Empire State Factory Sector Index Declines Sharply

The Empire State Factory Index of General Business Conditions deteriorated this month to its lowest level since the recession. The latest figure dropped to -14.92 from an unrevised 3.86 in July. It was the lowest level since April 2009. The latest disappointed expectations for 4.4 in the Action Economics Forecast Survey.

Based on these figures, Haver Analytics calculates a seasonally adjusted index that is compatible to the ISM series. The adjusted figure fell sharply to 45.0, also a six-year low. Since inception in 2001, the business conditions index has had a 62% correlation with the change in real GDP.

Declines in the component series were broad-based this month, but most pronounced in inventories, new orders and shipments. Unfilled orders, delivery times and the average workweek also posted negative readings. The number of employees remained positive, but it was at the lowest level since December 2013. During the last ten years there has been a 72% correlation between the employment series and the m/m change in factory sector payrolls.

The prices paid index eased to 7.27, the lowest point since May 2009. Eighteen percent of respondents reported higher prices but a sharply increased 11 percent paid less, the most since July 2009. Prices received also deteriorated modestly.

Despite the weakening of current business conditions, a sharply increased 42.7% of respondents expected improvement, near the high end of this year’s range. Each of the component series exhibited m/m gain except prices paid and technology spending.

This optimism is despite a collapse in new orders which have been falling in each of the last three months. . (Chart from Doug Short)

Housing Starts in U.S. Climbed in July to Almost Eight-Year High

Residential starts rose 0.2 percent to a 1.21 million annualized rate, the most since October 2007, from a 1.2 million pace in the prior month that was higher than previously estimated, a Commerce Department report showed Tuesday in Washington.

The increase in starts last month was led by a 12.8 percent gain in construction of single-family houses, taking them to a 782,000 rate, the most since December 2007.

Work on multifamily homes, such as condominiums and apartment buildings, fell 17 percent to an annual rate of 424,000. Data on these projects, which have led housing starts in recent years, can be volatile.

Two of four regions showed increases in starts last month, led by a 20 percent gain in the Midwest, the report showed.

Permits decreased to a 1.12 million annualized rate. The 16.3 percent drop was the biggest since July 2008.

Authorizations have been see-sawing because of changes in legislation in the Northeast, where permits plunged by 60 percent last month. Still all four regions of the country saw declines in July. (Chart from Doug Short)

U.S. Home-Builder Confidence Hits Near-Decade High

An index of builder confidence in the market for new single-family homes rose one point to a seasonally adjusted level of 61 in August, the National Association of Home Builders said Monday. (…)

The current-sales component of the index rose this month to 66 from 65 in July. Expectations for sales over the next six months stayed steady at 70. A measure of traffic from prospective buyers rose two points to 45.

The three-month moving average of the builders gauge by region posted gains in August in three out of four areas from the prior month’s revised figures, and the Northeast stayed constant at 46. The West and Midwest each gained three points, to 63 and 58, respectively. The South rose by two points to 63. (Chart from Bespoke Investment)

U.S. Lacks Ammo for Next Economic Crisis As the U.S. economic expansion ages and clouds gather overseas, policy makers worry about recession. Their concern isn’t that a downturn is imminent but whether they will have firepower to fight back when one does arrive.

(…) With the U.S. expansion entering its seventh year, policy makers are planning how to respond to the next downturn, which history shows is inevitable. The current expansion is now 16 months longer than the average since World War II, and none has lasted longer than a decade. (…)

The Fed’s strategy of keeping interest rates low well into an expansion is intended to help avoid a relapse into recession. Fed Chairwoman Janet Yellen has described low rates as insurance against another downturn. (…)

Many economists believe relief from the next downturn will have to come from fiscal policy makers not the Fed, a daunting prospect given the philosophical divide between the two parties. (…)

Federal debt has grown to 74% of national output, from 39% in 2008. To restrain short-term budget deficits, Congress and the White House agreed earlier this decade on a mix of spending cuts and tax increases. In all, total state, local and federal government spending, adjusted for inflation, shrank 3.3% since the recovery began in 2009, compared with an average increase of 23.5% over comparable periods in past postwar expansions.

While federal debt is high by historical norms, the budget deficit has narrowed to around 2.4% of national output. That provides the U.S. with a bit of fiscal breathing room. Even with steady economic growth, however, deficits are projected to surpass 3% by the end of the decade, pushing debt higher still, according to the Congressional Budget Office. (…)

CHINA: SLOW AND SLOWER

PBOC Injection Shows China Worries About Outflows

China’s central bank injected the largest amount of cash into the financial system on a single day in almost 19 months Tuesday, signaling Beijing’s growing concerns about capital outflows following the recent weakening of its currency.

Short-term interest rates and bond yields in the world’s second-largest economy have spiked in the past week, following an abrupt decision by the Chinese authorities to devalue the yuan last week.

As China’s economic slowdown continues and the central bank spends more foreign reserves to prevent the yuan from a free fall, Beijing will need to take more decisive measures to keep funds flush and borrowing costs low, such as by cutting banks’ reserve requirements, analysts say. The People’s Bank of China has been selling some of its dollar holdings to prevent the yuan from slipping further against the dollar.

In a routine money-market operation Tuesday, the People’s Bank of China offered 120 billion yuan ($18.77 billion) worth of seven-day reverse repurchase agreements, or reverse repos, which are a short-term loan to commercial lenders in the money market.

The cash injection marks the biggest of its kind since Jan. 28, 2014, when the PBOC offered 150 billion yuan via the 14-day reverse repos. (…)

The weighted average of the overnight repurchase agreement rate, a benchmark measure of short-term borrowing costs between commercial banks, is now at 1.72%, up from 1.57% on the eve of the yuan’s devaluation. (…)

According to the PBOC, the Chinese central bank and financial institutions sold a net 249.1 billion yuan worth of foreign exchange in July, marking the second month in a row of net sales. In June, total net sales stood at 93.7 billion yuan.

Most economists view the figures as a proxy for inflows and outflows of foreign capital as most foreign currency entering the country is generally sold to the central bank. (…)

This is also a risk for the Fed. AS the PBoC sells some of its foreign reserves, it will likely sell U.S. Treasuries, putting upward pressure on U.S. interest rates.

Has Beijing Lost Its Economic Touch? As economic managers, Chinese leaders have been in a league of their own for the past quarter century. Now, they appear to be floundering.

(…) According to international economists who’ve been briefed at a high level in Beijing, it became clear that regulators didn’t have a clear picture of huge money flows from the banking system to the stock market that were inflating a bubble. Fear of unknown dangers took over when shares changed course. At that point, the government decided to override the market and assert control, despite leadership assertions that markets must be given a greater role.

Stock prices are now supported by massive government buying — and warnings to large investors not to sell. But investor confidence is fragile: On Tuesday the Shanghai market tumbled more than 6%. (…)

Confusion, too, has surrounded currency moves this month. Ostensibly, the sharpest reduction in the value of the yuan since 1994 was meant to usher in a more market-based trading system, and as such was cautiously welcomed by the International Monetary Fund. In practice, the central bank is intervening to influence the currency’s level against the dollar, just as it has done for decades.

At any rate, the ambiguity rattled stock markets and currencies around the world. At a time when deft management is needed more than ever, policy miscues and confusing explanations have sent worrying signals to investors that a steady leadership hand is being replaced by a panicked reflex to avoid an economic stall. (…)

China facts from Ed Yardeni:

China shadow banks appeal for bailout Collapse of guarantor threatens nearly 50 financial institutions

(…) Eleven shadow banks have written an open letter to the top Communist party official in northern China’s Hebei province asking for a bailout that would enable the bankrupt company to backstop loans to deadbeat borrowers. If the guarantor cannot pay, it could spark defaults on at least 24 high-yielding wealth management products (WMPs).

Analysts worry that a series of bailouts in recent years has encouraged irresponsible lending by fuelling the perception the government will not tolerate default. The latest appeal for a bailout will again force officials to choose between ensuring short-term financial stability or imposing market discipline on investors, which should improve lending practices in the long term.

Hebei Financing Investment Guarantee Group has guaranteed Rmb50bn ($7.8bn) in loans from nearly 50 financial institutions, according to Caixin, a well-known financial magazine. More than half of this total is from non-bank lenders, mainly trust companies, who lent to property developers and factories in overcapacity industries 

The letter appeals directly to the government’s concern about social stability and the fear of retail investors protesting the loss of “blood and sweat money”. The 11 companies sold 24 separate WMPs worth Rmb5.5bn.

“The domino effect from the successive and intersecting defaults of these trust products involves a multitude of financial institutions, an immense amount of money, and wide-ranging public interests,” 10 trust companies and a fund manager wrote to Zhao Kezhi, Hebei party secretary. (…)

• China slowdown weighs on Russia

• Japan’s GDP Sinks in Q2

• Thai Economic Growth Rises 2.8% In the first quarter of 2015, GDP grew 3% from a year earlier.

• Malaysia’s Economy Expands 4.9% Malaysia’s economy grew 5.6% year-over-year during the first quarter.

• China’s devaluation adds to EM woes

(…) The rout has been fierce and broad. Turkey’s lira, the Mexican peso and South Africa’s rand all touched new record lows versus the dollar on Monday, while the currencies of Malaysia and Indonesia slumped to their lowest since the Asian crisis of 1998. JPMorgan’s EM Currency Index has now declined 2.4 per cent this month, to its lowest reading since it was first calculated in 2000.

The pain is also being felt in equities and bonds. The difference between the trailing price-to-earnings ratios of EM and global stock markets is now the widest since the financial crisis.

Likewise, while bonds across the developed world have rallied on concerns that China’s devaluation could exacerbate deflationary forces, EM fixed income has mostly been thumped. (…)

• Currency Woes to the South Currencies in major Latin American countries are tumbling in the face of falling commodity prices, a sluggish growth outlook in China and fears of an imminent rate increase by the Federal Reserve.

Latin America has been at the forefront of a global selloff in emerging markets ahead of an expected increase in U.S. interest rates as the American economy improves. With rates low in the U.S., investors had flocked to emerging markets, where yields were higher and assets denominated in foreign currencies held out the promise of potential profits.

Many economies in the region also rely heavily on exports of commodities, and, therefore, the economic strength of China, which in recent years has been a big consumer of commodities. The latest bout of currency weakness was in part triggered by last week’s devaluation of the Chinese currency. A cheaper yuan would hurt China’s purchasing power for commodities produced in Latin America, such as copper and oil.

China is the biggest consumer of Chile’s copper, while Colombia and Mexico ship a significant amount of crude oil to China. (…)

Many large companies in these countries have large amount of USD debt. The strength in the dollar boosts servicing costs, forcing these commodity producers to keep producing even with low prices.

SENTIMENT WATCH

This is from Pictet Wealth Management displayed on the FT’s front page.

Overvalued equities can keep rising Central banks’ informal policy style puts floor under asset prices

(…) As central banks, led by the Fed, end QE and zero rates, asymmetric asset price targeting is emerging as the implicit new policy style. Implicit, in that this is not a policy style formally announced by central banks. And asymmetric, in that it continues to involve a floor but not a cap for asset prices. The targets are broadly unchanged: maintaining a wealth effect, keeping down financing costs, expanding the credit cycle, and hence boosting lacklustre economic growth. (…)

The 12-month forward price/earnings ratio is at 16.7 for the S&P 500 and 15.6 for the Euro Stoxx 600, well above historical averages (since 1988, excluding bubbles) of 14.1 and 11.7 respectively. Meanwhile, long-term interest rates have been driven below fundamental levels.

Against this background, what are the implications for investors of the new policy style? A key conclusion is that although developed market equity valuations are stretched, they could continue to rise — contrary to consensus, which is tending to neutral or underweight. (…)

The current bullishness is built less on earnings growth, which remains low, and more on valuation expansions, which account for around four-fifths of the rise in the Stoxx 600 this year. With monetary policy supportive, assuming that economic growth matches expectations — not too hot, which would force a sharper than expected tightening of policy, and not too cold, as that would disappoint expectations — valuation expansions can continue. (…)

Wal-Mart Cuts Outlook

Home Depot Lifts Guidance Amid Housing Recovery