Month: March 2024

Powell Juices Bets in Bond Market on Inflation With Tilt to Jobs

Federal Reserve Chair Jerome Powell’s increasing focus on protecting the job market is encouraging a swath of bond traders putting bets on inflation rates to remain elevated.

“Powell essentially endorsed being long breakevens,” said Tim Magnusson at Garda Capital Partners, referring to a trading strategy that profits from inflation-linked securities outperforming regular Treasuries.

The Fed chief for the first time in the current cycle last week in his press briefing rammed home the point that a surprise increase in unemployment could prompt officials to lower interest rates. Central bank policymakers’ updated forecasts, released March 20, also featured a faster expected pace of inflation and growth for 2024 while retaining a projection for three rate cuts in the so-called dot-plot.

“I guess they are willing to tolerate a little more inflation than what we otherwise would have thought,” said Magnusson, the hedge fund’s chief investment officer. (…)

“A Fed that is guiding to cut alongside easy financial conditions, stronger growth expectations and greater upside risk to inflation suggests higher inflation compensation.” (…)

“The Fed is paying closer attention to the unemployment rate than inflation. It’s more likely for breakeven rates to go up than go down.”

Dalio Says China Must Fix Debt Problems or Face ‘Lost Decade’

(…) “When there is a lot of debt and big wealth gaps at the same time as there are great domestic and international power conflicts, and/or great disruptive changes in nature, and great changes in technology, there is an increased likelihood of a ‘100-year big storm,’” he wrote.

He added that China-US tensions are causing foreign investors to diversify or leave China for fear of being discriminated against. That’s causing China to face difficulties obtaining investments, and without a reconciliation of economic and cultural clashes, the chance of a war in the next 10 years is high. (…)

To manage its debt problem, Dalio recommends that China engineer a deleveraging and an easing of monetary policy at the same time, but acknowledges that such a move would be difficult and politically dangerous as it would lead to big changes in wealth levels.

“No one knows how far the pendulum will swing back toward the more Maoist/Marxist ways of doing things,” Dalio wrote. “The impediment is that communicating more directly is not the Chinese leadership’s traditional way of doing things, which, as China goes back toward the more traditional ways of doing things, is understandable.”

China’s Property Crisis Is Rippling Through Its Biggest Banks

Bank of Communications Co. reported Wednesday that its property bad loan ratio jumped to 4.99% at the end of last year from 2.8% a year earlier. While the balance of its overdue mortgages slipped, the special mention loans for the segment — a leading indicator of soured loans — jumped 23% to 9.88 billion yuan ($1.4 billion).

Its bigger rival, Industrial & Commercial Bank of China Ltd. saw its bad loans from residential mortgages rise 9.6% to 27.8 billion yuan, according to a Wednesday filing. While its property NPL ratio slipped to 5.37%, it was still the highest among all sectors.

Bocom’s Vice President Yin Jiuyong said the pressure to keep asset quality in check remains “immense” this year as it will take time for home sales and developers’ liquidity conditions to recover. Overall risk from its property exposure is still manageable, he said at an earnings briefing. (…)

Combined profits at China’s commercial banks rose 3.2% to 2.38 trillion yuan last year, the slowest pace since 2020, according to official data. Outstanding bad loans climbed to a record 3.23 trillion yuan. (…)

Yellen Warns China’s Industry Ramp-Up Is Distorting World Economy Treasury secretary calls out China for excess capacity buildup, China overcapacity ‘distorts global prices and production’

US Treasury Secretary Janet Yellen slammed China’s use of subsidies to give its manufacturers in key new industries a competitive advantage, at the cost of distorting the global economy, and said she plans to press China on the issue in an upcoming visit.

“There is no country in the world that subsidizes its preferred, or priority, industries as heavily as China does,” Yellen said in an interview with MSNBC Wednesday — highlighting “massive” aid to electric-car, battery and solar producers. “China’s desire is to really have global domination of these industries.”

China’s industrial policy has a track record of causing “substantial overinvestment,” Yellen said in remarks prepared for delivery during her trip. She cited aid to industries including steel and aluminum that supported China’s production and employment “but forced industry in the rest of the world to contract.” (…)

“Now we see excess capacity building in ‘new’ industries like solar, EVs, and lithium-ion batteries,” Yellen said. China’s industrial surplus “hurts American firms and workers, as well as firms and workers around the world.”

Faced with a powerful drag on growth from a crisis in China’s real estate sector, President Xi Jinping and his lieutenants have been prioritizing the manufacturing sector. The “new three” growth drivers of electric vehicles, batteries and renewable energy have been a particular focus, along with advanced technology semiconductor production.

Yellen in her visit to Georgia highlighted Biden administration policies to help build up the US’s own renewable-energy industry. The Suniva Inc. solar-cell manufacturing plant she’s set to visit is slated to reopen this spring. Suniva’s revived fortunes are due in part to incentives from the Inflation Reduction Act and its measures to “onshore clean energy manufacturing,” Yellen said.

“China flooded the market with solar panels, drove down the prices to levels in which virtually no American company could compete — this company went bankrupt,” Yellen said on MSNBC. “And we don’t intend to let that happen again.” (…)

The USA is also ramping up its manufacturing capacity, well ahead of demand:

Mrs. Yellen is now a true politician, probably too busy to do thorough research. This 2001 Bloomberg analysis seems to reasonably objectively explains what’s happening:

• How China Beat the U.S. to Become World’s Undisputed Solar Champion

Why the surprise? In November 2023, I wrote China Imploding? No Exploding?

Here’s the related excerpt of the post:

The Chinese are coming!

On the other hand, the Chinese government and Chinese entrepreneurs are not standing still. The real estate and LGFV issues are now well understood. So is the need to react to the tech war with the U.S.. Chinese decision makers are now urgently focused on impact mitigation (higher budget deficits) and new growth alternatives.

In addition to rapidly increasing its self-sufficiency on microchips technology and production, China will accelerate its macro rebalancing process, focusing on the service economy, its Belt & Road investments, high-value-added exports, and “New Manufacturing”, what Goldman Sachs calls “The New Three”: NEVs, battery and wind/solar power generation.

In effect, China will be resolving its domestic problems with massive growth initiatives aimed at boosting it exports of high value-added products.

Outside China, this will create significant economic challenges and exacerbate trade tensions.

China already has overcapacity in NEVs and its largest manufacturers are aggressively pushing their brands across the world (ex-USA), even building new manufacturing plants abroad. (…)

In fact, China has likely exported more cars than Japan in 2023, a true seismic shift that will certainly create major political and financial waves in 2024. Consultants at AlixPartners forecast that overseas car sales of Chinese companies will hit 9 million by 2030, boosting their global market share to 30%, up from 16% in 2022.

The battery market looks very similar given Chinese technological and cost advantages as the WSJ explains:

Having charged up in their massive home market, Chinese electric-vehicle-battery firms are becoming major export players, too. The West’s efforts to protect its own markets might prove too little, too late.

Chinese firms are also eyeing big new factory expansions in Europe itself, and in U.S. free trade partners, as a way to sidestep current and future import restrictions—much like Japanese carmakers did in the U.S. in the 1980s. (…)

Contemporary Amperex Technology, or CATL, and carmaker BYD are already the top two producers of EV batteries in the world. Outside China, Chinese battery manufacturers still lag behind South Korean rivals—the top three have nearly half the market. But if CATL keeps logging growth numbers as it did this year, that could change fast.

Meanwhile, American auto makers recently celebrated the signing a new labor contract:

The contract will add about $1.5 billion to Ford’s annual labor costs, equal to roughly 13% of its global operating profit based on the company’s most recent earnings guidance, according to J.P. Morgan

Ford’s per-hour labor cost, including benefits, would be around $67 this year and rise to about $88 by the final full year of the contract, in 2027, according to Wells Fargo. That is significantly higher than the labor costs of the foreign automakers, estimated in the mid-$50s per hour, and Tesla at $45 to $50. (WSJ)

A Reuters analysis of the estimated income included in recent job adverts from 30 Chinese auto firms showed hourly salaries of 14 yuan ($1.93) to 31 yuan ($4.27), with Tesla, SAIC-GM, Li Auto and Xpeng at the higher end.

Reuters:

While the average price of electric cars has risen in Europe since 2015 from 48,942 euros to 55,821 euros and 53,038-to-63,864 in the United States, it has dropped in China to 31,829 from 66,819 euros, taking it below the price of gasoline cars, according to a study by JATO Dynamics, which provides analysis on industry trends.

Europe is relatively open to vehicles imported from China, and Chinese vehicle makers as well as global manufacturers such as Tesla Inc are rushing to step up shipments.

Countering perceptions Chinese goods are lower quality, they have earned five-star safety ratings from European regulators. (…)

By contrast, high duties [27.5% vs 10% in the EU] in the United States on Chinese-made vehicles have so far kept China’s share of the U.S. auto market negligible.

But for how long?

At the recent Munich auto show, there were about 50 Chinese companies presenting their products.

Electric cars sold in China are roughly 40% cheaper than those sold in Europe, and 50% cheaper than in the US, according to research firm Jato Dynamics.

The average price of an EV in China was €31,829 ($34,096) in the first half of 2022, compared with €55,821 ($59,797) in Europe and €63,864 ($68,429) in the United States, the firm said in a report last year. (CNN)

Motor Trend last October 11:

Chinese cars are closer to the U.S. market than most people know. MotorTrend traveled to Mexico City, where there are Chinese-branded, Chinese-manufactured vehicles in North America—and they’re making a big impact.

Over the past three years, nine Chinese automakers have set up shop in Mexico, and today their wares represent 9 percent of all passenger vehicles sold there. That’s remarkable when you consider that just four years ago, Chinese vehicles weren’t represented in Mexico’s market share at all. But Chinese giants like BYD, Chery, and SAIC Motors have established themselves south of our border, offering quality products at attractive prices. (…)

Chinese manufacturers have expanded around the world, but choosing Mexico as a place to build and sell cars is a notably strategic move. Mexico has seen steady annual economic growth, and its residents purchase more than 1 million new cars each year.

But Mexico’s geopolitical landscape is especially attractive. Being a neighbor to the U.S., the world’s second-largest automotive market, has lured many foreign car companies to set up production plants in Mexico over the years. The North American Free Trade Agreement (NAFTA), which went into effect on January 1, 1994, between the U.S., Mexico, and Canada, made it easier to export cars from Mexico into the U.S., and car companies used this opportunity to invest billions of dollars in the nation.

NAFTA was replaced on July 1, 2020, by the United States-Mexico-Canada Agreement (USMCA), which changed the rules for exporting cars around the region. Under the present deal, 75 percent of a vehicle must be built in North America for its maker to avoid paying import tariffs, and 70 percent of its steel and aluminum must be sourced from the region. The agreement also has provisions aimed at improving wages, such as stipulating that 40 to 45 percent of a vehicle must be made by workers earning at least $16 per hour.

What’s more, the U.S. Inflation Reduction Act of 2022 allows certain electric vehicles and batteries made in North America to qualify for the full $7,500 federal tax credit, a lifeline for Mexico’s auto production, as some U.S. car companies already produced or planned to produce EVs south of the border.

Some Chinese car companies such as Chery, SAIC Motors, and BYD are looking to build plants in Mexico. For now, BYD says it doesn’t intend to enter the U.S. market, but Bryan Wu, Chery Mexico’s executive vice president, told MotorTrend the automaker does plan to do so, but he declined to specify when.

California and 10 other states (107 million people, 32% of the U.S. population) currently have legislations banning the sale of new gasoline cars by 2035.

President Biden’s Executive Order 14057 mandates that all new light duty vehicles added to the government fleet be 100% zero emissions by 2027, and that the entire fleet of government-owned vehicles with ICE engines be phased-out and replaced with 100% all-electric vehicles by 2035-2040.

Will Americans accept to buy cars and trucks at twice what most other people in the world pay. Can America afford that?

According to the Bureau of Labor Statistics, “Transportation equipment manufacturing” employs 1.8 million people, 1.1% of the U.S. labor force.

It’s not only vehicles. Most gas-powered equipment and tools will soon be battery-powered, mostly using Chinese batteries.

Political fights ahead: costs/competitiveness vs American jobs vs climate change…

Explosive!

It will be electric!

Recent personal experience: In Hong Kong two weeks ago: The cars Suzanne and I saw in a BYD dealership last week were very well designed and built, with very comfortable and thoughtful interiors. The BYD sales representative said the “export cars” are better built than the “China cars” to meet all western crash tests.

Never Ending Revenge Spending—‘What Is the New Norm?’ Consumers continue spending on experiences, defying the expectations of many and leaving finance chiefs to wonder where shoppers will spend their money

(…) Some shoppers are doing what they can—running down their savings and spending on credit—to keep up their lifestyles, ING’s Knightley said, and have written off the possibility of buying a home or saving for retirement.

“Revenge spending, by some reports, has turned into ‘doom spending,’” he said. “Therefore, whatever money comes in gets spent, and you enjoy it.”

Michele Allen, CFO at Wyndham Hotels & Resorts, agrees that consumers are still taking trips. And it’s more than revenge travel, Allen said, explaining that what travelers are doing now is more intentional.

“It’s not just, get me out of New Jersey or get me into warm weather or get me out of this house, it’s like, ‘What am I looking for?’” said Allen, adding that travelers are setting out for specific events like concerts or the solar eclipse next month.

Around 2.6 million passengers went through airport security on March 25, up around 9% from a year earlier, according to data from the Transportation Security Administration. (…)

Consumers also continue eating out, though that has declined some. U.S. restaurant dining numbers are down 5% for the week ended March 23 compared with a year earlier, according to data from OpenTable.

Burrito chain Chipotle Mexican Grill reported 7.4% transaction growth for the quarter ended Dec. 31—and consumers are spending more, Chief Financial Officer Jack Hartung said. “We’re not seeing people that are adding less to their check,” Hartung said. “They’re not skipping the chips and guacamole; they’re not skipping the quesadilla on the side or the chips and salsa.” 

Some shoppers are searching for value, but their willingness to buy apparel such as shirts, dresses and pants is holding up longer than anticipated, Ralph Lauren CFO Jane Nielsen said. “They’re willing to make investments, be that an investment in experience or be that an investment in their apparel or wardrobe.”

Ralph Lauren has focused on inventory, which globally was down 15% in the latest quarter from a year earlier, and is managing the company’s buys to focus on its “core,” iconic pieces such as jackets, vests and certain sweaters, said Nielsen, who is also chief operating officer. These are the more “timeless” purchases, she said, rather than end-of-season, need to liquidate items. And if purchasing pressure from consumers does emerge, Ralph Lauren is ready to pull back on the replenishing cycle. (…)

Recent personal experience, for what it’s worth: last year, specialty restaurants upsold by cruise ships were full; they were almost empty last week. Still cruising, but somewhat more budget conscious.

Note: I will be travelling in Asia until April 24. Limited equipment and different time zones will limit the frequency and depth of my postings.

US FLASH PMI

Maybe it’s because I am travelling, but I have seen no major media post on this flash PMI. Yet, it may be revealing. The latest FOMC raised the estimated growth rate from 1.4% to 2.1% and the inflation rate from 2.4% to 2.6% but kept 3 rate cuts this year.

The headline S&P Global Flash US PMI Composite Output Index posted 52.2 in March, down slightly from the reading of 52.5 in February but still signalling a solid monthly improvement in business activity at US companies. Output has now risen in each of the past 14 months.

The overall slowdown in the pace of output growth reflected a loss of momentum in the service sector, where activity rose at the weakest pace in three months. While there were some reports of demand improving, anecdotal evidence also suggested that price pressures had restricted the ability of customers to commit to new projects. As a result, the rate of new business growth in the service sector also softened.

More positive was a sharp and accelerated expansion of manufacturing output in March, with the rate of growth the fastest since May 2022 amid a further solid rise in new orders.

Overall, new orders increased at a slower pace than in February. New business from abroad was up marginally as a rise in manufacturing contrasted with a drop in services.

Business confidence jumped to a near two-year high at the end of the first quarter amid signs of a pick-up in the broader US economy. Some service providers also linked confidence to planned marketing activity. While both sectors posted improvements in optimism since February, the jump in confidence was more marked in the service sector than in manufacturing.

While rates of expansion in output and new orders softened in March, this was not the case with regards to employment. The rate of job creation ticked higher and was the fastest in 2024 so far. Staffing levels rose across both sectors, with jobs growth in manufacturing hitting an eight-month high.

Inflationary pressures picked up in March. The rate of input cost inflation quickened to a six-month high amid faster increases across both monitored sectors. Service providers indicated that higher operating expenses generally reflected increasing wages, while rising oil and gasoline costs were often mentioned by manufacturers.

In turn, companies in the US raised their own selling prices at a faster pace. In fact, the rate of inflation was the sharpest in just under a year and stronger than the series average. Respective rates of output price inflation accelerated sharply across both manufacturing and services, quickening to 13- and eight-month highs as companies passed through higher input costs to their customers.

Commenting on the data, Chris Williamson, Chief Business Economist at S&P Global Market Intelligence said:

“Further expansions of both manufacturing and service sector output in March helped close off the US economy’s strongest quarter since the second quarter of last year. The survey data point to another quarter of robust GDP growth accompanied by sustained hiring as companies continue to report new order growth.

“The brightest news came from the manufacturing sector, where production is now growing at the fastest rate since May 2022. Production gains are linked to improving demand for goods both at home and abroad, driving a further upturn in business confidence in the outlook.

“Service providers meanwhile reported a slower pace of expansion than factories, with the rate of increase also moderating slightly compared to February, linked in part to ongoing cost of living pressures. However, service providers have also become increasingly optimistic about the outlook, with confidence striking a 22-month high in March to suggest the broad-based economic expansion seen in March will persist into the summer.

“A steepening rise in costs, combined with strengthened pricing power amid the recent upturn in demand, meant inflationary pressures gathered pace again in March. Costs have increased on the back of further wage growth and rising fuel prices, pushing overall selling price inflation for goods and services up to its highest for nearly a year. The steep jump in prices from the recent low seen in January hints at unwelcome upward pressure on consumer prices in the coming months.”

Ed Yardeni:

During his presser last week, Fed Chair Jerome Powell was asked if he was sticking with what he had told lawmakers two weeks earlier, i.e., “we are not far from …[beginning] to dial back the level of restriction.” That statement was premised on his assumption that incoming data would give the FOMC “more confidence that inflation is moving sustainably to 2.0%.” One week after he said so, February’s CPI and PPI reports were a bit hotter than expected.

Yet Powell chose to blow them off in his presser: “I would say that the story is really essentially the same and that is of inflation coming down gradually toward 2% on a sometimes bumpy path, as I mentioned. I think that’s what you still see. We’ve got nine months of 2-1/2 percent inflation now and we’ve had two months of kind of bumpy inflation.”

In the chart below, the black line is where monthly inflation needs to be to achieve a sustained 2% annual rate. The next debate will be on how to define bumpy!

You have surely noted the sharp improvement in the manufacturing PMI sigalling the end of the goods inventory cycle.

Also that “Respective rates of output price inflation accelerated sharply across both manufacturing and services, quickening to 13- and eight-month highs as companies passed through higher input costs to their customers.”

If goods deflation is about to end …

BTW:Source: BofA Global Research

Surveillance Special: Powell Serves Up Words Rather Than Answers  El-Erian hears a signal of Fed tolerance for higher inflation, and so does the market

In the torrent of words from the Federal Reserve’s statement and Chair Jerome Powell’s press conference, some of the numbers stood out. And underneath the data was an implicit suggestion that the Fed is going to stay quite patient on inflation in order to achieve a soft landing.

“This is a signal and the market is taking it as that, that they will tolerate slightly higher inflation for longer,” Mohamed El-Erian said on the Surveillance Fed special today, unpacking a stand-pat rate decision in which nuance was everything. (…)

“As you see in the equity market today, it’s everybody back in the pool,” BlackRock’s Jeffrey Rosenberg said.

When Powell was asked specifically about recalibrating to something other than the Fed’s 2% inflation target, he offered a lot of words and indicated that this wasn’t the case, but didn’t really address it further. He even suggested that the Fed was going to wait a longer period of time for inflation to get to target.

This, of course, raises a philosophical question: How long can the Fed accept hotter-than-desired inflation before policymakers have de facto adjusted the targeted inflation rate? If you say you’re going to be rich one day but you’re happy only earning a penny a day, is it really your goal to be rich?

William Dudley, the former New York Fed president who is now a Bloomberg Opinion columnist, gently pushed back at Jon’s joking suggestion that Powell’s real message was simply “buy stocks.” But he did detect an important tell in Powell’s response to a question about whether financial conditions were too loose.

“He did not take the bait on financial conditions easing,” Dudley said. “And of course when he doesn’t take the bait on financial conditions easing, what does it do? It causes financial conditions to ease more.”

John Authers:

(…) For context, this is Bloomberg’s measure of financial conditions, and it’s almost as lenient as in 2021 when fed funds were being held at zero:

(…) As it was, the market concluded that the Fed didn’t care about inflation — or was perhaps  surreptitiously giving up on lowering it to the official target of 2%. (…)

Unfortunately, Fed governors are no better at predicting the future than the rest of us. Let’s take “long term” to mean four years into the future. This is what the FOMC predicted from 2012 to 2020, with the actual fed funds rate from four years later:

At no point has the fed funds rate been where the FOMC predicted. It stayed far lower than expected throughout the post-crisis decade, then exploded higher — though the governors can be forgiven for not predicting the pandemic. And 2.5% was as high as the rate ever reached in the pre-Covid years. It’s unlikely to fall very far in the future, no matter what the FOMC now thinks.  

Should we talk about the FOMC’s inflation prediction record?