SERVICES PMIs

Eurozone economy expands at strongest pace since June 2022

• The S&P Global Eurozone Services PMI Business Activity Index posted 52.7 in February, up from 50.8 in January and its highest level for eight months.
• Volumes of new work rose moderately in February and at the quickest pace since May 2022. The uptick in demand added strain to operating capacities, as evidenced through a rise in backlogs of work. The rate of backlog accumulation was the strongest since last June.
• The rate of job creation was slightly faster than seen on average across the survey history, but slowed since the beginning of the year.
• Service sector operating expenses rose substantially in February, with the rate of increase accelerating slightly. Output price inflation was little-changed since January and among the strongest seen on record.
• Doubts linger about the underlying strength of demand, especially as some of the February uplift appears to have been driven by temporary drivers, such as unseasonably warm weather and a marked improvement in supplier delivery times – likely linked in part to China’s recent reopening.
• Eurozone Composite Output Index at 52.0 (Jan: 50.3). 8-month high.

CHINA: Business activity rises sharply in February

• Services PMI rose from 52.9 to 55.0.
• Overall new business rose solidly in February, with the rate of growth the quickest seen since April 2021.
• New business
  from abroad also continued to rebound in February, expanding at the
  fastest rate for nearly four years.
• The rate of job creation was the steepest seen since November 2020.
• Operating expenses rose mildly and prices charged rose at a marginal pace that was little-changed from those seen in the three prior months.

Fed Official Says Hotter Data Will Warrant Higher Rates The Fed will need to raise rates to higher levels than previously anticipated to prevent inflation from picking up if the recent strength in hiring and consumer spending continues, says Fed governor Christopher Waller.

(…) So far, three officials out of 18 who participate in policy-setting deliberations have suggested they would have favored an increase of a half-percentage-point at the recent meeting or could support such a move this month. (…)

RENT WATCH

As expected (by me!) based on seasonality, the Apartment List’s national rent index increased by 0.3% MoM in February, after five straight month-over-month declines.

After a few months of record-setting price declines, it appears that rental demand is rebounding in line with the usual seasonal trend.

Year-over-year rent growth is continuing to decelerate, and now stands at 3.0 percent, its lowest level since April 2021. Year-over-year growth is now pacing just slightly ahead of the average rate from 2018 to 2019 (2.8 percent), and is likely to decline further in the months ahead. (…)

It’s typical to see prices dip and fall and early winter as moving activity slows, but things normally begin to pick back up around this time of year, and rent growth then tends to accelerate until the early summer peak.

The normal rent seasonality has showed up in February, interrupting the normal seasonal declines of the previous 5 months, which most pundits, including all FOMC members, have been using to base their “forecast” of rapidly slowing rent growth rates in 2023.

Apartment List’s data only goes back to 2017 but the positive seasonal trend from February to July is clear through February 2020, when the pandemic started to distort the trend.

Between 2017 and 2019, monthly rent growth averaged 0.8% (range: 0.75-0.86) between March and July. The February 2023 increase of 0.26% is in line with the 3 Februarys of 2017 to 2019 (+0.22%).

If we assume 0.70% monthly through July, the YoY growth would fall to below 1% in the summer due to the high base effect, but the annualized monthly trend would remain in the 8% range.

Yesterday, Tricon Residential Inc., which owns and rents 35,908 homes revealed that its renewal rent growth has remained steady well above 6.0% in the last 12 months.

Tricon favored occupancy in Q4’22 but seeing continued demand strength reverted to a rent growth bias in January and was able to increase new move-in rents 13.9%.

Tricon’s homes are admittedly virtually all located in the U.S. Sun Belt, including in Phoenix and Las Vegas where rents are under pressure, but this is also where supply is increasing the most. Yet, it is able to grow renewals 6%+.

The reality is that trends in rents are intimately linked with trends in wages, still in the 5-6% range.

It so happens that the K.C. Fed just released a paper titled A Tight Labor Market Could Keep Rent Inflation Elevated

Rent inflation responds more to labor market conditions compared with other components of inflation. We attribute this link between labor market tightness and rent inflation to greater demand for rental units afforded by job gains and wage growth. Although online measures of asking rents currently suggest official measures of rent inflation will decline, we caution that rent inflation is likely to remain above pre-pandemic levels so long as the labor market remains tight.

When Apartment List says that its vacancy index, at 6.4% is at its highest reading in two years and asserts that the record number of multi-family apartment units currently under construction should see “property owners competing for renters, rather than the other way around”, it omits the fact that even a 7% vacancy rate would be historically low and that the 932k apartment units currently under construction will only increase the U.S. total renting stock by 2% when Fannie Mae estimates the shortage of housing units at about 4 million.

Tricon’s calculates that it currently costs $700/month more to own versus rent…

…while mortgage rates keep rising:

U.S. Jobless Claims Ticked Down Last Week Applications for benefits remain historically low, pointing to a still strong labor market

US labor market stays resilient; Q4 labor costs revised higher

(…) A second report from the Labor Department showed unit labor costs – the price of labor per single unit of output – grew at a 3.2% annualized rate last quarter. That was revised up from the 1.1% pace reported last month. Labor costs accelerated at a 6.9% rate in the third quarter, and notched hefty gains in the prior two quarters.

They surged 6.5% in 2022, instead of 5.7% as reported last month. Economists estimated that labor costs were running at a pace consistent with underlying inflation slowing to 4% by the end of the year, double the Fed’s 2% inflation target. (…)

Hourly compensation grew 4.7% in 2022. It averaged 5.0% in the past five years, well above the 3% that is viewed by some policymakers as compatible with the inflation target.

Higher labor costs meant nonfarm productivity, which measures hourly output per worker, grew at only a 1.7% rate last quarter, downgraded from the previously reported 3.0% pace.

“The revised data suggest that the underlying inflation problem in the U.S. is worse than previously thought,” said Michael Pearce, lead U.S. economist at Oxford Economics in New York. “That helps to explain the persistence of sticky services price inflation, which is mostly a reflection of domestically-driven wage costs.” (…)

Big Retailers’ Sales Declines Reflect Shopper Pullback Consumers pulled back on purchases of apparel and electronics in recent months while continuing to spend on groceries and other necessities, say some of the largest U.S. retailers.

Macy’s Inc. and Best Buy Inc. said they expect sales to fall this year, after declining in 2022, as stubbornly high levels of inflation and other economic issues weigh on shoppers. Macy’s Chief Executive Jeff Gennette said he expects consumers to be in worse shape in 2023 than they were last year.

Shoppers are looking to stretch their budgets, buying more lower-cost store brands and smaller sizes of some items such as paper products, said Rodney McMullen, chief executive of Kroger Co., the biggest U.S. supermarket operator.

“They are behaving as if they are already in a recession,” Mr. McMullen said. At the same time, consumers are shopping more frequently than they have in recent months and, in some cases, still are splurging on products they want, such as premium beer, he said. (…)

As of January, 33% of consumer spending was on goods, compared with 30% before the pandemic. As spending continues to revert to prepandemic norms, that could equate to an additional $450 billion sucked out of goods and into services, he said. (…)

Macy’s said that sales could fall as much as 3% this year. The retailer said it expects prices to rise slightly this year, but not as much as they did last year. (…) The company’s comparable sales, or those from stores open at least a year and digital channels, fell 3.3% in the fourth quarter, as people spent less online and in stores. (…)

For the three months ended Jan. 28, Best Buy’s U.S. sales fell nearly 10%, dragged down by soft spending on products from computers and phones to home theaters and appliances. (…) The company forecast a 3% to 6% drop in same-store sales. (…) Its forecast for adjusted earnings was also lower than analysts were expecting. (…)

Costco Wholesale Corp. executives said Thursday that people are buying more food and essentials but fewer big-ticket items, eating into sales. (…) Comparable sales, those from stores or digital channels operating for at least 12 months, rose 6.8% from a year earlier in the quarter ended Feb. 12 excluding fuel and currency movement. (…)

INSIDERS

From Ink Research:

We continue to have an overvalued reading for the broad American market. At the sector level, the US Financials Indicator has slipped below 80%. As such, we have it on watch for a potential downgrade to fair-valued. It is currently the only sector with an undervalued sentiment reading.

MANUFACTURING PMIs

USA: Softest decline in output for three months as supply chain conditions improve

• Manufacturing PMI at 47.3 from 46.9 in January but down from the earlier
  released ‘flash’ estimate of 47.8.
• Still a solid deterioration in the health of the goods-producing sector.
• A further drop in new order inflows contributed to the continued overall decline in manufacturing sector health in February. The rate of contraction was little-changed from that seen in January and was strong overall. Lower new sales were often attributed to destocking at customers.
• Foreign demand conditions also weakened further, with new export orders falling for the ninth month running. The pace of decrease quickened from January and was solid overall.
• Input prices faced by manufacturing firms increased at a sharp pace midway through the first quarter, as higher raw material costs pushed operating expenses up. That said, the rate of cost inflation eased to the second-slowest since September 2020 amid reports that some items had fallen in price.
• Nonetheless, firms sought to pass-through higher costs to clients via another rise in selling prices in February. The rate of charge inflation gathered pace for the second month running and was the quickest since November 2022. Although slower than those seen throughout the last two years, the pace of increase was well above the series trend.
• Manufacturers recorded the fastest pace of job creation since September 2022. Firms reported an easing labor shortages as some long-held vacancies were filled.
• Meanwhile, goods producers registered a further fall in backlogs of work amid lower new order inflows.

  

The ISM:

• ISM Manufacturing PMI at 47.7 vs 47.4.
• 14 of 18 industries reported contraction in February (15 in January).
• New orders 47.0 vs 42.5. New export orders 49.9 vs 49.4.
• Employment back in contraction at 49.1 vs 50.6.

   New Orders                           New Export Orders

  

Recall that the S&P 500 Index is a “goods” index. This Yardeni.com chart illustrates the tight correlation between trends in the ISM Manufacturing PMI and S&P companies revenues growth.

At its current level, the ISM PMI suggests that revenue growth will turn negative in 2023. Not in analysts’ models yet.

See also the Feb. 21 Daily Edge: Margins Threats

This Gavekal chart (to January) indicates that S&P 500 earnings are facing the worst conditions since at least 1980:

Source: Gavekal Research via The Daily Shot

David Rosenberg shows that it may not be wise to load up on cyclicals at this point:

CANADA: Growth accelerates in February

• Manufacturing PMI at 52.4 from 51.0 in January.
• Both manufacturing output and new orders continued to rise during February, with growth rates picking up from relatively modest levels seen in February to their highest since last May. There were reports of firmer market demand, linked in part to lower inflation and growing confidence in the outlook.
• Foreign sales remained subdued, with exports down for a ninth successive month and suggestive that the current upturn in overall orders is being predominately led by the domestic market.
• Input prices rose to the slowest degree since July 2020 amid reports that greater stability in supply chains was placing some downward pressure on costs. That said, underlying inflation remained elevated, and firms continued to pass on a significant proportion of their cost bases to clients in the form of increased output charges, albeit to the weakest degree in the past five months.
• Staffing levels increased modestly for a fourth successive month.
• Buying activity declined for a seventh month in a row, albeit modestly, whilst there was a similar sized decline in stocks of purchases.

Vehicles Sales at 14.89 million SAAR in February

Wards Auto estimates sales of 14.89 million SAAR in February 2023 (Seasonally Adjusted Annual Rate), down 5.4% from the January sales rate, and up 8.6% from February 2022.

What Now for a Fed That Has Fallen Behind the Curve Again?

By Mohamed A. El-Erian:

(…) At least three Fed officials have already publicly signaled their openness to a 50-basis-point  increase after they all opted for a downshift to 25 basis points on Feb. 1. Others have yet to weigh in and may well be on the fence because of the counterargument that it is too early to evaluate the full impact of what, after a hesitant start, was one of the most front-loaded rate-increase cycles in decades. After all, the conventional wisdom among many is still that monetary policy acts with “long and variable lags” — a consideration that assumes greater importance in the light of forward-looking data that point to a potential slowing of the economy. (…)

It is often said that the first rule of finding yourself in a hole is to stop digging. With the Fed having already dug itself a deep hole, it is no longer crystal clear to me what the right policy step should be now. I suspect I am not the only one.

This ambiguity is not just a problem for Fed policy but also for the well-being of both the domestic and global economy. As always, it is the most vulnerable segments that are most at risk.

• BTW, the pandemic-era expansion of the food stamp program, covering 32 million Americans, expired yesterday. Food prices have jumped 23.7% over the last 3 years. The monthly support of $251 per average recipient drops $82 (-33%) to $169. And “Those who qualify for the minimum benefit under the standard income guidelines — many of whom are older Americans relying on Social Security — will see the steepest decrease, from $281 in monthly benefits to only $23”. (NYT)
• BTW #2: Student-Loan Borrowers Likely Won’t Know for Months if Debt Will Be Forgiven The Supreme Court is expected to rule on a challenge to the Biden administration’s program in late June.

The Atlanta Fed’s Raphael Bostic:

(…) So, now we must determine when inflation is irrevocably moving lower. We’re not there yet, and that is why I think we will need to raise the federal funds rate to between 5 and 5.25 percent and leave it there until well into 2024. This will allow tighter policy to filter through the economy and ultimately bring aggregate supply and aggregate demand into better balance and thus lower inflation.

Here’s what I will need to see to consider reversing the course of monetary policy:

• A narrowing of the gap between labor supply and demand
• Higher interest rates more decisively affecting aggregate demand
• Ongoing recovery in aggregate supply
• Reduction in the breadth of inflation
• Stable inflation expectations

Eurozone inflation comes in higher than forecasts Slight easing in inflation rate to 8.5% fuels expectations over further ECB interest rate rises this year

FYI:

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