Initial Jobless Claims Increase More Than Expected

Initial jobless claims increased 22k to 231k in the week ended May 4, the highest level since the week ended August 26, 2023. The four-week moving average of claims increased by 5k to 215k. Claims increased by 12k in New York, by 3k in California and Indiana, and by 2k in Illinois, and decreased by 2k in Iowa.

New York jobless claims had been unusually low over the last two weeks, and we suspect that seasonal adjustment difficulties around the end of the academic year could explain some of the increase in jobless claims in the state. Nationwide continuing claims—the number of persons receiving benefits through standard programs—increased 17k to 1,785k in the week ended April 27. (GS)

Bank of Canada warns of steep jump in mortgage payments

Homeowners who are due to renew their mortgages over the coming years will face steep jumps in payments, according to the Bank of Canada, with the median monthly payment increasing by more than 60 per cent for those with a variable rate mortgage.

So far, many homeowners have been able to weather the sharp rise in interest rates, with residential mortgage defaults remaining below 0.5 per cent across Canada, the central bank said in its annual Financial Stability Report, published Thursday.

But the report warns that the ability of households and businesses to service their debt has become one of the main risks to the stability of the country’s financial system.

“If more Canadians lose their jobs, the unemployment rate goes up, all of a sudden that stress, that vulnerability is really at risk of crystallizing,” Governor Tiff Macklem said in a press conference about the report.

“More households won’t be in a position to pay that mortgage, particularly given the larger reset. So it is a vulnerability. And the point here is households and banks need to get ahead of that. We know what’s coming.”

Since the central bank started aggressively hiking interest rates in March, 2022, about half of the country’s outstanding mortgages have renewed at higher rates. This process has gone relatively smoothly, according to the bank, as income growth, accumulated savings and a pullback in spending has helped homeowners handle the higher rates.

Indeed, the report showed that renters are facing greater financial stress than homeowners, and have been increasingly missing payments on car loans and credit cards.

The next phase of mortgage resets, however, could be more painful. Many people whose mortgages are scheduled to renew over the next two years purchased their home early in the pandemic, when the bank’s policy interest rate was at an emergency low of 0.25 per cent. It has since risen to 5 per cent. (…)

Those that will shoulder the largest payment increase are homeowners who have a variable rate mortgage with a fixed monthly payment, where the monthly payment has remained the same throughout the term of the mortgage. For those mortgage holders, the steepest rise will occur in 2026, with the median monthly payment rising by more than 60 per cent, according to bank estimates. In 2025, the median increase is more than 50 per cent; this year, about 30 per cent.

For those with a fixed-rate mortgage, where the interest rate does not change over the loan term, the shock at renewal time will not be as great. Fixed-rate mortgages are based on longer-term bond yields, which have fallen since the autumn. The bank estimates that the sharpest rise will occur in 2026, with the median increase being more than 20 per cent. (…)

The report says the office real estate market is under pressure with office vacancies rising in major cities. That includes Toronto, the country’s financial capital, where the vacancy rate is nearing 20 per cent.

Small to medium-sized banks had the highest exposure to the commercial real estate sector with their loans accounting for 20 per cent of their portfolio, according to the report. For large banks, commercial real estate loans made up 10 per cent of their portfolio.

As a whole, the banking sector is in fairly good shape to handle potential losses, the report says. Canada’s large banks have sizeable liquidity and capital buffers, and they’ve built loan-loss provisions, which provide a buffer if borrowers default. (…)

A similar divide appears to exist between smaller and larger non-financial businesses. The report says large companies are handling their debt fairly well. In contrast, small business insolvencies have risen sharply over the past year. This is likely the result of both higher borrowing costs and an end of pandemic-era government support programs, the report says. (…)

Biden Set to Impose Tariffs on China EVs, Strategic Sectors China’s strategy of ramping up manufacturing to arrest an economic slowdown at home has triggered alarm abroad.

President Joe Biden’s administration is poised to unveil a sweeping decision on China tariffs as soon as next week, one that’s expected to target key strategic sectors while rejecting the across-the-board hikes sought by Donald Trump, people familiar with the matter said.

The decision is the culmination of a review of Section 301 tariffs first put into place under Trump starting in 2018. The new tariffs will focus on industries including electric vehicles, batteries and solar cells, with existing levies largely being maintained. An announcement is scheduled for Tuesday, two of the people said.

While a decision could be delayed, it nonetheless represents one of Biden’s biggest moves in the economic race with China. It builds on his call last month to hike tariffs on Chinese steel and aluminum, and the formal launch of a fresh probe into China’s shipbuilding industry. (…)

President Xi Jinping’s strategy of ramping up manufacturing to arrest an economic slowdown at home has triggered alarm abroad. US and European Union leaders have scolded Beijing over state support that they say has fueled a deluge of cheap exports that threaten jobs in their markets. The EU launched an EV subsidy investigation in October that may lead to additional tariffs by July.

The US is standing up to China’s “unfair economic practices and industrial overcapacity,” Biden said last month. “I’m not looking for a fight with China. I’m looking for competition, but fair competition.”

The tariffs would likely have little immediate impact on Chinese firms, since its world-beating EV manufacturers have steered clear of the US market due to tariffs. Its solar companies mostly export to the US from third countries to avoid curbs, with US firms seeking higher tariffs on that trade, too. (…)

Trump has promised to hike tariffs on China across the board if reelected, vowing a 60% tax on all Chinese imports. Many Democrats have dismissed that approach, in part because it would raise prices for US consumers grappling with inflation. (…)

The move comes after Biden last month proposed new 25% tariffs on Chinese steel and aluminum as part of a series of steps to shore up the American steel sector and woo its workers in an election year. That vow was viewed as largely symbolic, because China currently exports little of either metal to the US.

Beijing responded with restraint to the threat of metal curbs, imposing tariffs on US propionic acid, an export market worth $7 million to America last year, according to customs data. Still, ramping up tariffs on a broader spectrum of industries could prompt a stronger response from Chinese officials.

The full range of existing duties spans imports from industrial inputs, such as microchips and chemicals, to consumer merchandise including apparel and furniture. Trump imposed the first of the tariffs in 2018, citing section 301 of the Trade Act of 1974.  (…)

RESTRICTIVE?

Fed’s Daly Says ‘More Time’ Needed for Restrictive Rates to Work

(…) “We are restrictive, but it might take more time to just bring inflation down,” Daly said Thursday during a moderated discussion at George Mason University’s Mercatus Center, echoing remarks Fed Chair Jerome Powell made on April 16. (…)

“There’s considerable now uncertainty about what the next few months of inflation will be and what we should do in response,” she said. (…)

No restraint there:

There’s a party in global credit, and (almost) everyone is invited.  Investment-grade firms priced some $53 billion of bonds from Monday through Wednesday per Bloomberg compiled data, the busiest three-day period since 2021.  Junk supply likewise registered at a healthy $11 billion over that stretch, marking the most active week since February with two sessions to spare, while European high- and speculative-grade borrowers priced roughly $23 billion despite an array of holidays on the Old Continent.

Lenders and borrowers alike are living their best lives these days, as credit spreads for both junk-rated and high-grade firms sit near their tightest of the post-crisis era, while meaty all-in rates relative to the ZIRP-era norm helps drive investor interest. 

Underscoring the serendipitous state of play: single-B-rated Citrix Systems parent Cloud Software Group sold $1.8 billion in eight-year bonds yesterday at an 8.25% yield, Bloomberg relays, with ravenous demand serving to balloon the offering from an initial $1 billion. Wednesday’s result marks a diametric shift from the aftermath of Citrix’s January 2022 Elliott Investment Management and Vista Equity Partners-led leveraged buyout, in which syndicate banks eventually ate a $1.5 billion loss after struggling to offload the cloud computing firm’s debt for months during the post-Covid bond market swoon.

Today’s free and easy conditions likewise extend to leveraged loans, long a key cog in the private equity machine. Dollar denominated issuance over the first four months of the year reached $395 billion according to Fitch Ratings, already topping the $377.6 billion in volume seen throughout last year and far above the $250 billion logged in calendar 2022. Refinancing and repricing transactions accounted for more than 80% of activity from the start of January through April. (Almost Daily Grant)

SMALL VS LARGE

Addendum to my April 29 post Small vs Large. This is from Torsten Slok, Apollo’s chief economist:

Middle-Market Firms Hit Harder by Fed Hikes

Forty-one percent of companies in the Russell 2000 have negative earnings, see the first chart.

With this backdrop, it is unsurprising that Fed hikes have a more negative impact on small-cap and middle-market companies than on large-cap companies, see the second chart.

The negative impact can be felt in particular in tech, enterprise software, venture capital, and similar firms with no earnings and no revenue.

THE SWIFT ECONOMY

Americans flock to Taylor’s Swift’s Eras Tour in Europe

Swift’s tour was credited with boosting local economies across the U.S. last year. Many European cities are anticipating the same boom.

• Many fans are taking advantage of significantly cheaper ticket prices, thanks to tighter regulations on fees and resales in Europe.
• Americans have already bought up 20% of the tickets for Swift’s four sold-out Paris shows, per AP.

The Eras Tour shows in Paris are also attracting five times more luxury travelers from the U.S. than anticipated travelers for this summer’s Olympic Games in the French capital, Bloomberg reported.

• About 10,000 Americans are expected to attend the Eras Tour shows in Stockholm alone, per AP.

Tickets for Swift’s remaining U.S. shows — in Miami, New Orleans and Indianapolis — have skyrocketed since she dropped her latest album The Tortured Poets Department last month.

• The average lowest ticket price is a whopping $2,600 per ticket, Billboard reported, citing data from TicketIQ.
• By comparison, the average lowest ticket price for her Paris kickoff show is $340 per ticket — about 87% cheaper. Tickets are even lower on some of her other stops, like Stockholm and Lisbon, per Billboard.

In many of Swift’s planned European stops, hotel and short-term rental prices have spiked and seen increased booking rates well in advance of her arrival, the Guardian reported.

• Stockholm’s Chamber of Commerce said in March that it anticipates the Eras Tour shows to pump more than $46 million into the local economy.
• It’ll be a “real hit,” according to chief economist Carl Bergkvist.

Profits Are Booming—and That’s Shielding the Economy CEOs are upbeat, and results are on the upswing. The somewhat slower job growth reported last week isn’t the same as a major downturn.

(…) The bulk of U.S. companies have now reported first-quarter results, and they show profit growth is picking up. Earnings per share for companies in the S&P 500 now look to be up 5.2% from a year earlier, according to FactSet, better than the 3.4% analysts expected at the end of March, and marking the strongest growth in nearly two years.

Company results coming in ahead of the estimates is a regular occurrence. More unusually, analysts also spent last month lifting their current-quarter estimates. They now expect second-quarter earnings per share to gain 9.8%, compared with 9% at the end of March. The last time analysts spent the first month of a quarter raising rather than lowering earnings estimates was during the fourth quarter of 2021, according to FactSet earnings analyst John Butters.

Corporate profits are important because they show the U.S. economic engine continues to purr. While some other economic indicators, such as consumer-sentiment readings, have been downbeat, and inflation has ticked up, a strong U.S. profit performance typically points toward continued expansion.

The drift higher in earnings estimates might be because companies, instead of feeling a need to temper analysts’ optimism and nudge estimates lower, are upbeat themselves. Among companies in the S&P 500, the term “recession” showed up in just 100 transcripts of earnings calls, investor events and conferences recorded in the first quarter, according to FactSet. That was down from 302 in the first quarter of 2023, and the fewest in two years.

Survey-based measures of corporate sentiment have picked up. The Business Roundtable’s index of chief executive officers’ economic outlook rose to the highest level in the first quarter since the second quarter of 2022. Indexes of CEOs’ hiring and capital-spending expectations have gained ground. A survey of chief financial officers conducted by Duke University’s Fuqua School of Business with the Federal Reserve banks of Atlanta and Richmond showed a similar increase in optimism.

“There is not a reason if profits are good to retrench,” said the Duke economist John Graham, who directs the CFO survey. Moreover, many CFOs say their companies are still struggling to attract workers.

For now, Graham thinks companies are in the mode of adding workers when the profit outlook is good, and holding employment steady if the outlook becomes shaky, rather than shedding the employees they put so much effort into hiring. So even if earnings do falter, companies might be slow to turn to layoffs. (…)

Initial claims for unemployment insurance—a leading indicator of layoff activity—have remained low. (…)

True for S&P 500 companies.

Not for mid and small caps where profits and margins are not rising as Ed Yardeni illustrates:

And not for very small biz:

  

• NFIB Job openings are now back in line with levels reached before the pandemic (2017-2019).

• Job creation plans are below what would be typical in a strong growth economy.

• Labor cost reported as the single most important problem for business owners increased 1 point to 11 percent, only 2 points below the highest reading of 13 percent reached in December 2021.

Data: Goldman Sachs 10,000 Small Businesses Voices. Chart: Axios Visuals

Employment reports indicate strong labor markets, but it is less clear where all these jobs are being created. Non-professional services spending is strong, but not strong enough to explain the reported job creation. GDP growth was weak in the first quarter, so where are all those job increases occurring? Small businesses are not reporting net gains in employment. Job reports have been puzzling for some time now, and with an election at hand may remain so until after the election. (NFIB)

Yes, large companies are doing very well, but they are not the economy.

Investors are totally cognizant of these trends (charts courtesy of Ed Yardeni):

• S&P 500/S&P 600

• S&P 100/S&P 500

• S&P 500 equal-weighted/market cap-weighted

Perhaps the real shield to the economy is from the wealth effect from equities and housing.

The economy looks pretty great for Americans who own their own homes — that’s nearly 66% of the population! A record $11 trillion of home equity is “tappable,” meaning homeowners can borrow against it while maintaining at least 20% equity in the house, per the report, which looks at data from March. About 48 million folks have access to tappable equity, with an average of $206,000 per mortgage holder.

Data: ICE; Chart: Axios Visuals

• Royal Caribbean recruiting thousands to meet surging demand, sources say The company confirmed it will hire around 10,000 workers this year

As to employment, so far, so good but recall these charts from recent posts:

Cumulative pandemic-era excess savings

This is helping:

The price of a barrel of West Texas Intermediate crude is falling again today, and at least as of the time I’m typing this it’s right around $77. Just a month ago, it was above $85. (Bloomberg)

Rents Set to Be Last Domino to Fall in Global Inflation Battle

Surging rents across many developed economies are proving to be a stubborn hurdle for central banks as they struggle to nail down inflation once and for all this tightening cycle.

In the US, UK, Canada and Australia, rapidly rising housing costs — which have a hefty weighting in consumer price index baskets — are preventing inflation from declining closer to central banks’ targeted levels. The danger is that workers will demand even fatter pay checks to deal with the cost-of-living squeeze, undermining the inflation fight even further. (…)

“I am confident that as long as market rents remain low, this is going to show up in measured inflation,” Powell told reporters last week after the Fed’s two-day policy meeting. The central bank held rates at a more than two-decade high, while signaling a desire to cut when confident that inflation is under control. Traders are currently betting on at least one 25-basis-point rate cut this year.

Still, Powell may have to wait. Household expectations about the change in the cost of rent have risen sharply from last year, with rental costs expected to increase by 1.5 percentage points to 9.7% for the next year, according to a survey by the New York Fed released Monday. (…)

“Housing is a real problem in the United States due to a huge shortage of affordable housing, and in part because of high interest rates,” Treasury Secretary Janet Yellen told Bloomberg News. “That said, I strongly believe — I think it is highly likely — that shelter costs, which have been pushing up inflation, will come down.” (…)

Mrs. Yellen surely meant shelter inflation because shelter costs never come down. As a labor expert, she should know the tight relationship between wages and rents. People generally chose their abode based on what they can afford, whether they buy of they rent.

ACCURACY MEASURED

Data: UmpScorecards; Chart: Will Chase/Axios

• The Forecasting Record of the Fed and the Market (Apollo)

The Fed started publishing the dot plot in 2012, and comparing the Fed’s forecasts with the forecasts from Fed funds futures yields three important conclusions, see charts below:

1) The Fed’s and the market’s forecasts about the future path of the Fed funds rate are almost always wrong.

2) The forecasts are very similar, and the Fed has managed to anchor market expectations about where it thinks the Fed funds rate is going.

3) The direction of the forecasting mistake is always identical, suggesting that the market is taking its cue about the future path of interest rates from the Fed’s dot plot.

The good news is that the Fed is able to anchor market expectations, and thereby reduce volatility in financial markets.

The bad news is that when the Fed’s forecast is wrong and the FOMC has to move from three cuts in 2024 to say, one cut, it will hurt Fed credibility.

The US economy’s lower interest-rate sensitivity, combined with strong structural and cyclical tailwinds to growth, brings us to the conclusion that the Fed will not cut interest rates in 2024.

Source: FOMC, Bloomberg, Apollo Chief Economist