SERVICES PMIs

USA: Here we go again with very different PMI reports!

• S&P Global: Strongest upturn in business activity for over a year as demand conditions improve

The seasonally adjusted final S&P Global US Services PMI Business Activity Index registered 54.9 in May, up from 53.6 in April and broadly in line with the earlier released ‘flash’ estimate of 55.1. The latest upturn in business activity was the fourth successive monthly increase, with the pace of expansion accelerating to the steepest since April 2022. Greater output reportedly stemmed from stronger demand conditions driving a sharper rise in new orders.

Growth in new business quickened again, with the rate of increase the steepest in just over a year. Companies noted that greater client confidence supported the expansion in new orders, as customers – especially in consumer markets – were more inclined to spend. Some also highlighted a broader client base and the acquisition of new customers.

Contributing to the rise in new orders was a renewed upturn in new business from abroad in May. New export orders increased for the first time in a year, and at a solid pace. Demand conditions at new and existing customers reportedly strengthened to support the latest expansion.

At the same time, service providers registered another marked increase in input costs. Greater business expenses were partly linked to increased supplier prices, but were largely attributed to higher wage bills and upward pressure on salaries. Although easing from that seen in April to the second-slowest since October 2020, the rate of input cost inflation remained historically elevated.

Service sector firms also saw a moderation in the rate of output charge inflation during May. Companies commonly stated that greater selling prices were due to the pass-through of higher costs to customers. The rate of charge inflation eased from April but was the second-fastest since September 2022 and sharper than the long-run series average.

In line with a stronger expansion in new business, service sector firms increased their workforce numbers at a solid pace. Matching the payroll gain seen in April, the rate of job creation was the joint-fastest since August 2022. Some companies noted that long-held vacancies were also filled following an increased availability of candidates, whilst others mentioned hiring was stepped up amid anticipated growth in demand.

Greater employment allowed firms to reduce the level of unfinished business during May.Backlogs of work contracted for the first time in four months.

Output expectations for the year ahead among service providers improved in May, as the degree of confidence rose to the highest in a year. Although weaker than the series trend, optimism was attributed to investment in marketing and advertising, alongside hopes for further boosts to new business.

• The ISM:

In May, the Services PMI^® registered 50.3 percent, 1.6 percentage points lower than April’s reading of 51.9 percent. (…) The Business Activity Index registered 51.5 percent, a 0.5-percentage point decrease compared to the reading of 52 percent in April. The New Orders Index expanded in May for the fifth consecutive month after contracting in December for the first time since May 2020; the figure of 52.9 percent is 3.2 percentage points lower than the April reading of 56.1 percent. (…)

Eleven industries [out of 18] reported growth in May.

WHAT RESPONDENTS ARE SAYING

• “Restaurant sales continue to track positive year over year, up an average of 8 percent past month. Employment needs have leveled off, and we are in a position to evaluate and upgrade rather than just maintain. (…)” [Accommodation & Food Services]
  

• “Overall slowing growth and market conditions dragging on some construction sectors.” [Construction]
  

• “(…) Our [higher-education] enrollment is currently projected to drop 2.5 percent, which will have a negative effect on our budget.” [Educational Services]
  

• “Pent-up demand for services is driving strong revenue performance, but expenses (labor and supplies) continue to put pressure on margins, hindering the financial forecast. There is modest improvement in financial metrics, but it is becoming clear we will have to find ways to do more with less. (…) The overall outlook, however, suggests the forecast is good for the next quarter. Pent-up demand for services is also causing capacity constraints, but we appear to be managing appropriately at this time.” [Health Care & Social Assistance]
  

• “Electronic components supply is strong, and lead times are nearly back to pre-pandemic.” [Information]
  

• “Everything seems to have leveled off: not getting any worse, not getting any better.” [Professional, Scientific & Technical Services]
  

• “Lead times are starting to shorten, due in part to greater transportation availability. Prices, in general, are continuing to increase but at a slower pace. (…) [Public Administration]
  

• “Overall business is good, and there has not been a significant change in direction.” [Retail Trade]
  

• “Business has significantly increased, with more orders, newer customers and more activity in general. More end users are getting back to business as usual, fighting for lower prices and taking a few more days to pay. The leverage point seems to have shifted back to end users, which is healthy.” [Transportation & Warehousing]
  

• “Business conditions continue to remain elevated as CapEx (capital expenditures) spending in clean energy follows regulatory demands.” [Utilities]
  

• “Supply is plentiful, freight is moving quickly and costs are coming down. This is a 180-degree change from a year ago. Also, sales demand is down.” [Wholesale Trade]

ING highlights how weak the ISM is:

(…) the only time the service sector report has been weaker in the past 14 years was in April and May 2020 at the peak of Covid containment and the December 2022 blip caused by the huge winter storm that was so disruptive for the travel, entertainment and service sectors.

ISM reports are heading in the wrong directions

The details are poor throughout with business activity having similar metrics to the headline. New orders fell 3.2 points to 52.9, but the backlog of orders plummeted to 40.9 from 49.7. The backlog of orders are not seasonally-adjusted so comparisons are tricky, but for what it is worth, this is the worst reading since 2009. This is something that we also saw in the manufacturing report, dropping from 43.1 to 37.5.

Now at least in the manufacturing report we saw the employment component rise to 51.4 from 50.5, yet the payrolls report said manufacturing employment fell 2000. We saw private sector employment rise 257,000 in that same report, yet the ISM has service sector employment in contraction territory at 49.2! (…)

It looks likely that the manufacturing sector is already in recession (seven consecutive sub-50 readings for ISM manufacturing). The service sectors order books are weak and will need to turn around rapidly to prevent the service sector joining it. Given this situation it is difficult to imagine that employment will continue to make such large gains.

The rival reports are at such extremes that one of these 2 firms will lose face. Which one does the FOMC listen to?

Interestingly (or sadly), neither ING nor Goldman Sachs cared to mention that S&P Global’s report is very buoyant in all aspects. In fact, all media I surveyed this morning only featured the ISM report.

• WSJ: Bond Yields Slip After Weak Services Data Though the non-manufacturing sector narrowly expanded, it whiffed on stronger expectations and is nearing contraction, according to ISM’s survey of business leaders.

• Bloomberg: US Services Activity Nearly Stalls as Price Gauge Slides The US service sector nearly stagnated in May as business activity and orders downshifted, while a measure of prices paid slid to a three-year low.

• Reuters: The U.S. services sector barely grew in May as new orders slowed, pushing a measure of prices paid by businesses for inputs to a three-year low, which could aid the Federal Reserve’s fight against inflation.

From all I read, and based on past occurrences, I would side with S&P Global’s survey.

Supporting evidence (via The Transcript):

• “…from what we see, things still are probably far stronger than we would have thought they would have been at this point in the cycle. There’s still a fair amount of cash in deposit accounts. Consumer spend is holding up. Debit card spend is kind of flattish. Credit card spend for us is up roughly 10%. It’s slowing slowly, which is what we would expect. But again, still, you’re not seeing any meaningful declines or any acceleration of that.” – Wells Fargo (WFC ) CEO Charles Scharf
• “As we kind of shared with you as part of our Q1, we continue to see a consumer which is just remarkably resilient and consumer spending continues to be remarkably resilient…And as I look at our drivers as in the performance drivers, which drive our top line, what we’re seeing effectively is that through the first 2 weeks of the month of May, our drivers are generally in line with our expectations” – Mastercard (MA ) CFO Sachin Mehra
• “…in March, she simply pulled back, and back half of March, we saw her pull back and really pull out of spending. The good news is in April, she started to return and she continues to return in May as well.” – Dollar General (DG ) COO Jeffery Owen
• “Quarter-to-date, demand trends have accelerated from April across nameplates.” – Macy’s (M ) CEO Jeffrey Gennette
• “…in the last 3 months, it’s fallen from a 9% growth rate year-over-year to 3%. So the American consumer spending has slowed down.” – Bank of America (BAC ) CEO Brian Moynihan
• “I think the bottom line is demand is really strong. So demand in the second quarter continues at what we predicted as we closed out earnings in Q1. So demand is strong. Leisure demand, in particular, is very strong. Obviously, leisure was really strong last year, particularly close in demand on the leisure side. So some of that on the booking curve. Leisure has gone back — is beginning to go back to a more normal booking curve, but it’s very strong.” – Southwest Airlines (LUV ) CEO Bob Jordan

Not a moot point given how important Services have become in the economy and in the framing of monetary policy.

On inflation and wages, the Fed’s current focus, here’s what the ISM data infer:

  

But S&P Global’s data say:

• Service providers registered another marked increase in input costs. Greater business expenses were partly linked to increased supplier prices, but were largely attributed to higher wage bills and upward pressure on salaries. Although easing from that seen in April to the second-slowest since October 2020, the rate of input cost inflation remained historically elevated.
• Companies commonly stated that greater selling prices were due to the pass-through of higher costs to customers. The rate of charge inflation eased from April but was the second-fastest since September 2022 and sharper than the long-run series average.

BTW, the Cleveland Fed’s Inflation Nowcast, updated yesterday, sees no easing in core inflation just yet:

Eurozone Services PMI®

The HCOB Eurozone Services PMI Business Activity Index remained in firm growth territory during May with a reading of 55.1. While this was above the series long-run average by a notable margin, it was down from 56.2 in April and thereby indicated a weaker expansion.

May’s upturn was supported by a further improvement in demand for eurozone services. New business intakes rose solidly and for a fifth month in succession, although the rate of growth was the softest since February. Surveyed companies recorded a historically marked uplift in new work from external clients during May, with new export sales rising at one of the sharpest rates since data were first available in September 2014.

Service sector employment growth continued in May and remained much stronger than the long-run average for the series. Nevertheless, firms’ backlogs of work rose for a fourth straight month, indicating pressure on capacity.

Euro area service providers registered another steep rise in their operating costs, although the increase was the softest since August 2021. That said, firms were more aggressive in their price setting as average prices charged rose at a quicker pace than in April.

Finally, businesses remained optimistic towards the outlook for business activity in the year ahead. However, the overall level of positive sentiment dipped to the weakest seen in 2023 so far.

China: Business activity continues to rise sharply in May The seasonally adjusted headline Business Activity Index increased from 56.4 in April to 57.1 in May, to signal a sharp and accelerated rise in services activity midway through the second quarter. Furthermore,the rate of expansion was the second-steepest seen over the past two­-and-a-half years. Business activity has now increased in each month since the start of 2023. The steeper upturn in activity coincided with a stronger rise in overall new business received by Chinese service providers in May. The rate of growth was likewise the second-sharpest since November 2020, with panel members citing continued improvements in demand conditions and customer numbers since the rollback of pandemic restrictions. Increased amounts of new work and rising business requirements led firms to expand their staffing levels for the fourth successive month. That said, the pace of job creation eased to a modest rate that was the softest seen over this period. May survey data indicated that capacity pressures persisted, as highlighted by a sustained increase in outstanding business. There were reports that greater intakes of new work had impacted firms’ abilities to process and complete orders. That said, the pace of accumulation eased from the previous month and was only slight. Average input costs faced by service sector firms in China continued to increase in May. The rate of inflation slowed from April’s one-year high but remained solid overall. Companies often mentioned that greater operating expenses stemmed from increased prices for labour and raw materials. The further strong rise in costs and improvement in demand conditions led service providers to hike their fees again during May. Though modest, the rate of inflation was the quickest recorded since February 2022 and above the series average. Firms operating in China’s service sector remained upbeat that business activity will rise from current levels over the next 12 months.Companies widely linked growth projections to expectations of further improvements in market conditions and customer demand as the sector continued to recover from the pandemic. That said, the overall degree of optimism dipped to a five-month low.

• China Asks Big Banks to Cut Deposit Rates to Boost Growth The government escalates efforts to boost the world’s second-largest economy.

(…) The guidance, which follows similar rate reductions in September last year, will help alleviate pressure on lenders as they strive to balance shrinking margins and government directives to beef up lending support to the economy. (…)

After spiking in the first quarter, credit and new loans weakened in April as consumers and businesses curbed their borrowing. Households are saving more and paying down their mortgages, rather than taking on more debt, while businesses are faced with falling demand and declining profits. (…)

Once the deposit rates cut take effect, it would lower costs of banks, enabling them to reduce lending rates over time. That, in turn, would make it more attractive for consumers and businesses to borrow. Lower deposit rates would also make it less attractive for consumers to park their cash at banks.

Commercial Properties Face Massive Loan Bill Nearly $1.5 trillion in commercial mortgages is coming due over the next three years. Many of them are vulnerable to default.

(…) Fitch Ratings recently estimated that 35% of pooled securitized commercial mortgages coming due between April and December 2023 won’t be able to refinance based on current interest rates and the properties’ incomes and values. While many malls and hotels face high default risks, the situation is particularly dire for office owners.

Xiaojing Li, managing director at data company CoStar’s risk analytics team, estimates that as much as 83% of outstanding securitized office loans won’t be able to refinance if interest rates stay at current levels.

A rise in defaults could ripple through the commercial real-estate market by forcing distressed sales and pushing down property values. It could also hit regional and community banks that are heavily exposed to the sector, forcing them to write down the value of commercial mortgages on their books and set aside more cash to cover for losses.

Mortgage defaults are still rare but rising fast. The share of securitized office loans that are delinquent jumped to 4.02% in May, up from 2.77% in April and the highest level since 2018, according to data company Trepp. (…)

After the 2008 financial crisis, many banks were willing to extend troubled loans, buying owners time. Interest rates were falling, the crisis seemed temporary, and the hope was that building values would eventually recover to the point that borrowers could pay back their loans. That is exactly what happened.

This time, fewer lenders are betting on a quick recovery, at least in the office sector. Most expect remote work to be a lasting phenomenon, meaning many office towers could struggle for years to come.

“Banks don’t want to kick the can down the road anymore,” Edelstein said.

Here’s what Daniel Pinto, JPM’s COO said last week at a Bernstein conference (courtesy of The Transcript):

So we did a bit of work to understand the dynamics in the real estate market in the last several months. And so the real estate market’s totality in this country is around $13 trillion, $14 trillion, commercial real estate. Offices — the average insertion loan-to-value was in the low-50s. If you were to do a mark-to-market of that portfolio now at the new cap rates and new occupancy rates and all that, so that probably, the loan to value at the moment is between 70% to 80%.

So definitively, it has been a deterioration. So an asset class that an insertion was $2.2 trillion, giving or taking, probably now is sometime between $1.5 trillion to $1.7 trillion. The amount of lending against that is $1.2 trillion. That is roughly half by — provided by banks and half provided by the markets, CMBS, some insurance companies, other participants.

So out of all that, $600 billion of lending. So we have, including First Republic, around $15 billion, $16 billion. So it’s around 8% to 9% of the total amount of our commercial real estate exposure that two-thirds of — close to two-thirds of our commercial real estate portion is multi-family lending and multi-family lending. Essentially rents, they’ve been catching up with inflation, so it hasn’t been deterioration. We have a very conservative portfolio with relatively low loans to — loan to value.

So the office — and then you have retail that a lot is being refinanced already, industrial, the other segments, they’re fine.

So the issue is real estate. There is still a cushion overall. Clearly, lower quality business — buildings in some areas. West Coast, for example, they are more impaired. So I think that we see that as an opportunity. There will be plenty of opportunities to refinance all those portfolios and all those business, but it’s something that you want to keep an eye. It’s very likely the occupancy rates has gone up — has gone down to roughly, at the moment, 87%, 13%; vacancies starting [8%, 9%] (ph).

So if you were to go another few points out, a lot of the equity gets wiped out and then there may be some losses, but still cushion. And in the risking of things, it is a problem. Don’t get me wrong, because a lot of that exposure is with the regional banks and community banks. But I don’t think there is a systemic issue. It is something that will be dealt over time through restructuring all these loans. (…)

Well, there is no doubt, you can see that regional banks and smaller banks, they are building up liquidity, building up capital, they are lending a bit less. So for sure, there is a tightening credit conditions, particularly coming from that segment. I don’t think that the big banks have really changed the lending standards at this point, because of that. And I think that private credit has plenty of dry power to absorb some of the demand. (…)

• Half of big multinationals plan to cut office space in next three years

Characteristics of a new bull market

From Richard Bernstein Advisors

It has been over seven months since the October lows, and during this time, the S&P 500® has rallied over 19%. Naturally, investors are pondering whether this marks the beginning of a new bull market. In this report, we aim to take an objective approach to determine if historical patterns can guide us in assessing the current situation. Spoiler alert: While it is certainly possible for this rally to evolve into a full-fledged bull market, historical precedent suggests it is far from a foregone conclusion. Here are some key takeaways from history:

1. No definitive technical thresholds: There are no specific technical indicators that serve as magical signals for a new bull market. It is not as simple as crossing a specific threshold to confirm the start of a bull market.

2. Breadth indicates strength: A broad-based rally with a wide range of sectors and stocks participating indicates a stronger foundation for a potential bull market.

3. The market leadership of bounces tends to be backward looking: The composition of a market bounce primarily reveals information about the past rather than the future.

4. Fundamentals matter: Rallies cannot transform into bull markets without support from underlying fundamentals.

This would not be an unprecedented start of a bull market or a bear market rally

Bear market rallies are relatively common occurrences. Putting aside the pandemic bear market in 2020 — which only lasted 23 trading days — the 2000 and 2007 bear markets each experienced four bear rallies of 10% or more, including some rallies of over 20% in both periods. In fact, the current 19% rally from the October lows is not much greater than the rally observed just last summer. Although seven months is a considerable duration since the 2022 lows, five of the past 14 bear markets since 1929 had longer periods between new lows being reached. It appears there are no magic levels or stop clocks that ring in the new bull market (Table 1).

The narrow breadth of this rally raises technical concerns. Historically, bull markets have often commenced with broad participation across various sectors, but the current rally does not exhibit this characteristic. In fact, this would be the first bull market since at least 1990 to begin with the market cap-weighted S&P 500® index outperforming the equalweighted index (Chart 1).

Investors would be wise not to read too much into the sector leadership of the initial market bounces. Sector leadership in these rallies tends to merely be a reversal of the preceding drawdown and has historically had no relationship with what worked throughout the remainder of the bull market. Based on history, it is unsurprising that this year’s big winners (Tech and Comm Services) were last year’s big losers and that this year’s big losers (Energy and Health Care) were last year’s big winners. It would also be quite normal for the sector leadership of the upcoming cycle to look quite different from the rally we have seen thus far.

While historical technical statistics are interesting to discuss, at RBA, we believe that fundamentals ultimately drive market performance. Corporate profits, liquidity, and sentiment/valuation are the primary factors influencing market trends over time. A sustained market rally requires support from at least one, if not a combination, of these factors. The table below provides an overview of the prevailing macroeconomic conditions at bear market bottoms (Table 2) and 231 days into a new bull market (Table 3). It is important to note that this table is not exhaustive and does not include factors such as fiscal policy (e.g. TARP or PPP), bank lending standards or investor positioning, but still offers a general understanding of the circumstances surrounding historical market bottoms.

Investors always try to anticipate troughs in fundamentals, and the times they get it wrong turn out to be the bear market rallies discussed earlier in this piece. But investors also get it right sometimes, and thus it’s not surprising that the market has historically tended to bottom before earnings growth reaches its trough. Nevertheless, when the markets have bottomed in the absence of earnings support, there has always been significant support from either liquidity or sentiment/valuation (typically both) to pick up the slack:

• Fed policy was more difficult to characterize before the Fed began targeting the Fed funds rate in the 1970s, but since then every bull market has begun with easing Fed policy.

• Prior to the Internet Bubble, every bull market began with a trailing GAAP P/E multiple below the historical median of 16.6x.

• Up until the pandemic, every bull market started with a P/E ratio on the prior peak EPS below the historical median of 15.4x.

The current rally may indeed be the early stages of a bull market, but this would truly be an unprecedented beginning without some signs of improving profit fundamentals, increasing liquidity or much cheaper valuations.

• From my EQUITY MARKETS: SEEKING FAIR VALUE post of January 10:

While it is true that equities eventually tend to do well after Fed easing episodes, “eventually” is the key word here: most times, the Fed eases for “good” reasons. Equity markets are not always in sync with the FOMC and some lags have been very costly.

I found 15 “Fed changes of posture” since 1957.

• From the first pause to the market low, the S&P 500 troughed 9 months after, on average. But the range is -3 months to +31 months.
• From the first cut to the market low, the S&P 500 troughed 6 months after, on average. But the range is -3 months to +21 months.

Actually, the S&P 500 declined after every Fed cut but five (1966, 1980, 1984, 1989, and 1995). Equities dropped between -4.0% to -47.7% (month end data) with an average of -16.1%. If we exclude 1974 (inflation) and 2001 and 2007 (bubbles), the average is -5.9% (range: 0.0% to -19.9%).

And I found no stable correlation with valuations, inflation and profit trends that could help decide when it might be safe to jump in.

A dovish turning Fed then only tells us to reduce our underweight and get ready to buy more aggressively.

• John Authers:

A related point is that the stock market tends to wait until the Fed has started cutting rates (in other words, when a recession is either imminent or has already started) before making a low. If this really is a new bull market, it’s the first to start when the Fed is still hiking:

If a recession has only been delayed, it would be very strange if the low for the stock market were already in. If a downturn can be avoided altogether, maybe last year’s selloff can be classified as an extreme response to speculative excess, like the Black Monday Crash of 1987. But it’s a stretch. It’s very odd for a bull market to start at this point in the economic cycle.

FYI:

Population Growth Y/Y In Canada and U.S.

Strong May Hiring Shows Labor-Market Resilience U.S. employers added 339,000 jobs in May, and the prior two months’ payrolls were revised up by nearly 100,000—complicating the Fed’s next decision on rates.

U.S. employers added a seasonally adjusted 339,000 jobs in May and the prior two months’ payrolls were revised up by nearly 100,000, the Labor Department said Friday. Workers gained more than 1.5 million jobs in 2023, more evidence of economic vitality, including robust consumer spending and a stabilizing housing market. (…)

The U.S. unemployment rate rose to 3.7% in May, still near historic lows but an uptick from April’s 3.4%, the Labor Department said. Average hourly earnings grew a solid 4.3% in May over the prior year, similar to annual gains in March and April. (…)

The average workweek fell to 34.3 hours, the lowest since April 2020 near the start of the pandemic. As a result of fewer hours worked, average weekly earnings advanced at a slower rate than hourly earnings, and gains have cooled since the start of the year.

The labor-force participation rate, the share of Americans who are working or actively seeking jobs, remained flat in May at 62.6% and below the February 2020 prepandemic level of 63.3%. That partly reflects the aging U.S. population. Among workers age 25 to 54, the participation rate rose to 83.4%, a level last touched in 2007.

May’s job gains were broad-based. (…)

Average hourly earnings rose 0.33% and April was revised to +0.4% from 0.5%. Wages are up 3.8% annualized YtD, down from +4.7% during H2’22. However, wages for production and nonsupervisory workers (80% of the total) rose 0.45% in May up from 0.35% in April and 0.39% in March. They are up 4.6% annualized YtD, down from +5.0% during H2’22.

This payrolls chart illustrates the resilience of labor income growth, +6.2% YoY in May, and the tight fit with total consumer expenditures:

On a MoM basis, aggregate payrolls rose 0.27% in May, right on the average of the previous 3 months. The stacked payrolls contribution chart below shows that wage growth (black) has been steady at +3.7% annualized this year while the sum of jobs and hours worked grew 1.7% a.r.. Excluding the outsize January (warm weather), the labor market and its components have been very steady in the past 12 months.

• Data Boost Likelihood of Short-Lived Pause A continuing strong labor market could lead officials to raise rates higher than anticipated

(…) Friday’s report was the 14th-straight time payroll growth has exceeded Wall Street forecasters’ estimates. Given that streak, “it is hard not to conclude that the labor market just has more momentum than standard models suggest,” said Krishna Guha, vice chairman of Evercore ISI, in a report Friday.

But the contradictory data from the two Labor Department surveys, which can occur at times when economic growth is slowing, “offers a rationale for skipping June with a default to hike again in July unless the data shows more signs of cooling by then,” he said.

The establishment survey has been pretty steady in the past year, unlike the household survey. Household employment declined 310k in May which caused the unemployment rate to spike to 3.7%.

The household series has been unusually erratic post-pandemic suggesting that relying on the unemployment rate to assess the labor market could be dangerous. In fact, the BLS tells us that when adjusted to the payroll definition, household employment was actually up 394,000 in May. It seems better to fade May’s rise in the unemployment rate.

In May, the number of unincorporated self-employed Americans fell by 369,000, dragging the household survey down. There are now 8.73 million Americans who are self-employed without owning their own company. That’s down from a peak of 9.51 million in August 2021, and it’s even lower than the 8.89 million registered in January 2020, before the pandemic hit. (Axios)

Data: FRED; Chart: Axios Visuals

Some of the fall in May in this volatile series might be attributable to the Hollywood writers’ strike, notes The American Prospect’s David Dayen.

Looking at labor supply, the participation rate of Americans aged 25-54 is now exceeding its pre-pandemic level (by 0.5%). But all other age groups remain well below, particularly those aged 55+ who are 5% below and still declining:

Actual employment levels for all age groups are above pre-covid levels except the 55+ group whose employment remains 1.7% below and declining.

This seems to reflect another “unexpected” (overlooked) effect of rising interest rates. Personal interest income jumped $160B (+9.5%) since the Fed started to hike, benefitting savers, largely retired/retiring people who had endured a decade of Fed financial repression.

Another example of why the normal monetary policy playbook is not effective.

• The Fed wants to curb demand with higher interest rates which normally primarily hit housing and vehicle demand and hurt construction and manufacturing employment. Combined employment in these swing sectors remains 2.5% above its pre-pandemic level and is up 3.5% since the Fed first hike and has yet to show any weakness. Why? Multi-family construction, government infrastructure spending, reshoring, and worker shortages.
• The 70 million baby boomers (21% of the total population) have a net worth of $73.1 trillion (52% of the total), up $43T (145%) since 2009 thanks to the explosion in house prices (+102%) and equity values (+275%) as the Fed kept interest rates lower for longer post the GFC. Per Ed Yardeni: “During April, consumers had record or near-record amounts of proprietor’s income ($1.9 trillion), interest income ($1.8 trillion), dividend income ($1.7 trillion), and rental income ($0.9 trillion).” The pandemic and financial repressions are over and boomers are spending, much of it on services like travel, eating out, and health care. Higher rates are actually boosting such spending.
• Total household debt servicing was 9.7% of disposable income in Q4’22, unchanged from the end of 2019 and down from 12.4% on average before the last 3 recessions (ex-covid).
• Significantly, mortgage debt and HELOCs account for 72.6% of consumer debt in the U.S. We can easily assume that most of it is 30-year mortgages at fixed interest rates much lower than today’s. Mortgage debt servicing is now 4% of disposable income.
• Even the so-called “goods recession” did not dent “goods employment”, still up 450k (+2.5%) since 2019.

• Meanwhile, the much larger services sector has seen its number of employees swell by 3.3M (+2.5%). During the first 5 months of 2023, services jobs have been rising by 295K per month on average, twice the pace between 2017 and 2019.

• The reality is that the goods sector, now less than 14% of all employment, is not responding much to tighter monetary policies, even less so when consumers are still flush with helicopter money. Demand for services is much less impacted by rising interest rates, even less so when baby boomers spend their wealth accumulated during years of extremely loose monetary policies and now boosted by rising interest rates which also contributes to reduced labor supply. Not only are Fed policies not effective, they are in many ways counter productive.

• It’s true that monetary policy works with lags, but one has to admit that even after a 500bps jump in 15 months, higher interest rates have yet to show any visible effect on employment, consumption and even core inflation, all well above pre-covid levels and all still in uptrends:

In all, the tight monetary policy is actually having little, if any, impact on consumer demand, employment and inflation. The conventional monetary policy playbook is not doing its normal job in the current unusual environment following the monetary and fiscal experiments after the GFC.

What could “save” a pausing Fed and produce the desired immaculate disinflation?

• Excess savings are gradually being exhausted. Goldman Sachs estimates a Q4’23 end.
• Federal student loans will need to be serviced again by the fall, after a 42-month pause. That will impact 34 million borrowers who have saved about $15,000 each over that period. But was it actually saved…or spent?
• Commodity prices, including energy prices, could keep declining, particularly if China underperforms.
• Corporations could stop hoarding labor if overall demand drops and/or profit margins decline.

In truth, nobody really understands this rather unusual economy. But what if the Fed keeps lifting rates?

• Larry Summers: “We’ve still got a tight, hot labor market. If they don’t raise rates in June, I think they have to be open to the possibility that they may have to raise rates by 50 basis points in July if the economy continues to stay way hot and if inflation figures are robust”.
• KKR sees “six percent short rates as the ‘red line’ where Fed policy dramatically retards growth and capital formation required to sustain positive, forward momentum.”

What would 6% rates do to a market widely expecting rate cuts this year?

Last week, Steve Blumenthal alerted subscribers to his Trade Signals of “A Rare –4 Zweig Bond Model Reading”

It’s not often that the Zweig Bond Model reaches a –4 Sell Signal reading. The last time it registered a –4 reading was in 2007. Prior to that was in 1989. And of course, there was the inflation era in the 1970s early 1980s.

Ned Davis Research calculates that when the Zweig Bond Model is on Sell, bonds provide negative returns in nominal terms vs +9.8%/annum when on Buy.

All four of Blumenthal’s fixed income indicators are currently giving sell signals.

Vehicles Sales at 15.05 million SAAR in May; Up 19.6% YoY

The BEA estimates sales of 15.05 million SAAR in May 2023 (Seasonally Adjusted Annual Rate), down 6.5% from the April sales rate, and up 19.6% from May 2022.

We are still 2M short vs pre-covid trends. Hence:

Saudi Arabia Cuts Oil Output After OPEC Members Clash Over Quotas Riyadh and some other producers also extend earlier voluntary curbs

Saudi Arabia said Sunday it would cut 1 million barrels of oil a day as part of a deal between OPEC and its allies after one of the most contentious production meetings in recent years amid concerns over slowing global energy demand.

Saudi Arabia said the output cut was for July and on top of previously announced curbs, which would be extended until the end of 2024. The United Arab Emirates and some other large producers also extended their previously announced cuts.

The Saudi announcement came soon after the Organization of the Petroleum Exporting Countries and its Russia-led allies said the group had agreed to stick to current production targets until the end of the year. Each member of the cartel, called OPEC+, is allotted a production quota, but sometimes members don’t hit that level. (…)

OPEC+ announced adjustments to collective targets that would reduce the cartel’s overall production ceiling by almost 1.4 million barrels a day next year. Russia, along with three African countries—Nigeria, Angola and Congo—will bear the brunt of those cuts while the U.A.E. received a bigger allocation, for which it has lobbied hard for years. (…)

The decision to keep the additional 1-million-barrel cut in July open for extensions is “likely put in place to discourage future short positioning,” it said. (…)

Saudi officials and other people familiar with Saudi oil policy say Riyadh is under pressure to maintain higher oil prices, with its budget requiring an estimated $81 a barrel to break even. In recent months, Saudi economic advisers have privately warned senior policy makers that the kingdom needs elevated oil prices for the next five years to keep spending billions of dollars on ambitious projects that have so far attracted meager investment from abroad.

• According to Airportia data, air traffic remains strong, still up more than 200% YoY. (@C_Barraud)

US hotel developers run out of cash as construction lending dries up

Tighter lending standards from regional banks are making it harder for U.S. hotel developers to secure funding, slowing construction of new hotels at a time Americans’ appetite for travel is ripe.

Hotel developers, private equity firms, and general contractors told Reuters the financial stress on regional banks — the largest lenders to hotels and other commercial real estate markets — has forced developers to postpone projects or find other creative ways to raise capital. (…)

Following the collapse of Silicon Valley Bank in March, California developer Shopoff Realty Investments paused construction of Dream Las Vegas, a 21-story hotel and casino resort, and said the firm was trying to secure more financing.

Since March, 59 of the 98 total U.S. hotel projects that broke ground or were in the pre-construction phase this year have been paused, according to previously unreported data shared with Reuters by Build Central Inc., a subscription-based research and analytics firm used by some large hotel brands to gauge market opportunities by location.

“The regional banks that used to be active for us 9 to 12 months ago are not showing up to finance hotels for us today,” said MCR Hotels Chief Investment Officer Joseph Delli Santi, the third-largest U.S. owner-operator of hotel brands including Hilton.

Over the past year, access to loans and higher construction costs have delayed projects across Florida, Texas, and California, said James Hansen, executive vice president of business development of hotel developer and operator Hotel Equities, adding that the regional bank upheaval had extended wait times for construction loan approvals.

Chief executives of major hotel companies, Hilton Worldwide Holdings Inc (H.N) and Marriott International (MAR.O), have also alluded to the issue – warning of a reduction in hotel developments as credit becomes more expensive and less available, in their latest earnings calls. (…)

As lending criteria grew more stringent, smaller hoteliers without existing lending relationships began to hit roadblocks, said Andy Ingraham, a hotel developer and president of the National Association of Black Hotel Owners, Operators, and Developers.

Ingraham said he and other members are struggling to get financing for various projects.

In some cases, private equity firms have stepped in to fill in funding gaps for construction loans, but at steeper costs, said Evens Charles, chief executive of Frontier Development and Hospitality Group, a Washington D.C. developer whose portfolio includes 10 hotels.

“I’m hearing 9-10% (interest rates) and it’s coming from a 4% environment two-and-a-half years ago,” he said. (…)

Banks started to reduce their hotel loan portfolios in the first quarter of 2023, an analysis by S&P Global Market Intelligence found. Based on available data from regulatory filings, the study showed 14 of 24 banks that held more than $125 million in outstanding hotel and motel loans reported quarter-over-quarter decreases. (…)

Elevated interest rates and inflated raw material costs due to supply chain backlogs were already hurting hotel developers even before the regional banking crisis, said Mitchell Hochberg, president of Lightstone Group, a New York-based private real estate investor and developer with a $3 billion portfolio of hotel properties.

The firm is putting the brakes on new projects.

“It’s getting harder to pencil in a good hotel deal,” he said. “A lot of developers would prefer to sit on the sidelines until rates come down rather than be burdened with the excess costs.”

The latest Fed data through May 29 show loans and leases are still growing, even more so at smaller banks:

EARNINGS WATCH

We got 9 new pre-announcements last week, 2 positive an 5 negative. Compared with after Q1, half as many companies guide negatively so far.

Q2 EPS are now seen down 5.4%, worse than the -3.9% expected on April 1.

Trailing EPS are now $220.02. Full year 2023: $220.89. Forward 12m: $225.50.

TECHNICALS WATCH

• The 13-34w EMA trend:

• The 200d m.a. has flattened:

• Extended:

• The equal-weight S&P 500 200dma is turning down:

• Bad breadth:

@Growth_Value_

• We just saw the largest weekly inflow to tech ever (@Mayhem4Markets)

• Speculative fervor is coming back as well. In a note to clients at the end of last week, Deutsche Bank pointed out that the volume of call-option buying in tech and Mega Cap Growth is nearing its highest levels of the pandemic era. (Joe Weisenthal)

• Americans feel good…about themselves…

Data: Federal Reserve “Survey of Household Economics and Decisionmaking.” Chart: Axios Visuals

Big Banks Could Face 20% Boost to Capital Requirements Those relying on fees might need bigger buffers to absorb losses under planned rules.

U.S. regulators are preparing to force large banks to shore up their financial footing, moves they say will help boost the resilience of the system after a spate of midsize bank failures this year.

The changes, which regulators are on track to propose as early as this month, could raise overall capital requirements by roughly 20% at larger banks on average, people familiar with the plans said. The precise amount will depend on a firm’s business activities, with the biggest increases expected to be reserved for U.S. megabanks with big trading businesses.

Banks that are heavily dependent on fee income—such as that from investment banking or wealth management—could also face large capital increases. Capital is the buffer banks are required to hold to absorb potential losses.

The plan to ratchet up capital is expected to be the first of several steps to beef up rules for Wall Street, a shift from the lighter regulatory approach taken during the Trump administration. (…)

Institutions with at least $100 billion in assets might have to comply, effectively lowering an existing $250 billion threshold for which regulators have reserved their toughest rules. (…)

The new framework was completed in 2017, but efforts to implement it in the U.S. were delayed by the pandemic. The Fed is playing a leading role in crafting the measure, along with the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency.

All three agencies are expected to seek comment on the proposed capital rules. They would have to vote again to complete the changes, likely implementing them over the coming years.

They are also expected to propose ending a regulatory reprieve that had allowed some midsize banks to effectively mask losses on securities they hold, a contributing factor in the collapse of SVB. Supporters of the change say it would have forced SVB to address the issue earlier as interest rates began rising and the value of its holdings declined.