Hot Service Sector Might Be Cold Water on Swift Rate Cut Hopes

Wells Fargo’s take of the ISM:

Not only is the services sector still expanding, it picked up steam in November with the ISM coming in at 52.7. With prices still firmly in expansion and employment rising slightly, it suggests that recent expectations for rate cuts might have been pulled too far forward. (…)

It is tough to justify cutting rates when the prices paid component is still consistent with rising prices (…)

The employment component of the ISM services index rose modestly to 50.7, consistent with a faster expansion in jobs last month, though the gain was slightly smaller than expected and presents some downside to our estimate for November job growth.

When we get the full employment situation release on Friday, we expect to see employers continued to add jobs at a robust clip in November. Specifically we forecast about 230,000 jobs were added during the month, as the conclusions of the United Autoworkers and Hollywood strikes lead to a pickup in payroll growth. Despite the rise, the overall trend in hiring has downshifted since earlier in the year. (…)

Goldman Sachs’ take:

The ISM services index increased by 0.9pt to 52.7 in November, against expectations for a smaller increase. The underlying composition was strong, as the employment (+0.5pt to 50.7) component and business activity (+1.0pt to 55.1) components increased while the new orders (55.5) component was unchanged.

S&P Global’s survey was much more muted:

• U.S. Services PMI: Renewed upturn in new business supports output growth in November

The seasonally adjusted final S&P Global US Services PMI Business Activity Index posted 50.8 in November, matching the earlier released ‘flash’ estimate and little-changed from October’s reading of 50.6. The latest data signalled the fastest expansion in output since July, albeit only marginal and slower than the long-run series average. Greater business activity was often linked to stronger client demand and a renewed upturn in new orders.

Service sector firms recorded a return to growth in new business in November, following a three-month period of decline. The upturn was only slight overall and historically muted, but firms attributed the rise to an improvement in demand conditions and successful marketing campaigns.

Contributing to the rise in total new orders was a second consecutive monthly uptick in new business from abroad. Stronger demand from key export partners in North America and Europe reportedly drove the expansion.

Relatively subdued demand conditions led firms to rein in hiring activity during November. Employment rose at the weakest pace since October 2022, and only fractionally.

Some firms noted that greater new orders spurred growth in staffing numbers, but others highlighted that cost-cutting initiatives and evidence of spare capacity led to the non-replacement of voluntary leavers.

Services firms reported a sustained decrease in backlogs of work during November, as incomplete business fell for a fifth successive month. The rate of contraction quickened from October to a solid pace, as companies were able to process incoming work in a timely manner.

Cost pressures weakened for the third month running in November, as the pace of input price inflation dropped to the slowest in over three years. The rate of increase was below the long-run series average, as some companies noted that lower fuel and supplier prices had eased inflationary pressures. Upticks continued to be driven by higher wage, food and transportation costs, however.

Although business expenses rose at a softer pace, firms increased their selling prices at a quicker rate midway through the fourth quarter. The pace of inflation was the fastest since July and above the series trend, as companies sought to pass through higher costs to customers.

Finally, concerns regarding the sustainability of demand amid strain on customer purchasing power dampened business confidence in November. Service providers remained upbeat that output would increase over the coming year, but the degree of optimism slipped to the joint-lowest in 2023 to date.

At 50.7 in November, the final S&P Global US Composite PMI Output Index was unchanged from October, and signalled a marginal upturn in business activity. The expansion reflected growth at manufacturers and service providers, albeit only slight.

Despite a renewed contraction in manufacturing new orders, a return to growth in the service sector drove the latest rise in new business, ending a three-month sequence of decline. Supporting the rise in new orders was a broad-based increase in new export business.

Cost pressures across the private sector eased in November, as input prices rose at the slowest pace in over three years. Although muted demand conditions in the manufacturing sector led to a moderation in charge inflation, overall output prices increased at a sharper pace as service providers hiked selling prices at a steeper rate.

Meanwhile, a further decline in manufacturing employment and only a fractional rise in service sector headcounts led to broadly unchanged workforce numbers. The Composite Employment Index posted its lowest reading since June 2020.

• Only three out of seven US sectors recorded an expansion
  in business activity during November, down from five in October, according to the latest PMI data compiled by S&P Global. Latest data also suggested lacklustre demand conditions in the Consumer Services sector, which led to a second successive monthly decline in business activity.

What the ISM respondents are saying:

• “Restaurant sales and traffic trends are consistent with the previous month and at our annual seasonal lows — should pick up again in December. We continue to trend positive to pre-pandemic and last year.” [Accommodation & Food Services]
• “Business conditions remain steady to the end of 2023. Annual cost escalations are a bit higher than planned, more than 5 percent versus 3 percent due to overall economic conditions and concerns.” (Finance & Insurance)
• “There are fewer new projects in comparison to last month and November 2022. Customers are not requesting quotes for new services.” [Information]
• “Customers are conservative in spending, so competition to maintain market share is tight.” [Management of Companies & Support Services]
• “Fourth-quarter revenues lower than projected. Seeing negative revenues trend into the first quarter of the new year. We remain positive yet concerned about 2024.” [Professional, Scientific & Technical Services]
• “Prices for most items increasing, but only slightly. Increase in pricing for services much more noticeable and impactful on the organization.” [Public Administration]
• “Candidate expectations during the hiring process have made staffing up more difficult.” [Retail Trade]
• “Solid activity heading into the final stretch of the fourth quarter.” [Transportation & Warehousing]
• “Labor, equipment and material price escalation requests are increasing, both through existing contracts as well as re-pricing of markets via requests for proposal.” [Utilities]
• “A comparably flat month of business activity — no major swings one way or the other. Inventories in our extended supply chain look healthy, and fill rates are improving.” [Wholesale Trade]

JOLTS: Labor Market Coming into Balance

The October JOLTS report is supportive of the view that labor supply and demand have come into better balance. Job openings fell to 8.73 million at the end of the month, the lowest reading since March 2021.

The ratio of openings to unemployed persons is 1.34, only a bit above the 1.2 ratio that prevailed before the pandemic. The quit rate is also in line with its pre-pandemic level in a sign that workers are no longer quitting their jobs at the same pace they were when the labor market was at its hottest.

On balance, today’s labor market data are consistent with a cooling labor market and decelerating wages, which bodes well for future progress in the Federal Reserve’s fight to bring inflation back to its 2% target.

The FT’s headline: US job openings drop to lowest level in more than 2 years

The strange fact is that the U.S. economy has been producing a lot more job openings than actual jobs and that private hires have been falling for almost 2 years to levels currently below their pre-pandemic levels.

This NFIB chart from Ed Yardeni shows that small companies, the main job providers in the USA, display substantially more job openings than in 2019 while actually planning fewer hires over the next 3 months.

Perhaps more emphasis should be placed on actual hires vs posted openings. The private sector is now generating fewer than 100k new monthly jobs, 70 % of all new jobs on average in the last 4 months, down from 84% in the last 4 months of 2019.

• Economists see Fed keeping rates at 22-year high until at least July FT-Booth survey respondents think US central bank will remain more hawkish than market expects

Canada: Service sector activity falls in November to greatest degreesince June 2020

November’s index reading came in at 44.5, down from 46.6 in October. It was the lowest level since June 2020 and consistent with a steep decline in activity. Moreover, the index has now posted below 50.0 for six months in a row.

Panellists widely commented that market activity was slow and securing new sales challenging. Overall, new business was down for a fourth successive month, and to the greatest degree for nearly three years. There were some reports that market activity was being negatively impacted by elevated interest rates. New export business was also down, falling to the greatest degree since April 2021.

A lack of new work enabled firms to comfortably keep on top of their existing workloads. November’s survey showed that work outstanding was cut to the greatest extent since the end of 2020. Such evidence of excess capacity weighed on employment, which fell slightly for the first time in three months. Some panellists noted difficulties in finding suitable staff to replace leavers.

There was also evidence from the survey panel of the need to pay higher wages both for retention purposes and to help workers with the high cost of living. Rising salary payments, alongside price increases throughout the supply chain, meant that overall operating expenses continued to increase sharply. That said, inflation did ease during the month, slipping to its lowest level since September 2021.

Similarly, output charges rose to a softer degree, with inflation dropping to its weakest for 27 months. Where charges increased, this was linked to efforts to protect margins from rising input costs.

Finally, service providers retained some confidence about the future, and firms are hopeful of an improvement in economic conditions over the next 12 months. There were suggestions, however, that high interest rates and the possibility of economic recession could weigh on activity. Confidence subsequently dropped to a three-month low and remained below trend during November.

Latest PMI data showed output declines across the manufacturing and services sectors during November. In both cases, rates of contraction accelerated, and overall private sector output fell to the greatest degree since June 2020. This was highlighted by the S&P Global Canada Composite PMI Output Index* which fell to 44.8, down from 46.7 in the previous month. November marked the sixth successive month that the index has posted below the 50.0 no-change mark.

Concurrent declines in new orders were also recorded, and there was evidence of spare capacity with backlogs of work falling to the greatest degree for nearly three-and-a-half years. Private sector employment fell slightly for the first time in three months, although the contraction was centred on services as manufacturing staffing levels increased.

Cost inflation remained elevated, though eased to a six-month low. Output charge inflation was little-changed but remained well below that of input costs and thereby pointing to continued margin pressure for private sector companies in November.

FYI, Canada’s GDP declined 1.1% a.r. in Q3.

Moody’s changes Hong Kong’s outlook to negative from stable

Companies Are Going Broke Gradually, Not Suddenly

(…) Financial strength has been declining for a while, a trend that was only briefly interrupted by the attempted cleanup in the wake of the Global Financial Crisis in 2008. The following chart, compiled by Dimos Andronoudis, economist at Fathom Consulting in London, classifies all quoted US companies by their Altman Z-scores — a measure promulgated by the New York University professor Edward Altman to estimate how close they were to bankruptcy. It combines concepts such as account profitability, leverage, liquidity, solvency, and activity ratios.

In the last century, more than half of all public companies looked strong and healthy on Altman’s metric. That number has now dropped below 10% for the first time on record:

Presenting this differently, we find the number of companies that are imminent candidates for bankruptcy has also been rising consistently, and has reached a new high. The “post-Volcker” era of low interest rates has seen companies grow more and more accustomed to taking risks with their financial health, and getting away with it:

Andronoudis stresses that the Altman system may be outdated by now, as intangible assets make up a far greater share of balance sheets and generally do have value. But the idea that credit quality is degrading still stands. (…)

This chart from Andronoudis defines zombies loosely as companies whose earnings before interest and tax did not cover their interest costs for one year, and also on a stricter basis where this situation needs to have persisted for at least three consecutive years. By this standard, slightly more than a fifth of US companies are zombies:

(…) In this chart from Bank of America, which gauges balance street strength with the simple measure of the cover they have to pay interest charges, we discover that the biggest 150 companies have barely ever been stronger on this metric. Smaller companies are dramatically weaker, and have seen a significant weakening over the last two years:

(…) As a share of employment, the mass of severely indebted smaller companies could do serious damage. (…)

The following chart, from Jim Reid of Deutsche Bank AG, illustrates the average length of high-yield bonds in circulation in the US and Europe going back to 2002. On both sides of the Atlantic, high-yield borrowers have never had less time to play with: (…)

CONSUMER WATCH

More evidence that something happened since the end of September:

• Goldman Sachs:

We review the preliminary holiday spending indicators from Big Data and industry sources. Tracking holiday spending is confounded by the multitude of data points and press accounts available, and the official data from the Census Bureau will not be released until December 14 and January 17. At this point in the season, we place considerably more weight on hard measures that track actual spending, as opposed to consumer surveys, mall traffic, or website visits. One of the timeliest of these hard measures is Adobe Digital Insights, a panel of 4,500 retail websites that includes 80 of the top 100 retailers.

(…) we find that the Adobe panel is indeed predictive of the broader retail control category in November (correlation +0.69, see right panel). For November 2023, the Adobe data would imply roughly unchanged sales on a sequential basis for this subaggregate.

Indicators of brick and mortar spending trends argue for a potentially softer reading. As shown in Exhibit 2, the seasonally adjusted change in Fiserv credit card spending and the Redbook department store panel would be consistent with outright declines in the brick-and-mortar segment, which represents 70% of retail control. (…)

Taken together, we are assuming a 0.1% decline in Census retail control in both November and December (ex-auto, gas, building materials, mom sa). (…)

Adobe data show a sharp increase in online discounting in the month, with apparel prices falling 25% over the course of November on a not-seasonally-adjusted basis—a larger drop than the 15.5% comparable decline reported by Adobe a year ago.

• Credit card spending has collapsed (@GameofTrades)

More US holiday shoppers turn to ‘buy now, pay later’ loans

• BNPL: The Phantom Debt

Our sense after surveying what limited data are available is that BNPL is not a major problem for consumer spending yet. But until there is a definitive measure for it, there is no way to know when this phantom debt could create substantial problems for the consumer and the broader economy. This report looks at the upsides and downsides of one of the fastest growing categories in consumer finance. (…)

While some individuals may be in over their heads, even by the most robust estimates, the total pile of BNPL loans is not large enough yet to be problematic enough to derail consumer spending on its own. The category is still small relative to more traditional forms of consumer financing. (…)

More worryingly, BNPL does this in de-facto stealth mode because it largely flies beneath the radar of both regulators and policymakers. (…)

Needless to say, the specific size of the BNPL market can be maddeningly difficult to quantify. Or, as researchers at the Philadelphia Fed put it “data on BNPL loans…are scarce. BNPL loans are not currently reported to any of the major credit reporting agencies, and the firms themselves are understandably reluctant to share proprietary data in a competitive environment.” ^(…)

If we look at publicly available data from Affirm, the market leader in the BNPL space, the gross merchandise value rose from $12B in 2021 to what WF equity analysts estimate to reach $23B this year. If Affirms’ share of the U.S. BNPL market simply held constant over the period, that would suggest a BNPL total of around $46 billion in loans originated in 2023.

  

 Company reports and Wells Fargo Securities FRB New York and Wells Fargo Economics

Through Q3, credit card debt totaled roughly $1.079 trillion, which represents a $154 billion increase from what the total had been a year earlier. If BNPL transactions indeed accounted for $46 billion in transactions in the current year, then that implies that BNPL transactions are roughly equivalent to about a third of the annual increase in credit card debt.

The BNPL providers are quick to point out that they provide consumers with increased purchasing power and greater control in managing their personal finances. To a degree, they have a point. When credit card interest rates are north of 21%, it is just common sense for consumers to take reasonable measures to avoid such financing cost. But with no oversight of BNPL providers, it is not immediately clear that savings on financing cost are not offset by fees and penalties.

The watchdogs have their doubts. In a report to Congress in November, the CFPB made it clear that some of the consumers apt to engage in BNPL programs were households that were financially vulnerable. Specifically, the report stated “BNPL borrowers were, on average, much more likely to be highly indebted, revolve on their credit cards, have delinquencies in traditional credit products, and use high-interest financial services such as payday, pawn, and overdraft compared to non-BNPL borrowers.” Even if BNPL is a relatively small share of the consumer borrowing market today, increasing vulnerabilities in a small segment can still pose a risk. (…)

Vehicles Sales decrease to 15.32 million SAAR in November; Up 7% YoY

Labor-related plant shutdowns in the U.S. that covered the latter half of September and most of October negatively impacted deliveries in November. Combined sales of the vehicles impacted by shutdowns fell 15% year-over-year in November. If those vehicles had matched year-ago results, sales would have totaled a 15.9 million-unit SAAR.

The case for early rate cuts (Axios)

“The Fed is on a path to a March rate cut,” Tim Duy, chief U.S. economist at SGH Macro Advisors, writes in a new note. “All the pieces are there, the Fed just needs to put them together.”

• “I have high confidence the data will unfold in a way that allows for the Fed to cut by then,” he continues, arguing that the central bank may need to ease in January to avoid a recession.
• “I am beginning to suspect that January instead might be the drop-dead date for the soft-landing,” Duy writes. “The longer the Fed waits, the more likely that we start seeing soft employment numbers and rising unemployment. It will be harder to arrest any recessionary dynamics at that point.”
• He acknowledges this is a “a non-consensus call.” Many leading analysts don’t envision rate cuts until May or June.

With the underlying inflation trend now approaching the Fed’s 2% target (the three-month annualized rise in core PCE inflation is at 2.4%, for example), the central bank finds itself at a delicate juncture.

• With inflation falling, real interest rates — borrowing costs over and above inflation — are rising. The absence of rate cuts, against that backdrop, amounts mechanically to monetary tightening.

Duy has leaned hawkish for the last couple of years, which adds credibility to his dovish forecast. Back in 2021-22, he was among those shouting from the rooftops that inflation pressures were building and the Fed was behind the curve in raising rates.

• Rate cuts are accelerating, driven by EM central banks. (The Daily Shot)

Source: Bank of America Institute

The Beat Goes On! U.S. oil production record (Axios)

American production is part of the reason that recent efforts by OPEC — and its strategic ally, Russia — haven’t been able to end the slide in global oil prices.

Economic weakness in China — the world’s largest oil importer — is dampening demand and also playing a role in the price drop.

U.S. benchmark oil prices are down nearly 20% in the fourth quarter, to below $75 a barrel.

The national average price for a gallon of regular gasoline is $3.24, according to AAA. That’s down 5% in the last month.

Eurozone Services PMI: Employment drops for first time in nearly three years as eurozone economic activity continues to shrink

The HCOB Eurozone Services PMI Business Activity Index remained below the 50.0 mark that separates growth from contraction in November, posting 48.7. This was up slightly from 47.8 in October, but nevertheless signalled a continuation of the service sector’s decline in activity that has been ongoing since August.

New business wins fell for a fifth month in succession midway through the fourth quarter. While the rate of decline was the slowest for three months, it was solid overall and outpaced that for activity.

The drag on activity from falling new business was once again partially alleviated by backlogs of work, which fell further during November. The rate of depletion was moderate and broadly in line with the trend since July.

Inflation remained persistent across the eurozone services economy in November, with rates of increase in both input costs and output prices edging higher on the month.

The seasonally adjusted HCOB Eurozone Composite PMI Output Index recorded a sub-50.0 reading for a sixth successive month in November, signalling another month-on-month reduction in private sector output levels across the eurozone. While the latest reading of 47.6 was up from October’s 35-month low of 46.5 and the highest since July, it was still indicative of a solid deterioration in economic conditions.

The euro area’s four largest economies all registered contractions in business activity during November. France remained the worst performer, with output declining at a rate that was only slightly softer than September’s near three-year record. Germany and Italy saw downturns ease from October, while activity across Spain’s private sector shrank for the first time since August. Ireland was the only monitored eurozone constituent to record an expansion in output.

Demand for eurozone goods and services remained a major drag on business activity during November. New business fell for the sixth month running, albeit at the softest rate since July. Manufacturing new orders continued to fall at a sharper rate than demand for services.

Demand from non-domestic clients once again faltered midway through the fourth quarter. New business received from external sources fell sharply and for a twenty-first month in succession. As was the case with total order volumes, export sales performances were considerably worse at manufacturers than service providers.

Falling receipts of new work led eurozone companies to make additional inroads into their backlogs during the latest survey period. As a result, November saw outstanding orders across the private sector fall strongly and for an eighth month running.

Weak demand conditions, coupled with falling levels of pending work, clearly weighed on businesses’ appetite for hiring as employment fell for the first time in nearly three years. The drop in workforce numbers exclusively reflected job losses at manufacturers, however, as services companies recorded a further, albeit slower, expansion in staffing capacity.

Meanwhile, November survey data indicated a slight intensification of price pressures across the euro area. Input prices rose sharply and at the joint-fastest pace since May (matching that seen in September). The service sector was once again the root of input cost inflation as manufacturers’ expenses continued to decrease.

Equally, softer factory charge discounting, in tandem with slightly more aggressive price setting by services firms, saw the overall rate of output charge inflation tick up in November.

Factoring in the latest PMI indicators, a fall in GDP is on the cards for the fourth quarter. If two consecutive quarters of negative growth define a recession, we find ourselves currently on the brink.

Moody’s Cuts China Credit Outlook to Negative on Rising Debt China stepped up usage of fiscal stimulus to aid growth

Moody’s lowered its outlook to negative from stable while retaining a long-term rating of A1 on the nation’s sovereign bonds, according to a statement. China’s usage of fiscal stimulus to support local governments and its spiraling property downturn is posing risks to the nation’s economy, the grader said. (…)

“Considering the policy challenge posed by local government debt, the central government is focused on preventing financial instability,” Moody’s said. “Still, maintaining financial market stability while avoiding moral hazard and containing fiscal costs of support is very challenging.” (…)

• China’s Colossal Hidden-Debt Problem Is Coming to a Head Cities and provinces across the country have accumulated a massive amount of hidden debt following years of unchecked borrowing and spending.

(…) The International Monetary Fund and Wall Street banks estimate that the total outstanding off-balance-sheet government debt is around $7 trillion to $11 trillion. That includes corporate bonds issued by thousands of so-called local-government financing vehicles, which borrowed money to build roads, bridges and other infrastructure, or to fund other expenditures.

No one knows what the actual total is, but it has become abundantly clear over the past year that local governments’ debt levels have become unsustainable. (…)

Economists say a significant chunk of the hidden debt—their estimates range from $400 billion to more than $800 billion—is particularly problematic and at high risk of default. (…)

Bonds from local-government financing vehicles make up close to half of China’s domestic corporate bond market, according to Wind data, and defaults could choke off funding for other borrowers if many investors and bond buyers back away.

In early November, China’s central government said it places “great importance to the prevention and resolution of the risk of hidden debts of local governments.” Bankers and local government officials were also warned that they would be held accountable for life if they raised new hidden debt.

Pan Gongsheng, the governor of the People’s Bank of China, said at a Beijing financial forum last month that the central bank would also provide emergency liquidity support to regions with relatively high debt burdens. He said China’s total government debt isn’t high by international standards and that the country is taking steps—including asset disposals and refinancing debt—to mitigate the risk posed by its local-government debt. (…)

A recent UBS report said domestic banks’ total exposure to local-government financing vehicles at the end of last year was equivalent to about $6.9 trillion—representing about 13% of the banking sector’s total assets. (…)

There has been an urgent push for local governments to issue so-called special refinancing bonds to replace some of their off-balance-sheet debt.

Since October, close to 30 Chinese provinces and cities have raised the equivalent of around $200 billion in such bonds. The fundraising was mostly in regions with high leverage including the provinces of Guizhou and Yunnan, and the city of Tianjin. The debt swaps have helped lower the risk of imminent local-government debt defaults, by giving local governments more time to come up with funds.

“It’s not enough, but I think this is just the beginning,” said Robin Xing, Morgan Stanley’s chief China economist, of the debt exchanges that have been done so far. He reckons that there will need to be at least $700 billion worth of debt swaps to resolve the bulk of the troubled hidden debt. 

“It is not really a restructuring plan but a refinancing plan. It leaves most of the problems with local government debt in place,” said Logan Wright, director of China research at Rhodium Group, a research firm. A report that Wright co-wrote last month said the debt extensions or swaps will hurt China’s economic growth in the long run because more fiscal resources will be required for debt repayment. (…)

The longer-term solution, which could be hard to achieve, would involve restructuring some local-government financing vehicles’ debt and making them commercially viable enterprises. “The goal is not to come out debt free, but for them to become sufficiently profitable companies that don’t rely on governments for funding and support,” said S&P’s Yip.

• Pressure Is Building in China’s Financial Plumbing Signs of indigestion in China’s money markets are an ominous sign—particularly given shadow-bank troubles and enormous government debt

Plumbing is something most of us take for granted—until there’s a problem, at which point things can get messy fast. Likewise for the “plumbing” of modern financial systems: the money markets, where banks and other financial institutions make short-term loans to each other. (…)

There is little sign of an immediate crisis such as the one that erupted in the wake of regulators’ sudden takeover of Baoshang Bank, a midsize lender, in 2019. But unusual rate movements in recent weeks—and, reportedly, actions by authorities behind the scenes to strong-arm lenders—are still worrying. For one, they come in the wake of a big rebound in short-term interbank lending, particularly to nonbank borrowers—a category which includes funds, asset managers and “shadow banking” trusts such as the one owned by Zhongzhi that defaulted on its obligations in August. (…)

Both benchmark interbank rates and rates for negotiable certificates of deposit, an important funding instrument for small banks, have marched higher since mid-August. Cash injections by the central bank through its medium-term lending facility have increased—with the outstanding balances rising by 600 billion yuan, equivalent to $84 billion, in November, the most since 2016. And in mid-November regulators asked some lenders to cap rates on an interbank debt instrument, according to Reuters.

The unease appears to be partly the result of massive new debt issuance by the government itself, which is making life difficult for some other borrowers: official government bond debt rose by 3.7 trillion yuan from end-July to end-October, according to figures from data provider CEIC. That was the largest three-month increase since at least early 2016.

But jumpy money markets also come on top of an enormous rebound in short-term money market borrowing through bond repurchase agreements, or repos, since mid-2021—primarily by nonbank financial institutions. On net, such borrowing by nonbank financial institutions, excluding brokerages and insurers, has roughly tripled to around 150 trillion yuan on a quarterly basis since mid-2021, central bank data shows. Moreover, if some of that cash has been used for leveraged bets on bonds to juice returns, then the recent rebound in Chinese rates could be squeezing some borrowers too.

The falling U.S. dollar—and slower capital outflows—could take off some of the pressure in the weeks ahead. But China now finds itself balancing enormous new government obligations, which the bond market needs to finance, against highly leveraged nonbank financial institutions, some of which probably still have significant exposure to the nation’s teetering real-estate sector. No wonder money markets are twitchy.

• CHINA IMPLODING? NO, EXPLODING!

China Services PMI: Business activity growth picks up in November

The latest PMI survey data signalled further increases in activity and demand across China’s service sector in November. Though modest by historical standards, upturns in both activity and overall new work were the best seen for three months amid reports of firmer market conditions. Concurrently, companies expressed stronger optimism around the year-ahead outlook. Employment meanwhile fell fractionally, as some firms maintained a cautious approach to hiring.

Cost pressures moderated again in November, with average operating expenses rising at the weakest rate in nearly a year-and-a-half. Prices charged by services companies likewise rose only slightly.

The seasonally adjusted headline Caixin China General Services Business Activity Index rose from 50.4 in October to a three-month high of 51.5 in November. The rate of growth was modest, however, and remained notably softer than the long-run series average. Nevertheless,the index has now signalled an expansion of business activity across China’s service sector in each of the past 11 months.

Aiding the quicker rise in Chinese services activity was a stronger upturn in total new business midway through the final quarter of the year. The rate of new order growth was likewise the best recorded since August, albeit moderate overall.

Companies that experienced higher sales often mentioned that this was due to firmer underlying market conditions. The surveys indicated that both domestic and overseas demand for Chinese services improved in November, with new export business rising modestly for the third straight month.

After stagnating in October, employment across China’s service sector fell fractionally in November. Firms that registered lower headcounts often linked this to restructuring efforts amid relatively subdued demand conditions. Sustained caution around hiring contributed to a further upturn in outstanding orders midway through the final quarter of 2023. That said, the rate of backlog accumulation slowed from October and was only marginal. Average input prices faced by Chinese services companies continued to rise during November. Where higher expenses were reported, firms often cited greater labour and raw material prices. That said, the rate of cost inflation was the slowest seen since June 2022 and marginal. Prices charged by service providers also increased at a softer pace. Notably, the rate of inflation slipped to a three-month low and was broadly in line with the series average. Signs of firmer growth momentum in November helped to lift business confidence when assessing the one-year outlook for service sector activity in November. Businesses were generally optimistic that stronger economic conditions will help to lift customer demand both at home and abroad over the next year. However, overall sentiment remained softer than seen on average since the survey began in late­2005.

At 51.6 in November, the Composite Output Index rose from the neutral 50.0 level in October to signal a renewed increase in total business activity across China. The rate of growth was the best seen since August, albeit modest overall. Sector data revealed that a fresh upturn in factory output and stronger rise in services activity helped to lift the composite figure.

Composite new orders also rose at a moderate rate that was the best seen for three months, supported by quicker increases in sales across both manufacturing and service sectors. New export business meanwhile declined again in November, as lower foreign demand for Chinese manufactured goods offset an increase in services exports.

Composite employment fell slightly for the third straight month, despite a slight rise in outstanding workloads. Cost pressures eased again in November, with composite input prices rising at the slowest pace since July. As a result,prices charged by Chinese firms increased only slightly.

Canada: Core PCE deflator decelerating faster

(…) core inflation in Canada is decelerating very rapidly and was slightly below that of the U.S. in the third quarter at 2.1% annualized. While the timing of a potential rate cut remains uncertain, current inflation trends in Canada suggest that some tangible relief for consumers is on the horizon in 2024.

• Toronto Home Prices Slide For Fourth Month as High Rates Weigh

The benchmark price for a home in Canada’s largest city fell 1.7% in November from the previous month to C$1.11 million ($820,000), according to seasonally adjusted data released Tuesday by the Toronto Regional Real Estate Board. That brings the total decline in Toronto home prices since July to 4.8%, the data show. (…)

SENTIMENT WATCH

• Dynamics behind the “everything rally” in November have “absolutely run out of gas right now,” Goldman’s Scott Rubner said.
• Investors are too optimistic about the central bank easing next year, according to Goldman, which suggests selling call options to counter some of the “excessive” rate-cut pricing.
  

• Markets are pricing in an “unrealistic” Goldilocks economic scenario, a JPMorgan strategist said, predicting a slowdown that threatens earnings and equities.
  

• And it probably won’t get better anytime soon. Stocks are heading for a rocky end to the year, Morgan Stanley’s Mike Wilson said. A flat run on returns in the S&P 500 may extend into the next decade, according to Stifel.
• Citi’s Chris Montagu said the bullish sentiment around positioning is weakening for the S&P 500.
• Check out this chart of Affirm, one of the pioneers of the Buy Now Pay Later model.

• ARKK, meanwhile, is up over 42%, just since late October, and now it’s close to its highs of the year.

• Crypto lives (Axios)

Binance and its CEO pleaded guilty to money laundering and fraud charges, agreeing to pay more than $4 billion — the largest penalty in U.S. Treasury history.

• Among the charges, Binance laundered money for terrorist groups including Hamas.
• Despite the current anti-crypto atmosphere among some U.S. regulators, the settlement agreement allowed Binance to continue operating.

Under the settlement, Binance is required to create an effective anti-money laundering system — under the watchful eye of an independent outside party that reports to federal regulators.

• “It’s the first such arrangement in crypto,” explain Henry Farrell and Abraham Newman in a must-read piece for the WSJ. And, they argue it’s more significant than the monetary penalty.
• The new system will transform Binance “from a scofflaw into a watcher and enforcer on behalf of the U.S. government,” they write.

The arrangement will also change the larger crypto market.

• Anti-money laundering rules “spread like a virus,” the WSJ piece argues. That’s because anyone who wants to do business with Binance needs to get their house in order, too. And the people doing business with those Binance users will need to adjust.
• The U.S. did something similar about 10 years ago with a crackdown on big banks — levying big fines and imposing monitoring arrangements. That terrified “other financial institutions into rapid and widespread compliance,” they write.

While the crypto market lives on, the vision of what cryptocurrency could be is very different from its early days.

• Given the Binance deal, it’s hard to argue that crypto traders are operating in a decentralized Wild West market outside of U.S. dollar hegemony.
• Instead, the market has drifted toward centralization where big exchanges — Coinbase, too — operate under the watchful eye of the U.S. government. (Lawbreakers could move to smaller less centralized trading to try to avoid detection.)

Regulators aren’t done with Binance. A lawsuit filed by the SEC is ongoing.

A year ago, in the wake of Sam Bankman-Fried’s downfall, the future of crypto looked uncertain — but it has survived and even mounted a bit of a resurgence.

But crypto’s supply/demand dynamics could change meaningfully…

EV, ESG Supply/Demand…

From Almost Daily Grant’s:

A big three automaker takes the off ramp: General Motors unveiled an instructive strategy shift this morning, increasing its quarterly dividend to $0.12 per share from $0.09 and authorizing a $10 billion share repurchase program – the largest in its history – which includes $6.8 billion in immediate purchases. For context, GM’s market cap currently stands at $44 billion. 

Funding for that monster capital return program, which dwarfs the $4.2 billion reverted to shareholders over the past seven quarters, will partly come “by freeing up capital previously earmarked for the development of electric vehicles,” notes The Wall Street Journal. 

Though CEO Mary Barra deemed herself “disappointed” with halting progress on the development of GM’s Ultium batteries, which are meant to underpin the company’s next-generation electric vehicle lineup, the executive declared that “there’s really no reason that EV demand won’t be higher in the years ahead.”

Global sales within the category grew by a more-than-respectable 49% clip over the first six months of the year according to research firm Canalys, but more recent trends cast some doubt on the GM boss’ upbeat appraisal. Thus, average used EV prices registered at just under $35,000 in October, newly released data from analytics firm iSeeCars.com show, off 33.7% year-over-year. That compares to a 9.6% drop for hybrids and a 5.1% decline for all used cars.

Citing data from Edmunds, the Financial Times likewise relayed on Nov. 13 that average discounts for new EVs in the U.S. now stand at $2,000, double that seen for conventional internal combustion engine autos and up from zero in January. “There are clear signs of carmakers pushing EVs,” Mike Tyndall, autos analyst at HSBC, told the pink paper. “This was almost unthinkable at the start of the year.” (…)

That growing consumer pushback is mirrored on Wall Street, as investors turn tail from environmental, social and governance-themed strategies. Thus, Morningstar determined earlier this month that fund flows in the so-called sustainable space have remained in negative territory for six of the past seven quarters after more than three years of uninterrupted quarterly inflows. Then, too, the third quarter marked the first time in which ESG-focused fund liquidations and marketing pivots from that theme outstripped new launches and sustainability-focused fund rebrandings. 

“We found that the demand for ESG investing, by financial professionals working with retirement-plan participants, was more limited than we anticipated,” Ron Rice, vice president for marketing at Pacific Financial, told the WSJ.