted affluence.

To its credit, industrial behemoths like Volkswagen AG, Siemens AG and Bayer AG are flanked by thousands of smaller Mittelstand companies, and the country’s conservative spending habits put it on a stronger fiscal footing than its peers to support the transformation ahead. But it has little time to waste. (…)

Affordable power is a key precondition for industrial competitiveness, and even before the end of Russian gas supplies, Germany had some of the highest electricity costs in Europe. Failure to stabilize the situation could transform a trickle of manufacturers heading elsewhere into a stampede.

Berlin is responding to concerns by seeking a cap on power prices for some energy-intensive industries like chemicals through 2030 — a plan that could cost taxpayers as much as €30 billion ($32 billion). But that would be a temporary patch, and shows Germany’s desperate situation in terms of supply. (…)

The bitter reality is that resources for generating that much clean power are limited in Germany by its relatively small coastline and lack of sun. In response, the country is looking to build a vast infrastructure to import hydrogen from the likes of Australia, Canada and Saudi Arabia — banking on technology that hasn’t been tested at this scale.

At the same time, Germany will need to speed the construction of high-voltage grids linking wind farms off the coasts in the north to power-hungry factories and cities further south. And there’s little in the way of storage to ensure the country can withstand disruptions. (…)

While small manufacturers still thrive, the number of new startups is declining in Germany — in contrast to growth seen in other developed economies, according to the OECD.

The reasons include excess bureaucracy — company registrations often taking place in paper form — and a cultural aversion to risk. Financing is also an issue. Venture-capital investment in Germany totaled $11.7 billion in 2022 compared with $234.5 billion in the US, according to DealRoom. Germany also labors under a ponderous academic system and doesn’t have a single university in the top 25 of the latest Times Higher Education ranking.

Patent data shows that Germany’s ability to stay at the forefront is fading. In 2000, the country was among the top three for world-class patents in 43 of 58 key technology categories, but in 2019, it achieved that rank in fewer than half the number of areas, according to a recent study by the Bertelsmann Stiftung.

(…) Germany’s electric cars have struggled. BYD Co. overtook VW to become the best-selling car brand in China last quarter. Key to its push was an electric model that costs around a third of VW’s ID3, but offers greater range and connectivity with third-party applications. (…)

Germany’s lack of investment is particularly acute in digital technology. Despite infrastructure that had it ranked 51st in the world for fixed-line Internet speeds, it had the fourth-lowest spending among OECD countries relative to the economy’s size. (…)

With Scholz’s messy three-way coalition racked with bickering, Germany is poised for instability, and the far-right Alternative for Germany has seized on the political vacuum, vying for second in some polls. (…)

This year, more than 1 million Germans will reach retirement age — about 320,000 more than those becoming adults. By the end of the decade, the German employment agency says the shortfall will rise to as much as 500,000 — roughly equivalent to the city of Nuremberg, adding to the strains on the economy.

In a recent report, the OECD put the scale of the challenges in stark terms: “No major industrialized economy has ever had the very basis of its competitiveness and resilience so systematically challenged by changing social, environmental and regulatory pressures.”

That in turn will ripple across the entire continent, according to Dana Allin, a professor at SAIS Europe. “The health of the German economy is crucial for the broader European economy, and the bloc’s harmony and solidarity,” he said.

• BYD Seagull EV Priced From $11,400, Gets 10,000 Orders On First Day Battery packs range from 190 miles (305 kilometers) and 251 miles (405 km),charging up to 80% in 30 minutes.

• TSMC in Talks for Up to Half German Plant’s Cost in Subsidies

Taiwan Semiconductor Manufacturing Co., the world’s biggest contract chipmaker, is in talks to receive German government subsidies for as much as 50% of the costs to build its new semiconductor plant in the country, people familiar with the matter said. (…)

The deliberations over the Dresden plant, which could cost as much as €10 billion ($10.7 billion) to build, show how competition for semiconductor manufacturing capacity has intensified. The top end of the subsidies being discussed would put German government support for the fab on par with what Japan’s offering TSMC to build a factory there. It would also outpace the 40% maximum that most other chipmakers are getting for their plants in Europe. (…)

Less than half of the oil and gas industry’s unprecedented cash flow from the energy crisis is going back into traditional supply and only a small fraction to clean technologies

Data: International Energy Agency; Chart: Alice Feng/Axios

Full International Energy Agency’s analysis.