Month: June 2024

US Economy Shows Further Signs of Slowing Under High Rates Thursday data show downward revision to 1Q personal spending

The government marked down personal spending — the main engine of the economy — by half a percentage point to an annualized 1.5% in the first quarter. Separate releases on Thursday showed declines in orders and shipments of certain business equipment, the widest trade deficit in two years, weakness in the job market and a slide in homebuying.

The Atlanta Fed’s GDPNow forecast now pegs second-quarter growth at 2.7%, a downward adjustment from the 3% penciled in before Thursday’s data.

The data highlight how Fed policy that’s kept interest rates at a two-decade high is tempering demand by making borrowing more expensive for everything from consumer goods to home purchases to business equipment. Officials are hoping the moderation in economic activity will put a further damper on inflation.

Another report on Thursday illustrated the impact of mortgage rates around 7% on the housing market. The National Association of Realtors index of contract signings for previously owned homes slumped to the lowest level in records back to 2001.

While monthly figures on Friday are projected to show a moderate rebound in May personal spending, signs of financial strain suggest cooler growth in coming months. After-tax personal income, adjusted for inflation, rose just 1.5% in the first quarter compared with a year earlier — the smallest annual advance since 2022.

Moreover, labor demand — the main source of the income growth that fuels spending — is moderating. Continuing jobless claims, a proxy for the number of people receiving unemployment benefits, climbed to the highest level since 2021. That suggests it’s taking longer for out-of-work Americans to find another job.

Businesses are also feeling the pinch of elevated borrowing costs. The value of core capital goods orders, a proxy for investment in equipment excluding aircraft and military hardware, matched the biggest drop this year, Commerce Department figures showed.

Core capital goods shipments, a figure that is used to help calculate equipment investment in the government’s gross domestic product report, decreased 0.5%, the most in three months. (…)

US Recurring Jobless Claims Rise to Highest Since End of 2021

Continuing claims, a proxy for the number of people receiving benefits, increased to 1.84 million in the week ended June 15, according to Labor Department data released Thursday. Meanwhile, first-time claims ticked down to 233,000 last week, a period that included the Juneteenth holiday.

Hiring has slowed significantly from the pandemic-recovery era of widespread labor shortages and the unemployment rate ticked up last month to 4% for the first time in two years. Economists and Federal Reserve policymakers are watching the claims data for signs of whether the labor market — which so far has been surprisingly resilient — is continuing to soften.

Weekly claims data tend to be volatile, even more so around holidays and school breaks. The four-week moving average, which smooths short-term fluctuations, increased to 236,000, the highest since September.

Initial claims before adjustment for seasonal influences decreased by 3,570 to about 224,400. (…)

Reuters:

Economists are split on whether the recent increase in claims points to rising layoffs or the repeat of volatility experienced during the same time last year.

The elevation in applications was also attributed to a change in policy that came into effect in Minnesota last year allowing non-teaching educational staff to file for unemployment benefits during the summer break.

Unusual seasonality and technical factors are blurring the reading from claims. Employment bounced back in May and recent Layoffs and Discharges stats are not worrisome. Last Friday’s S&P Global’s Flash PMI survey said that employment recorded its largest gain for 9 months.

Nothing gloomy yet.

From Bank of America:

Bank of America internal data can help us understand what’s happening beneath the surface of the still buoyant US labor market. Focusing on job-to-job (J2J) moves, we find little sign of significant slowdown, and the rate of J2J moves is still above 2019 levels.

Currently, there is some evidence of a slowdown taking place in the labor market, but arguably, it is very gradual. Payrolls continue to grow healthily, albeit at a somewhat slower pace than the past year. (…)

Since January 2024, the unemployment rate has risen from 3.7% to 4.0% in May. Is this rise a hint of labor market weakness or a blip? To gain insight into this, we use Bank of America data to look at the ‘Payroll Disruptions Rate,’ (PDR) which we use as a rough proxy for job losses. We define the rate as the proportion of customers who previously had 12 months of regular payroll payments in their accounts, followed by three months without a payment relative to the total number of customers with 12 consecutive months of pay.

Looking at our estimate of the PDR, we find the rate has averaged 0.9% in 2024 so far, in line with the 2019 average (Exhibit 6). In May 2024, we estimate the PDR at 0.8% – suggesting there is no sign here of a deterioration. (…)

Overall, we think the story is one of continued strength. J2J moves remain at levels above 2019 rates and we see no sign of a sharp rise in pay disruptions across any industries, which could potentially indicate some incipient weakness in one sector.

Axios:

Labor shortages that first emerged in the pandemic aftermath are likely to stick around, a new report from the McKinsey Global Institute finds — along with the benefits it entails for workers, headaches it causes for employers, and strains on inflation and growth.

• Businesses will have to figure out how to generate the same output with fewer workers — a big risk for U.S. economic growth, if new technologies like generative AI don’t deliver.
• It is part of a global phenomenon, the McKinsey researchers find, warning that tight labor markets around the world were not merely a blip but a long-term trend that will continue as the Baby Boom generation ages out of the workforce.

“The surplus of unemployed people or job seekers has dwindled to historic lows across the global economy,” Anu Madgavkar, co-author of the report, tells Axios.

• “This is a profound change. It means all of the assumptions that businesses have made — that they could grow relatively easily by hiring people — are being challenged,” Madgavkar adds. (…)

McKinsey found that the number of open jobs per available worker in the U.S. increased by more than seven times between 2010 and 2023.

• Without higher worker participation or efforts to boost productivity, “many advanced economies will struggle to exceed—or even match—the relatively muted economic growth of the past decade,” the report warns. (…)

Data: McKinsey Global Institute analysis of U.S. Bureau of Labor Statistics data; Chart: Axios Visuals

IMF Blasts US for Risky Deficits, Debt, Trade and Bank Rules Fund has grown critical of US fiscal path, China competition

The International Monetary Fund said Thursday that the US is running deficits that are too big and is weighed down by too much debt, and it warned of dangers from increasingly aggressive trade policies.

While calling the world’s largest economy “robust, dynamic and adaptable,” the fund leveled unusually harsh criticism toward the US, its biggest shareholder. It also slightly downgraded its estimate for growth this year to 2.6%, down 0.1 percentage point from its April forecast.

“The fiscal deficit is too large, creating a sustained upward trajectory for the public debt-GDP ratio,” the IMF staff said in a summary of its annual evaluation of the US economy. “The ongoing expansion of trade restrictions and insufficient progress in addressing the vulnerabilities highlighted by the 2023 bank failures both pose important downside risks.” (…)

As a share of gross domestic product, the US deficit is now seen widening for the 2024 fiscal year, which runs through September. The ratio is estimated at 6.7%, compared with a February forecast of 5.3%.

By comparison, European Union nations have a guideline of keeping shortfalls at 3% or less. The US averaged 3.7% over the past half-century, according to the CBO.

The IMF forecast that under current US policies, general government debt is expected to exceed 140% of GDP by 2032.

“There is a pressing need to reverse the ongoing increase in public debt-GDP ratio,” the IMF said Thursday. “These chronic fiscal deficits represent a significant and persistent policy misalignment that needs to be urgently addressed.”

Georgieva, speaking in a press briefing Thursday, said “US debt is sustainable, remains sustainable.’

“Debt levels have gone up, deficit has gone up. Yes, you can carry it,” she said. “But if you can bring it down, you would have an even stronger path for the future.” (…)

Speaking of indebtedness, from Oaktree Management:

We believe we could be on the precipice of one of the most significant real estate distressed investment cycles of the last 40 years. Many traditional lenders, particularly U.S. community and regional banks, are currently facing substantial balance sheet challenges, due to their exposure to commercial real estate, much of which has declined in value significantly since 2020. Consequently, these traditional lenders are now less willing and able to lend just as the real estate market is facing an imposing maturity wall. (…)

Consider the magnitude of the value destruction we’ve seen in U.S. commercial real estate. Valuations in the office sector have declined by 56%, on average, from their previous peak, while values in the multifamily and industrial sectors are down by 33% and 26%, respectively.
CRE exposure is concentrated among banks with under $250 billion in assets, particularly the roughly 4,600 banks with under $50 billion in assets. While the latter represent only around one-quarter of all U.S. banking assets, they hold over half of the CRE assets in the system.

To determine the extent of the potential risk, we conducted an analysis of all federally insured U.S. banks in this sub-$50 billion cohort. The FDIC defines “at-risk” banks as those whose equity-to-asset ratio is below 6%. At-risk banks are subject to increased regulatory oversight and operating limitations and therefore usually face severe liquidity challenges.

Even if we assume that U.S. CRE values have only fallen by 20% from their recent peaks, the number of U.S. banks at risk and the collective assets they hold would exceed what we saw during the Global Financial Crisis.

While CRE values have plummeted across many asset types in recent years, we don’t believe that fundamentals have eroded nearly as much in most sectors, with the notable exception of office.

Also from Oaktree:

Companies that took on too much debt through leveraged buyouts in 2020-21 are increasingly struggling in a higher interest rate environment. (…)

By the end of 2021, upwards of 80% of LBOs were using more than six turns of leverage, and almost 60% of LBOs had leverage exceeding seven times EBITDA.21 However, these massive debt loads appeared sustainable because the cash required to service them was fairly limited in a world where money was essentially free, i.e., when the base rate was near zero.

Of course, these calculations changed dramatically after the Federal Reserve began to raise interest rates in 2022 to combat the spike in inflation. Suddenly, pesky credit statistics – things like the fixed charge coverage ratio and EBITDA-to-interest ratio – didn’t look quite as good for a large swath of companies.

In the past, companies with unsustainable capital structures, rising borrowing costs, and upcoming maturities would typically have defaulted and restructured. However, today, private equity sponsors are often seeking to avoid this outcome by playing the long game and taking on new partners in hopes of salvaging some of their original equity value.

Huawei’s Harmony aims to end China’s reliance on Windows, Android

Packed into a small room, a drone, bipedal robot, supermarket checkout and other devices showcase a vision of China’s software future – one where an operating system developed by national champion Huawei has replaced Windows and Android.

The collection is at the Harmony Ecosystem Innovation Centre in the southern city of Shenzhen, a local government-owned entity that encourages authorities, companies and hardware makers to develop software using OpenHarmony, an open-source version of the operating system Huawei launched five years ago after U.S. sanctions cut off support for Google’s Android.

While Huawei’s recent strong-selling smartphone launches have been closely watched for signs of advances in China’s chip supply chain, the company has also quietly built up expertise in sectors crucial to Beijing’s vision of technology self-sufficiency from operating systems to in-vehicle software.

President Xi Jinping last year told the Communist Party’s elite politburo that China must wage a difficult battle to localise operating systems and other technology “as soon as possible” as the U.S. cracks down on exports of advanced chips and other components.

OpenHarmony is now being widely promoted within China as a “national operating system” amid concerns that other major companies could be severed from the Microsoft Windows and Android products upon which many systems rely.

“This strategic move will likely erode the market share of Western operating systems like Android and Windows in China, as local products gain traction,” said Sunny Cheung, an associate fellow at the Jamestown Foundation, a U.S. defence policy group.

In the first quarter of 2024, Huawei’s HarmonyOS, the company’s in-house version of the operating system, surpassed Apple’s iOS to become the second best-selling mobile operating system in China behind Android, research firm Counterpoint said. It has not been launched on smartphones outside China.

Huawei no longer controls OpenHarmony, having gifted its source code to a non-profit called the OpenAtom Foundation in 2020 and 2021, according to an internal memo and other releases.

But both the innovation centre and government documents often refer to OpenHarmony and HarmonyOS interchangeably as part of a broader Harmony ecosystem. The growth of HarmonyOS, expected to be rolled out in a PC version this year or next, will spur adoption of OpenHarmony, analysts said. (…)

Huawei first unveiled Harmony in August 2019, three months after Washington placed it under trade restrictions over alleged security concerns. Huawei denies its equipment poses a risk.

Since then, China has stepped up its self-sufficiency efforts, cutting itself off from the main code sharing hub Github and championing a local version, Gitee. (…)

Originally built on an open source Android system, this year Huawei launched its first “pure” version of HarmonyOS that no longer supports Android-based apps, in a move that further bifurcates China’s app ecosystem from the rest of the world.

A report from the Jamestown Foundation last month said OpenHarmony’s owner OpenAtom appeared to be coordinating efforts among Chinese firms to develop a viable alternative to U.S. technologies, including for defence applications such as satellites.

OpenHarmony was the fastest-growing open-source operating system for smart devices last year, with more than 70 organisations contributing to it and more than 460 hardware and software products built across finance, education, aerospace and industry, Huawei said in its 2023 annual report.

The aim of making it open source is to replicate Android’s success in removing licensing costs for users and to give companies a customisable springboard for their own products, said Charlie Cheng, deputy manager of the Harmony Ecosystem Innovation Centre, when Reuters visited.

“Harmony will definitely grow into a mainstream operating system, and will give the world a new choice of operating system besides iOS and Android,” he said. “China is learning from the West.” (…)

While OpenHarmony is largely confined to China, Brussels-based open-source group the Eclipse Foundation said it was using it to develop a system called Oniro for use in mobile phones and internet-of-things devices.

China’s previous efforts to build major open-source projects have struggled to gain traction among developers, but Huawei’s growing smartphone market share and extra work to develop a broader ecosystem gives Harmony an advantage, analysts said.

More than 900 million devices, including smartphones, watches and car systems are running on HarmonyOS, while 2.4 million developers were coding in the ecosystem, Huawei’s Yu said this month. (…)

China’s Xi calls for ‘bridges’ amid trade, diplomatic frictions

Chinese President Xi Jinping called on Friday for the building of “bridges” in the global economy, as Beijing grapples with economic, trade and territorial disputes with neighbours and trading partners.

The world’s second-largest economy will never leave the road of peaceful development, Xi told a conference to commemorate China’s guiding principles for foreign affairs, first formulated 70 years ago.

It will also not become a “strong” state seeking to dominate others, Xi told an audience that included Myanmar’s former president, Thein Sein, and Nong Duc Manh, the former general secretary of the Vietnamese Communist Party.

“Facing the history of peace or war, prosperity or unity or confrontation, more than ever before, we need to carry forward the spirit and connotation of the Five Principles of Peaceful Coexistence,” Xi said. (…)

After China brokered an unexpected detente between Iran and Saudi Arabia last year, China’s top diplomat, Wang Yi said the country would continue to play a constructive role in handling global hotspot issues.

But Beijing’s unwillingness to condemn Russia‘s invasion of Ukraine and its pursuit of a “no-limits partnership” with Moscow present hurdles to that ambition. (…)

“In the era of economic globalisation, what we need is not to create chasms of division, but to build bridges of communication, and not raise the iron curtain of confrontation but to pave the way of cooperation,” Xi said. (…)

New Home Sales Plummet 11.3% in May

The May release for new home sales from the Census Bureau came in at a seasonally adjusted annual rate of 619,000 units, lower than the 636,000 forecast. New home sales are down 11.3% month-over-month from a revised rate of 698,000 in April and are down 16.5% from one year ago. (…)

Dollar Soars to Fresh 2024 High as Fed Diverges From Major Peers Greenback’s gain pressures yen, which hits lowest since 1986

The dollar rose to its highest level since November amid speculation that the Federal Reserve will break with other central banks by keeping interest rates elevated, giving global investors an incentive to shift cash to the US to capture higher bond yields. (…)

“The US economy remains resilient, and the case for an imminent rate cut isn’t clear unless the data soften, meanwhile, central banks elsewhere are cutting,” said Kit Juckes, chief FX strategist at Societe Generale SA. (…)

Revival Gathers Speed Except in Europe: Bloomberg Trade Tracker

A string of indicators suggest a recovery in trade is taking hold almost everywhere outside of Europe, whose biggest economy is beset by a grim business outlook.

Bloomberg’s Trade Tracker showed the best reading in years, with nine of the 10 key measures of global commerce back in “normal” territory in June. Shipping volumes bounced back in Hong Kong’s ports, while export orders out of the US increased. An upturn in the tech sector, driven by the swift expansion of AI, ensured chips and electronics makers like Singapore, Taiwan and South Korea maintained their momentum.

The only one left in the red was Germany, where business expectations worsened anew. Factories reported weak order books, while consumers remained cautious despite rising incomes and cooling inflation. Reports of company insolvencies and restructuring could also hit the labor market in Europe’s largest economy. (…)

The Goldman Sachs Analyst Index (GSAI) is a monthly economic indicator based on a survey of Goldman Sachs equity analysts to assess business conditions in the industries they follow.

The GSAI jumped 17.7pt to 64.1 in June, its highest level since May 2022. The composition was strong, as the shipments, new orders, and employment components all increased notably. (…)

GSAI Reaches Two-Year High in June

Source: Institute for Supply Management, Goldman Sachs Global Investment Research

The GSAI’s activity components were strong in June. The sales (+15.9pt to 65.0) and new orders (+20.7pt to 68.3) components both increased notably to their highest levels since December 2023. The exports component decreased (-10.0pt to 50.0). Both the inventories component (+17.7pt to 75.2) and the orders less inventories gap (+3.0pt to -6.9) increased. (…)

The GSAI’s labor market components rose, as both the employment (+11.6pt to 55.6) and wages (+17.8pt to 63.3) components increased. (…)

Biggest Banks Can Withstand Severe Downturn, $685 Billion in Losses, Fed Says The latest stress tests found banks remained above minimum capital requirements.

This year’s exercise measured the 31 biggest banks’ ability to maintain strong capital levels in a hypothetical recession marked by double-digit unemployment and a severe stock-market decline.

The banks would collectively lose nearly $685 billion in the Fed’s imaginary worst-case recession, the Fed said. That would be more than last year, but all the banks would still remain above their minimum capital requirements.

The banks were expected to lose more in this year’s test because they faced higher projected credit-card losses, riskier corporate loans and lower projected income, the Fed said. (…)

The annual exercise aims to project confidence about the health of the banking system. If banks do poorly, they could face automatic restrictions on shareholder distributions and discretionary bonus payments. None of the banks face those limits after this round of tests.

Wednesday’s results could give banks and their lobbyists more ammunition to push back against large increases in capital requirements, which the Fed and other regulators have floated. Supporters of the plan say it will improve the overall resilience of the financial system after a spate of regional bank failures last year.

This year’s stress test included a severe global recession in which the U.S. unemployment rate jumps to 10%, housing prices crash by 36% and commercial real-estate prices drop by 40%.

Another wrinkle in this year’s tests, an “exploratory analysis” of the system suggests banks could withstand a repeat of the deposit crisis of 2023 or a potential catastrophe in hedge funds. The biggest banks could in the aggregate lose up to $85 billion if five big hedge funds failed, the Fed found.

Those scenarios have no impact on bank capital requirements. (…)

AI CORNER

OpenAI’s China Block to Reshape AI Scene as Big Players Pounce

OpenAI’s abrupt move to ban access to its services in China is setting the scene for an industry shakeup, as local AI leaders from Baidu Inc. to Alibaba Group Holding Ltd. move to grab more of the field.

The ChatGPT creator this week sent memos to Chinese users warning it will cut off access to its widely used AI development software and tools from July, triggering a scramble to fill the void. Since Tuesday, at least a half-dozen companies and startups including Tencent Holdings Ltd. and Zhipu AI began offering incentives to developers making the switch.

OpenAI’s shift will accentuate the divide between China and the US, which is trying to curb Beijing’s AI and chip efforts. While the startup’s exit offers an opportunity for sector leaders to grow their user base, it also deprives entrepreneurs and cash-strapped startups of some of the best tools available to fine-tune or get their AI applications off the ground.

For China, that could help usher out many smaller startups created during the “battle of a hundred models,” in the wake of ChatGPT’s late 2022 debut. And a bigger concern may be whether open-source models like Meta Platforms Inc.’s Llama also cut off access, said Bernard Leong, chief executive officer of Singapore-based Dorje AI. (…)

US firms such as OpenAI, Meta and Alphabet Inc. have led the world in generative AI, which spits out text, images and video from simple commands. Underpinning those models are application programming interfaces that developers use to build up and refine their own platforms to integrate services either with the likes of ChatGPT, or their own proprietary models.

That was a boon to Chinese developers starting from scratch, who accessed OpenAI’s tools through virtual private networks or other ways around the country’s Great Firewall. Many local developers — particularly those without deep pockets — favored training AI systems and applications via OpenAI’s tools, because they were regarded as industry benchmarks.

OpenAI is now threatening to sever the connection.

“(…) it will make it harder for Chinese developers to use the most advanced global AI algorithms.” (…)

OpenAI’s move coincides with rising pressure from Washington to curb Chinese access to the most advanced artificial intelligence and semiconductor technology. The US Treasury Department advanced plans over the weekend to further restrict investments by US individuals and companies into China, with a focus on curtailing next-generation technologies.

In the long run, industry experts say a lack of access to global tools may further impede Chinese AI players in general as they play catch-up to the US. Alibaba Chairman Joe Tsai has said it would take at least two years for homegrown AI models to match US ones.

It could also accelerate a migration overseas by Chinese tech startups seeking faster-growing markets with less political uncertainty. (…)

I’m not so sure where exactly there is more or less political uncertainty in the world.

Let’s also not sell Chinese tech short.

FYI, (from my son David):

“What’s this you ask? This is the paper announcing the new leader in LLM coding performance – and the list of engineers who achieved this. It surpasses the big three (Google, OpenAI and Claude) AND it is open source. The company DeepSeek was launched… in 2023 in Hangzhou, China.”

• Can China’s AI Technology Compete With the US?  https://www.youtube.com/watch?v=UitJxc9LE60
• China’s Xiaomi just showed Apple how a smartphone maker actually can make an EV

(…) For Lei Jun, Xiaomi’s billionaire cofounder and CEO, the launch marks an extraordinary feat: his EV managed to go on sale just three years after his company said it was venturing beyond consumer electronics into EVs. (…)

Like Apple, Xiaomi is best known for selling smartphones. Data from Counterpoint Research found that in the first six weeks of the year, Xiaomi has a 13.8% share of the smartphone market in China, putting it just behind Apple’s 15.7%. (…)

Xiaomi has managed to pull off something Apple dreamed about for 10 years. Tim Cook might have to look on from Cupertino to see what could have been.

That was in March 2024.

In May:

Xiaomi SU7 Reviewed: Yes, China’s Apple Car Is That Good

Within 24 hours of the Xiaomi SU7 making its grand debut in China earlier this year, about 100,000 people put down a deposit for an electric vehicle from a company that had never made a single car before. Even by the standards of some of the EV startups that have come and gone over the years, that’s a mind-blowing statistic. How did that happen, exactly?

To understand that, you have to understand Xiaomi. And you may just start to understand just how far ahead China’s EV industry has become. (…)

Xiaomi’s SU7 (pronounced “Soo-Seven”) has been described as China’s Apple Car, and for good reason. As Ethan explains, Xiaomi is a household name in China (and much of the rest of the world) for manufacturing TVs, battery packs, smartphones, washing machines… well, basically everything in the world of smart devices. It’s as robust as any consumer goods company with advanced software shared across most of those gadgets.

So naturally, if you’re in the Xiaomi device ecosystem already, a car built around that makes sense; we see the same appeal with Apple CarPlay and Android Automotive here. But Xiaomi’s approach goes deeper, and as an added bonus, the car looks kind of like a budget Porsche Taycan. (…)

Even if you’re not a fan of China or its EVs, you can start to see the appeal. Even more so when you get inside, when you can tell your car to turn on your Xiaomi smart home air conditioner, your Xiaomi smart lights, or check on your dog with your Xiaomi home camera… you get the idea. It executes on the idea Apple had, something that’s tied more directly to your other devices than ever before. (…)