Note: I will be traveling until June 27, with limited posting whenever possible given limited time, equipment and time zone constraints.

Fed Holds Rates Steady but Expects More Increases

New economic projections, released Wednesday after their two-day policy meeting, strongly suggested officials were leaning toward slowing down their increases rather than stopping them altogether. Most of them penciled in two more rate increases this year, which would lift them to a 22-year high, and boosted their expectations for growth and inflation. (…)

“We don’t know the full extent of the consequences of the banking turmoil that we’ve seen,” Powell said Wednesday. “It would be early to see those.” (…)

The projections Wednesday showed 12 of 18 officials think they will need to raise rates to between 5.5% and 5.75% this year—or higher—if the economy performs in line with their expectations. That would imply two additional quarter-point increases at any of four meetings later this year.

Another four officials projected rates would need to go up by only a quarter point. Two anticipated that rates could stay at their current levels for the rest of the year.

In March, most officials projected no further increases after lifting the fed-funds rate to its current level. (…)

Officials’ projections of penciling in two further increases this year, which was more aggressive than many interest-rate strategists had anticipated, offered a way to unite hawkish Fed officials that would have favored lifting rates this week with those who were more dovish, including Powell, who wanted to wait, said Swonk.

“This was the ultimate way that Powell corralled the cats, yet again,” she said. “He clearly is more dovish than some of his colleagues right now, but by all-but-guaranteeing a July rate hike, he was able to keep everyone on the same page.”

Powell offered few clues about what would lead the central bank to raise rates next month. Some analysts said Powell’s decision to forgo a rate rise Wednesday would prove to be a mistake.

“It will be harder next time to raise rates than they realize,” said Vincent Reinhart, a former senior Fed economist who is now chief economist at Dreyfus and Mellon. “The data probably will be a little bit more ambiguous. Their headline explanation is that they will know much more in six weeks, but the fact is they won’t know much more in six weeks. Chances are, they’ll be more confused in six weeks.” (…)

Is there any way to get this straight?

The Fed pauses to assess what +500bps will do to the economy (“the full effects of our tightening have yet to be felt”) while simultaneously showing projections of higher inflation and a more positive view of the economy and employment than their forecasts last March.

Again, +500bps did very little, if anything, to the economy and inflation (“There’s just not a lot of progress in core inflation”), but let’s see if a pause could help. They pause to get more info, hoping demand will finally slow down, but the info they actually got led them to raise their forecasts.

Note also that the Fed’s staff no longer sees a recession this year…

Bond Traders Step Up Bets the Fed Will Steer US Economy Into Recession

Policy-sensitive front-end Treasuries sold off Wednesday, while longer-date bonds rallied, after Fed officials indicated that they’re prepared to raise interest rates by another half-point this year following the first pause in the central bank’s 15 month hiking campaign. That sent the yield-curve inversion, as measured by the gap between two- and 10-year securities, to more than 90 basis points — a level last seen in March — and approaching this cycle’s 109 basis point extreme.

The price action suggests bond traders are skeptical that policymakers can avoid a so-called hard landing as they continue to press the case for higher borrowing costs in an effort to get a handle on inflation that remains more than double their 2% target.

“The Fed runs the risk of solving one policy error of being too easy for too long with another policy error as they ignore the growing credit contraction and persistent losses from higher rates,” said George Goncalves, head of US macro strategy at MUFG. “The catch-22 is that for them to ease, something now has to break or the economy has to crack.”

It’s not just bond traders who are growing concerned.

Sixty-one percent of respondents in a Bloomberg poll of terminal users conducted in the hours after the Federal Open Market Committee decision said tighter monetary policy will ultimately cause a recession at some point in the next year.

“The Fed was clearly trying to send a hawkish message that they are not quite done yet and don’t think they have made enough progress on inflation,” said Michael Cudzil, portfolio manager at Pacific Investment Management Co. “You see curve flattening and rates not pricing in the full extent of hikes, so the thinking is that these hikes may bite and the Fed is closer to the end.”

Officials (…) also revised higher estimates of core inflation for year-end to 3.9%, from 3.6%, owing to what Chair Jerome Powell called surprisingly persistent price pressures.

Still, markets aren’t convinced borrowing costs will rise as high as central bankers project.

The highest rate on swap contracts for future meetings by late Wednesday was about 5.27% in September, with the one for July at 5.26%, compared to a current Fed effective rate of 5.08%. (…)

“Inflation pressures continue to run high and the process of getting inflation back down to 2% has a long way to go,” Powell said at a post-meeting press conference. (…)

Powell said he and his colleagues still think inflation risks are tilted to the upside, though he said the risks of doing too little or too much “are getting closer to being in balance.”

He suggested rate cuts are probably “a couple of years out” once inflation comes down significantly. (…)

For 2023, the median estimate for gross domestic product growth was marked up to 1% from 0.4% in March.

Unemployment is forecast to average 4.1% in the fourth quarter, compared with 4.5% projected in March. The official jobless rate stood at 3.7% in May.

The PCE inflation rate was expected to be 3.2% this year, down from 3.3% projected in March, but the core inflation projections increased.

Walmart-backed fintech ONE raises savings rate as battle for deposits heats up

ONE, a fintech company backed by Walmart Inc (WMT.N), is offering 5% interest on savings accounts of up to $100,000 as of Wednesday, a source close to the company said, as the battle for consumer deposits intensifies.

The rate is more than 12 times the national average of 0.4%, the source said, citing Federal Deposit Insurance Corporation data.

Apple Inc began offering 4.15% on its Apple Card savings accounts in April in partnership with Goldman Sachs Inc. Step, a fintech app catering to younger customers, offered 5% in May.

China’s Recovery Weakens as Industrial, Retail Activity Slow

• Industrial production rose 3.5% in May from a year earlier, the National Bureau of Statistics said Thursday, in line with the median estimate in a Bloomberg survey of economists
• Retail sales climbed 12.7%, missing the median estimate of a 13.7% increase
• Growth in fixed-asset investment slowed to 4% in the first five months of the year, weaker than forecasts of a 4.4% uptick
• The urban jobless rate was unchanged at 5.2%

China’s slower home price growth, deepening investment slump signal more easing

China’s new home prices rose at a slower pace in May, while the steepest slump in property investment in over two decades underlined the depth of demand problems in the crisis-hit property sector and pointed to more easing steps on the cards.

New home prices in May rose 0.1% month-on-month, slower than a 0.4% gain in March, according to Reuters calculations based on National Bureau of Statistics (NBS) data.

Separate NBS data also showed property investment fell at the fastest pace since at least 2001, down 21.5% year-on-year from 16.2% drop in April, according to Reuters calculations.

Property sales by floor area also slumped deeper, falling 19.7% from 11.8% drop in April. (…)

China’s economy is way more screwed than anyone thought

(…) The problem is that while consumers may be picking up, the biggest drivers of the Chinese economy — property and exports — are going to stay dormant. Consumer consumption makes up about 37% of the Chinese economy (in the US that figure is about 70%). So a return to normal activity from consumers is helpful, but it’s not enough to carry the economy.

China was never going to be able to deliver on the miracle reopening that Wall Street wanted without getting the wheels of its massive export and property machines moving. Beijing has tried to shift the country toward a consumption model, like the US, but exports still make up 20% of China’s economy.

In May, outbound shipments declined by 7.5%, the first decrease this year. The slump is largely due to a general global economic slowdown, but it’s also due in part to unfavorable geopolitical dynamics that seem to worsen by the day. Imports, an important indicator of China’s domestic health, also slowed. Beijing put the entire economy in a deep freeze during COVID, but that doesn’t mean reopening will heat things up. China’s economic return will be lukewarm at best. (…)

China is facing a long, painful road ahead, and policymakers in the Chinese Communist Party seem uninterested in market-oriented solutions to ease their journey. “The root causes of the disappointing recovery look increasingly structural — a deleveraging mindset and a more permanent loss of animal spirits,” Societe Generale’s Yao warned in her recent note. (…)

For years, China’s local governments funded themselves largely by selling land to property companies. In the US, we fund local governments through property taxes. China doesn’t have that, and smaller, poorer provinces are already begging for help because the way they used to raise funds is no longer available. (…)

Property was supposed to be a safe investment for China’s savers. Over 70% of China’s wealth is tied up in real estate. It was the investment that secured a family’s place in the middle class. And the problem isn’t just for older people nearing their twilight years — the property bust is hurting the prospects for the next generation, too. Some starved local governments are raising college tuition fees as high as 54% at a time when youth unemployment is over 20% and a record number of students are trying to get a higher education. (…)

Last year, China made up 50.7% of US imports from Asia; that’s down from over 70% in 2013, according to the management-consulting firm Kearney.

Note: I will be traveling until June 27, with limited posting whenever possible given limited time, equipment and time zone constraints.

CPI Report Shows Inflation Has Been Cut in Half The consumer-price index rose 4% in May from a year earlier, well below the recent peak of 9.1% last June and down from April’s 4.9%

(…) So-called core consumer prices, which exclude volatile food and energy categories, climbed 5.3% in May from a year earlier, down from 5.5% in April. Economists see core prices as a better predictor of future inflation.

Core prices remain elevated in part because an earlier surge in housing-rental prices continues to show up in the inflation figures. Apartment-rent growth has since cooled significantly—declining to just under 2% over the 12 months ended in May from double-digit increases a year ago. Those price changes will take pressure off inflation, but they take time to show up in inflation data due to the lag in how rent is calculated.

Overall consumer prices increased a seasonally adjusted 0.1% in May from the prior month, down from April’s 0.4% increase. Core consumer prices rose 0.4% in May from the prior month, the same pace as in April and March, suggesting underlying price pressures remain firm.

Rising housing, used-vehicle and food prices drove inflation last month, the Labor Department said. Gasoline prices declined 5.6% in May from April, and other energy prices also dropped.

Fed officials have focused recently on prices for a subset of labor-intensive services by excluding food, energy, goods and housing prices, believing that category could reveal whether wage pressures from the strong labor market are passing through to consumer prices. That category rose 0.24 percentage point in May, close to its average in the two decades before the pandemic, J.P. Morgan economist Michael Feroli said in an analyst note. (…)

Renters Are About to Get the Upper Hand New-lease rents are poised to fall on an annual basis for only the second time since the 2008 financial crisis.

Apartment rent growth is declining fast, shifting the rental market to the tenant’s favor for the first time in years.

The average of six national rental-price measures from rental-listing and property data companies shows new-lease asking rents rose just under 2% over the 12 months ending in May.

That is down from the double-digit increases of a year ago and represents the largest deceleration over any year in recent history, according to data firm CoStar Group and rental software company RealPage. (…)

One of the rent measures, from real-estate brokerage Redfin, already shows asking rents turning negative with a decline of 0.6% in May, compared with the same month last year. The data includes both apartments and single-family rental homes, Redfin said.

A decline in asking rent over a 12-month period has only happened one other time since the 2008 financial crisis, according to some data sources, when the rental market briefly dipped in 2020 because of the outbreak of Covid-19, ending a decadelong streak of rent increases. (…

A historic number of new apartments under construction is also forcing more competition among landlords. That will help slow down rents in some parts of the country, such as the South and Southwest, which are seeing the most construction, housing analysts said. (…)

“There’s certainly a correction taking place,” said Rob Warnock, a researcher at rental website Apartment List. Apartment List reported rents rising under 1 percentage point for the year ending in May.

Relatively high renewal increases are one reason why rent, as captured by official inflation measures, is still shown to be rising at a higher-than-normal rate. The shelter component of the consumer-price index rose 0.6% in May to reach an 8% annual increase.

But new-lease rents, which measure the change in price for apartments available to be leased to new tenants, are considered more of a leading indicator. As new-lease rent prices cool, landlords also are expected to keep dropping how much they ask their existing tenants to pay, said Jay Parsons, chief economist at RealPage.

Property owners who don’t lower renewal rates risk watching too many of their tenants move out, driving up vacancies, which already increased 2.6 percentage points over the course of 2022.

“There’s effectively a cap on how much rents can rise on renewal in today’s market,” Parsons said.

The increases tenants pay to renew existing leases are also going down this year. The typical renter living in a professionally managed apartment building paid 6.5% more to renew their lease in May, according to RealPage. That figure has been falling for 10 months and is down from a peak rate of 11%. (…)

Overall, 48 of the 100 largest U.S. cities are posting negative rent growth for new leases, measured on an annual basis, according to Apartment List.

“It’s a break from the affordability crunch, but it is not an affordability windfall,” Warnock said.

Ed Yardeni shows these charts of the two CPI rent components. Still up more than 8.0% YoY and in the 6% annualized range using the latest 3 months.

Most rent data use new leases which account for less than 10% of all leases. Renewals are a better reflection of the market that the CPI tries to measure. Apartment List has the best data on renewals: we are now well past the year-end seasonal declines in MoM rents. The last 3 months have each been up more than 0.5% MoM, annualizing 6.5%. May was up 0.52% (6.3% a.r.)

So, beyond the positive YoY trends from the base effect, the secular trends are for rents to rise in a steady 6% range which mirrors the trends in wages.

BTW, while everybody focuses on so-called “super-core” inflation, my calculations of “Inflation on Essentials” shows the continued squeeze face by most Americans:

The good news is that the squeeze has become more bearable in the last 3 months:

John Authers: The Great Inflation Scare Reaches Its Final Phase

(…) In all, then, this was not a report that greatly shifts things in either direction. The overriding issue concerns services inflation. To look at the most important drivers that aren’t in the highly variable food and energy sectors, this chart shows the difference between inflation in “owner equivalent rent” — a statistical measure to capture the rise in accommodation costs — and core goods. The latter, thanks to some notorious pandemic horrors such as used cars, shot upwards and drove the initial shock. Now, shelter inflation, roughly a third of the index, is what keeps it at a politically and economically unpalatable level. (…)

The Cleveland Fed publishes “trimmed mean” inflation data, in which the biggest outliers in either direction are stripped out, and an average taken of the rest. This measure has turned down sharply on a year-on-year basis, while the latest month-on-month number, when annualized, implies that inflation is now below 3%, the upper range of the Fed’s target. (…)

The Atlanta Fed, meanwhile, publishes measures that divide prices into those that are “sticky” — meaning harder to adjust — and those that are flexible (such as for gasoline). The central bank’s great concern will be to keep sticky prices from growing out of control. On a year-on-year basis, sticky inflation has turned down but remains very high. However, once shelter is excluded, the trend over the last three months suggests that other sticky price rises are abating. The issue again is primarily shelter. (…)

In line with this, Michael Feroli of JPMorgan notes that core services ex-rent, Fed Chair Jerome Powell’s “super-core,” was up 0.24% month-on-month; “for context, in the two decades before the pandemic, this measure increased 0.23% on average.” And if there’s one startlingly positive news item buried in the data, it concerns the highly politicized but extremely important business of health insurance. Thanks largely to being driven so much by shifting political tides, premiums have had periods of extreme inflation in the decade since “Obamacare” came into effect. The latest data suggest that premiums are down more than 20% over the last 12 months. That might just be a handy spur to consumers’ disposable income if it continues. (…)

The upshot for all this is that the futures market now prices a “pause” for the fed funds rate this week as a virtual certainty, while continuing to retreat from predictions of any significant easing this year. The market’s prediction is now that there will be no net cuts at meetings of the Federal Open Market Committee for the rest of 2023. (…)

In as much as we try to analyse and decipher the CPI and its components, the reality is that core CPI inflation has stabilized in the 5.0-5.5% range, more than double the FOMC’s objective.

Meanwhile, the economy is also benefitting from lower energy prices, down 11.5% YoY in May. For how long?

OPEC Production Slumps as Voluntary Cuts Bite The group accelerated its efforts to tighten the oil market as a handful of the group’s largest members sharply slashed output as planned.

Output from OPEC’s 13 members slumped by 464,000 barrels a day to 28.07 million barrels a day, the cartel said in its monthly market report, citing figures sourced from independent data providers.

The drop suggests the group’s members have largely made good on a pledge announced in April to reduce their collective output. But the figures also show an uptick in production from other members who aren’t party to the plan that could soften the cuts’ impact on oil prices.

OPEC and a collection of Russia-led allied nations—known collectively as OPEC+—pledged in April to reduce oil production by around 1.1 million barrels a day from May onward. Russia said it would extend an already announced 500,000 barrel-a-day production cut. (…)

Saudi Arabia, OPEC’s de facto leader and largest producer, slashed its output by 519,000 barrels a day last month, slightly more than the half-a-million barrel cut it had announced. The United Arab Emirates also cut output by 140,000 barrels a day, largely in line with its agreed voluntary cuts

Kuwait reduced output by 95,000 barrels a day, falling short of its planned 128,000 barrel-a-day cut. Iraq, which had pledged to reduce output by over 200,000 barrels a day, saw its output tick slightly higher as supply disruptions at a major pipeline eased.

Still, the cuts’ impact on oil prices could be undermined as members of the group not party to the voluntary cuts boosted their output. Nigeria and Angola, which have long struggled to meet their output targets due to a lack of investment, lifted their production by 171,000 barrels a day and 54,000 barrels a day in May.

Iran, which is exempt from OPEC’s system of oil production quotas, increased its output by 61,000 barrels a day. Libya and Venezuela, two OPEC members that are also exempt and whose oil industries have been beset by problems, also saw their output inch upward. (…)

Separately, the oil producers group lefts its forecasts for global oil supply and demand largely unchanged. That means the group continues to expect a sharp run-up in demand later this year that supplies will struggle to keep pace with, raising the prospect of higher oil prices.

OPEC expects global oil demand will grow by 2.3 million barrels a day this year to 101.91 million barrels a day. Meanwhile, oil supplies from non-OPEC nations will grow by 1.4 million barrels a day to 72.61 million barrels a day.

The group also made no major changes to its forecasts for global economic growth, which it continues to see at 2.6% this year. China’s economy is forecast to grow by 5.2% in 2023, while the eurozone is expected to grow by 0.8%, in line with earlier forecasts. The exception was the U.S. economy, which OPEC now expects to grow by 1.3% this year, up from last month’s 1.2% forecast.

• Shell pushes up dividend and cuts spending

China’s Recovery Is in Real Peril Now China’s central bank cut its key short-term rate on Tuesday. On top of weak lending data for May, that should be ringing alarm bells.

(…) Chinese banks have suffered in recent quarters from narrowing net interest margins, which make it difficult to boost lending—and growth—without putting profits and balance sheets at risk. If the PBOC now guides its key medium-term lending facility rate lower this week, then the cost of three major funding channels for banks—deposits, the money market and central bank lending facilities—will all have moved meaningfully lower. That will lay the groundwork for actual cuts to borrowing costs for households and businesses.

The problem is that many households, already heavily indebted and viewing a shaky labor market, don’t seem all that inclined to borrow. By 2021, Chinese urban households already had a higher debt load as a percent of their disposable income than U.S. households, according to data from Clocktower Group, a California-based asset manager. Mortgage debt in China has risen rapidly in recent years, in part because Beijing has relied on household borrowing to revive the housing market during previous stimulus episodes. (…)

What this probably means is that more direct fiscal support from the central government will also be needed, one way or another. China’s economy came strong out the gate in the first quarter but it is increasingly clear that repairing the housing sector and the labor market could be a long slog—unless Beijing is willing to act much more decisively, and take on significantly heavier direct debts itself.

The Profit Squeeze Is On American companies’ profitability is worse than headline figures suggest

(…) Refinitiv now estimates that earnings per share among S&P 500 companies were flat versus a year ago. Compare that with April 1, when analysts had expected a 5.1% decline. Even allowing for analysts’ tendency to lowball ahead of earnings season, and for the fact that companies reduced their share count through stock buybacks, that is a significant beat.

S&P 500 sales grew more swiftly, rising 3.6% overall from a year ago (and more, on a per share basis), so profit margins did slip. Plugging Refinitiv’s earnings-per-share figures into sales-per-share figures from S&P Dow Jones Indices, earnings came to 11.8% of sales in the first quarter compared with 13.2% a year earlier. That is still a historically high level of profitability, however. In the prepandemic first quarter of 2019—a good quarter for margins—the margin was 11.6%.

Considering how companies’ labor bills, in particular, keep climbing, this might count as evidence that they have been fairly successful in passing rising costs on to their customers. But other data tell a different story.

The so-called pro-forma results that many companies highlight don’t include many of the charges (often characterized as “one-time,” or “nonrecurring”) that they must include under generally accepted accounting principles, or GAAP.

Use GAAP, and S&P Dow Jones Indices estimates S&P 500 profit margin in the first quarter was 10.8%. And in the fourth-quarter—the quarter when many companies kitchen-sink “one-time” problems, it was 8.6%. Moreover, as The Wall Street Journal recently documented, many companies have been employing earnings-boosting moves that are acceptable under accounting rules, such as reducing depreciation expenses. (…)

Commerce Department figures give a more sobering read on profit margins. Its measure of after-tax corporate profits as a share of gross domestic product—a common proxy for economywide profit margins—came to 8.7% in the first quarter. That was the lowest level since the first quarter of 2016. One factor behind the margin squeeze: Private industry’s wage and salary bill rose by 5.8% from a year earlier.

Separate data, also from the Commerce Department, shows that some of the industries that saw some of the biggest profit boosts from the flurry of buying, and price increases, set off by the pandemic, are now experiencing sharp margin declines. Profits for food producers came to 5.7% of sales in the first quarter compared with 8.2% a year earlier, for example, while metals producers’ margins slipped to 9.5% from 16.1%.

The decline in margins could persist. Analysts’ current estimates show overall revenue for companies in the S&P 500 falling by 0.5% from a year ago in the current quarter, but pro forma earnings per share falling by a steeper 5.4%. Moreover, with demand for workers still high, rising labor costs could outstrip companies’ ability to pass on costs. This could be especially true for the makers and sellers of goods—a much more significant share of employers represented in the stock market than in the overall economy. That is because, even as goods demand, and prices, seem likely to moderate, they must compete for workers with a growing services sector.

Companies might want to sugarcoat what is happening to margins, but for investors it could still be hard to swallow.

FYI:

May ranked as the largest month of buying of US equities since 2010. US L/S net leverage rose to 12 month highs as a result of the buying. Mega-Cap TMT drove the bulk of the buying in North America pushing net exposure to these names to decade highs. Traditional defensive continued to be bought with May being the 4th largest month of buying since 2018. (The Market Ear)