Fed Raises Rates, Signals Potential Pause

(…) “People did talk about pausing, but not so much at this meeting,” Fed Chair Jerome Powell said at a news conference. “We feel like we’re getting closer or maybe even there.” (…)

“I think that policy is tight,” Mr. Powell said. But he added, “we are prepared to do more if greater monetary policy restraint is warranted.”

Until now, officials have been looking for clear signs of a slowdown to justify ending rate increases. But Mr. Powell indicated that calculation could shift now, and officials would need to see signs of stronger-than-expected growth, hiring and inflation to continue raising rates. The Fed’s next meeting is June 13-14. (…)

“We have a broad understanding of monetary policy. Credit tightening is a different thing,” Mr. Powell said. (…)

Officials dropped a key phrase from their previous policy statement, in March, that said they anticipated some additional increases might be appropriate, and they replaced it with new language saying they would carefully monitor the economy and the effects of their rapid increases over the past year.

“That’s a meaningful change, that we’re no longer saying that we ‘anticipate’” additional increases, said Mr. Powell. (…)

Mr. Powell said conditions in the banking sector had broadly improved since March. “There were three large banks, really, from the very beginning that were at the heart of the stress that we saw,” he said. “Those have now all been resolved and all the depositors have been protected.”

Officials have signaled growing divergence over the policy outlook recently, with some urging greater caution about raising rates given the lagged effects of the banking stress and the Fed’s earlier increases. Others are more worried about stopping prematurely only to see economic activity and inflation remain strong. (…)

Mr. Powell said he didn’t share the staff’s view, but he didn’t dismiss the prospect of a recession. “It’s possible that we will have—what I hope would be—a mild recession,” he said. (…)

Mr. Powell pushed back against expectations of rate cuts this year, but he acknowledged that investors expecting inflation to fall quickly could take that view. “We on the committee have a view that inflation is going to come down not so quickly. In that world, if that forecast is broadly right, it would not be appropriate to cut rates, and we won’t cut rates,” he said.

• The decision was unanimous. Powell said support for the 25 basis-point hike was “very strong.”
• Powell’s Word Soup Leaves Fed Watchers Hungry for More The chairman made it clear that today’s rate hike means we can expect a pause. Or a cut. Or another hike.
• For many months, the central bank has dug itself and the economy into a hole “because of earlier failures in analysis, forecasts, actions and communication,” Mohamed El-Erian writes, arguing that the Fed needs to shift the way it thinks about rates entirely. (Bloomberg)
• Gundlach, DoubleLine Capital’s co-founder, cited the cumulative rate increases by the Fed since March 2022 and credit contraction for reasons he’s “turning more bearish at this point in time.” The Fed likely won’t lift interest rates again following its latest increase, he said. “Recessionary odds are pretty darn high right now.” (Bloomberg)

• Nearly Half of Americans Worry Their Bank Deposits Aren’t Safe Levels of concern are as high or higher than they were during the 2008 financial crisis.

A Gallup poll released Wednesday shows 48% of Americans are very or moderately worried about their money following the worst spate of bank failures in 15 years. Only 20% say they’re not worried at all. (…)

• PacWest explores potential sale after shares plummet 50% California lender is latest to seek financial lifeline amid worst industry crisis since 2008
• Canadian lender TD calls off $13.4 bln deal to buy First Horizon Bank

SERVICES PMIs

USA: Output growth quickens on stronger demand conditions, butprice hikes intensify in April

The US service sector upturn strengthened in April, according to the latest PMI™ data from S&P Global, as output, new orders and employment growth all accelerated. The rate of expansion in new orders was the sharpest for almost a year. Stronger demand conditions put pressure on capacity as backlogs of work rose again, spurring a quicker increase in employment. The rate of job creation was the fastest since last August. Firms were also more upbeat regarding the year-ahead outlook for output.

Concurrently, inflationary pressures regained momentum. Service sector input costs rose at the steepest rate for three months, while the increase in selling prices quickened to the fastest since August 2022.

The seasonally adjusted final S&P Global US Services PMI Business Activity Index registered 53.6 at the start of the second quarter, up from 52.6 in March and broadly in line with the earlier released ‘flash’ estimate of 53.7. The latest data signalled the third successive monthly increase in output at service providers, with the rate of growth accelerating to the fastest for a year. Panellists stated that output increased amid greater customer confidence and another increase in new business.

Supporting the expansion in output was a second successive monthly increase in new orders. The rate of growth was only modest overall, but quickened to the sharpest since May 2022. Where a rise in new business was reported, firms linked this to greater customer referrals, stronger demand conditions and successful marketing and sales initiatives.

The upturn in demand was largely confined to the domestic market, however, as new export orders for services fell for the eleventh month running in April. Challenging economic conditions in key export markets resulted in customer hesitancy in placing orders following rises in average prices charged, according to survey respondents. That said, the pace of export decline was only marginal and the second-slowest in the near year-long sequence of contraction.

Stronger overall demand conditions brought with it the reignition of inflationary pressures in April. Average cost burdens rose at a marked pace that was the fastest since January and historically elevated. Higher business expenses were reportedly due to hikes in supplier prices and greater salary costs.

Selling prices at service providers increased at a steeper rate at the start of the second quarter, reflecting a faster uptick in cost burdens as well as strengthening demand, the latter allowing the pass-through of higher input prices to customers. The pace of charge inflation accelerated for a third successive month to the sharpest since August 2022.

In line with greater new business, firms expanded their workforce numbers during April. Efforts to relieve pressure on capacity drove job creation, as the rate of employment growth reached the strongest since last August.

Nonetheless, backlogs of work rose again. Although the rate of accumulation softened, it was sharper than the series average and the second-fastest since May 2022.

Business expectations among service providers improved in April, as firms were more upbeat regarding the outlook for output over the coming 12 months. The degree of optimism was the second-highest in almost a year, despite being slightly weaker than the series average. Confidence was linked to investment in sales and marketing activity as a means to increase sales.

The ISM:

Economic activity in the services sector expanded in April for the fourth consecutive month as the Services PMI^® registered 51.9 percent, say the nation’s purchasing and supply executives in the latest Services ISM Report On Business. (…)

The New Orders Index expanded in April for the fourth consecutive month after contracting in December for the first time since May 2020; the figure of 56.1 percent is 3.9 percentage points higher than the March reading of 52.2 percent.

• “Retail environment is lower year over year, but trends are stable year to date. Inventory levels are coming more in line to match the new lower demand trends.” [Retail Trade]

BTW: ADP Employment Above Expectations in April

According to the ADP report, private sector employment rose by 296k in April, 146k above consensus and consistent with evidence from other Big Data sources that the underlying pace of hiring remained solid or strong in April. We also continue to believe the BLS seasonal factors represent a tailwind for Friday’s payroll numbers. We boosted our nonfarm payroll forecast by 25k to +250k (mom sa). (GS)

Euro area economy grows at strongest pace since May 2022 as service sector rebound gathers momentum

The HCOB Eurozone Services PMI Business Activity Index recorded 56.2 in April, up from 55.0 in March to signal the strongest expansion in service sector activity in a year. The latest upturn was the fourth in as many months and well above that seen on average across the survey history (since 1998).

Higher demand for eurozone services boosted activity levels during April. New order intakes rose at a similarly-strong rate to that of output. The increase in new business was likewise the strongest in precisely one year. Backlogs of work also rose, marking a third successive pick-up in outstanding business.

Companies stepped up their efforts to boost capacity, with employment levels rising at the sharpest pace since May 2022.

Meanwhile, price pressures subsided during April, although rates of inflation for both output charges and input costs remained well above long-run trends. For example, the latest rise in selling prices, albeit the weakest in 14 months, was greater than anything seen in the survey history prior to February 2022.

Finally, service sector business confidence slipped to a three-month low in April.

China manufacturing PMI: Business conditions moderate slightly in April

Latest PMI data pointed to a marginal deterioration in overall business conditions across China’s manufacturing sector during April. Firms signalled only a fractional rise in output amid a renewed drop in overall new business. Subdued demand conditions contributed to a further fall in overall employment in the sector, but helped to ease supply chain pressures, with lead times for inputs improving slightly. At the same time, average input costs declined at the quickest rate since January 2016, supporting a steeper reduction in selling prices as firms looked to attract new business.

When assessing the 12-month outlook for output, firms were hopeful that customer demand will pick up and drive production volumes higher. Notably, the degree of optimism was the second-strongest in two years.

The headline seasonally adjusted Purchasing Managers’ Index™ (PMI™) slipped from the neutral level of 50.0 in March to 49.5 in April. This signalled the first deterioration in the health of the manufacturing sector for three months, albeit one that was marginal overall.

Softer demand conditions were a key factor weighing on the performance of the sector, with total new orders falling slightly for the first time in three months. A number of firms indicated that sluggish market conditions and weaker-than-expected customer spending had dampened sales. Underlying data indicated that the fall was largely driven by softer domestic demand, as new export work was broadly stable.

Production growth meanwhile slowed for the second straight month in April, with output rising fractionally overall. Firms that recorded higher output often linked this to the return to more normal business operations.

In line with the trend seen for output, purchasing activity increased at the softest rate for three months in the latest survey period. Inventories of both pre- and post-production items were meanwhile little-changed compared to the previous month. A number of firms expressed a reluctance to stock build due to the softer demand environment.

Suppliers’ delivery times improved for the third time in as many months in April. Companies often noted that vendors were less busy or that they had requested quicker lead times. That said, the rate at which delivery times shortened was only marginal.

Muted client demand led firms to cut their staffing levels again in April, and at the quickest pace in three months. This was often through the non-replacement of voluntary leavers, though there were also reports of firms trimming headcounts to cut costs. Backlogs of work meanwhile expanded for the fourth month in a row, albeit at a modest pace.

Manufacturers registered the first fall in average input costs for seven months in April, with the rate of decline the quickest recorded since the start of 2016. Lower prices for some raw materials and fuel were linked to the renewed drop in expenses. Cost savings were often passed on to customers in the form of lower selling prices, which were cut at the fastest rate since December 2015, as firms sought to attract new business.

Optimism towards the 12-month outlook for output improved, as firms were hopeful that customer spending would pick up in the months ahead. New product releases, supportive state policies and investment in new equipment were also expected to drive growth.

EARNINGS WATCH

From John Authers:

(…) With around 74% of S&P 500 companies having reported as of Wednesday’s close, top-line growth has been stronger than forecast while margins have tumbled slightly less than feared, Bloomberg Intelligence found. Even if US large-cap earnings are still in recession, the downdraft is on track to turn out just half as bad, analysts Gina Martin Adams and Wendy Soong wrote. Barring a few big swings, price performance has been benign compared to previous seasons. Note, however, that for all the positive surprises, earnings are down year-on-year:

All sectors, save for utilities, are beating forecasts, led by discretionary and industrials, and 80% of reports topped EPS estimates vs. a long-term average of 65% (from 1992) and five-year pre-pandemic average of 73%. Still, the index is pacing a 4.5% decline in EPS year over year, with seven of 11 sectors on pace for a decrease. Materials and health care are suffering the most.

Investors are in the thick of the large-cap earnings season, with roughly 24% of the index market cap, headlined by Apple Inc., Berkshire Hathaway Inc. and Pfizer Inc., posting results this week. Small-caps will have their biggest week with as much as 40% of Russell 2000 Index market cap expected to report — utilities being the largest sector followed by health care.

The proportion of companies beating consensus estimates rose sharply to 81% (from 72% last quarter), the highest since the fourth quarter of 2021 when brokers were still struggling to get their arms around the massive post-Covid rebound, and well above the historical average of 74%, according to Binky Chadha of Deutsche Bank AG. A jump of this magnitude has only previously occurred when coming out of large downturns, including the GFC and the pandemic:

Source: Deutsche Bank Research

The most significant surprise lay in profit margins. Over time, they have been highly cyclical and mean-reverting, and they decline as the economy slows. Following historically high margins toward the end of 2021, the widespread expectation was that they would fall significantly. Instead, they are on course to tick up a little and remain historically high:

Ominously for central bankers, this shows that companies still have the power to raise prices. Beyond that, the overall 6.9% jump in the aggregate beat of earnings forecasts in the latest quarter is noteworthy. Beats have been on a steady decline since the first quarter of 2021 after they hit a 20% record, Chadha said. For context, beats in the fourth quarter of 2022 were just 0.9% in the aggregate, well below the historical average of 4.9%. As it stands now, the beat by the median company is tracking 5%, well above the typical 3.5% and at the top end of its non-recession range:

Source: Deutsche Bank Research

(…) Bank of America Corp. analyst Savita Subramanian points out that in earnings calls executives have been appealing to the zeitgeist, talking about productivity, repatriating jobs from China, and name-dropping artificial intelligence whenever possible. “Productivity gains could be the next multi-year bull case for margins and multiples.” For proof, this quarter saw a 27% jump in year-over-year mentions for the word “efficiency.” Mentions of “artificial intelligence” skyrocketed 85% (as did the word “re-shoring.”)

Source: Bank of America

But they’ve also suggested that the economy is in bad shape, by complaining about demand:

Now to put this in cruel context. Earnings are still down for the second quarter in a row. They’ve been such a market positive because prior expectations were in the cellar. Vincent Deluard, director of global macro strategy at StoneX Financial Inc., highlights four “ominous trends” that have emerged this season:

Russell 3,000 index companies’ earnings fell 2.3%, their second consecutive quarterly decline;

Top line surprises were rare and their magnitude kept falling — the big ones have been about margins and pricing power;

The market’s muted reaction to positive surprises may suggest that companies “used accounting trick,” or issued negative guidance;

The same analysts who expect earnings growth to accelerate next quarter also believe the Fed will cut rates by almost 100 basis points.

He wrote: “Can profits jump in the midst of a recession? As shown in the chart below, the two lines of profits and GDP growth were almost indistinguishable in eight of the past nine recessions. Earnings bottomed before economic growth only once, in the shallow recession which accompanied the first Iraq war, but profits dipped back during the ensuing recovery. The historical odds are not with bullish EPS forecasts.” (…)

Source: StoneX Financial

Job Openings Near Two-Year Low as Layoffs Jump Construction, leisure and hospitality and healthcare cuts drive March increase in layoffs

Layoffs rose to a seasonally adjusted 1.8 million in March from the prior month, up from a revised 1.6 million in February, the Labor Department said Tuesday. The increase was led by job losses in construction, leisure and hospitality and healthcare industries—sectors that have driven job growth in recent months as tech, finance and other white-collar industries cooled.

Employers also reported a seasonally adjusted 9.6 million job openings in March, the Labor Department said Tuesday, a decrease from a revised 10 million openings in February. (…)

Data: Department of Labor; Chart: Axios Visuals

The decline in job openings has been steep since December; -1.6M or -14.6%. However, job postings on Indeed have stabilized in April (through April 28).

April PMI surveys indicated continued resilience in labor demand:

• “the rate of job creation accelerated at the start of the second quarter of the year. Growth in private sector employment numbers was the quickest since last July as goods producers and service providers showed some success in efforts to expand capacity. Nonetheless, backlogs of work increased for the second month running as companies mentioned further struggles finding suitable candidates and retaining staff amid rising wage costs.”
• [April marked] “the fastest rise in employment at service providers since July 2022” as “new business grew for the second successive month in April, as the rate of expansion accelerated to the fastest since May 2022.”
• “Manufacturers expanded workforce numbers at the fastest pace in seven months in an effort to broaden capacity [given the] return of new order growth following six successive months of contraction.”

While we’re at it, here’s what purchasing managers were saying about costs and price increases:

• “Meanwhile, [manufacturers’] input costs and output charges increased at steeper rates during April. Higher supplier prices reportedly drove inflation as firms passed through greater operating expenses to customers. The rate of cost inflation quickened to the sharpest in three months, while the pace of increase in selling prices also accelerated above the series average.”
• “[Service providers’] selling prices increased at a sharper pace, as firms responded to higher cost burdens by passing these through to customers where possible amid more accommodative demand conditions. The rate of inflation accelerated for the third month running and was the quickest since last August.”

Recall that for service providers, the main costs are labor and energy. Given the decline in energy costs in recent quarters, their “higher cost burdens” must be labor.

One and done?

• Employees Are Bullish on Pay Raises, Companies Not So Much Workers are anticipating bigger increases than last year while companies are pulling back on earlier projections.

Businesses are still handing out substantial pay increases, though less than what they projected last fall, according to a new survey of nearly 1,000 major employers by benefits-advisory firm Mercer.

On average, employers are giving annual merit raises of 3.8% and total compensation increases of 4.1% in 2023—still the highest-reported raises in the survey since the 2008 financial crisis.

The companies also said they were being more cautious in doling out off-cycle raises and bonuses this year, a departure from 2022 and 2021, when employers were scrambling to address labor shortages and keep talent. Additional levels of approval are now required for raises at some companies, while others are limiting unbudgeted raises to a smaller number of employees, said Lauren Mason, senior principal in Mercer’s career practice. (…)

Increases in employee base pay rose an average 3.4% between October and March, down from 4.7% in between January and September of last year, according to Mercer.

Meanwhile, a majority of U.S. employees say they are confident they’ll get a pay raise this year and, on average, expect one of 6.7%, according to a recent survey of 2,000 workers by the research arm of payroll provider ADP. Last year, workers received an average 6.5% increase, ADP data show. (…)

The employment cost index was up around 5% YoY and sequentially in Q1.

The Atlanta Fed wage growth tracker reached +6.4% in March, +5.9% for job stayers. These are 3-m moving averages.

Mission not accomplished just yet…

• NYC Board Proposes Up to 7% Hike for Rent-Stabilized Apartments

Tenants in New York City’s 1 million rent-stabilized apartments could potentially face increases of 4% to 7% for two-year leases as a key panel offered preliminary support for price hikes.

The city’s Rent Guidelines Board also endorsed 2% to 5% increases on one-year leases at a meeting Tuesday. If rent hikes in those ranges are approved at a final vote in June, it would be the second year in a row of more substantial increases.

More than 2 million New Yorkers live in stabilized units and may face higher costs when renewing their leases starting Oct. 1. The increases for rent-stabilized apartments would compare with a nearly 13% rise in the median rent on new leases for market-rate Manhattan apartments tracked by appraiser Miller Samuel Inc. and brokerage Douglas Elliman Real Estate. (…)

During former Mayor Bill de Blasio’s tenure, the board approved small rent hikes of less than 3% and also froze rents multiple times. Last year, under the Adams administration, the panel increased rents 3.25% on one-year leases and 5% on two-year leases. (…)

The board typically votes on the proposed rent guidelines each June. An earlier report from the panel’s staff detailed how rents would have to rise 5.3% to 8.25% for one-year leases and 6.6% to 15.75% on two-year leases to keep net operating income constant for the apartments based on various formulas. (…)

Owners’ expenses have increased 8.1% through March 2023 from a year earlier, according to the board’s analysis. Higher taxes, driven by rising assessments, as well as gains in fuel and insurance costs contributed to the increase in expenses. That’s pressured the margins for landlords, with net operating income — revenue that remains after operating costs are paid — falling 9.1% from 2020 to 2021 citywide for buildings with rent-stabilized apartments. (…)

Vehicles Sales at 15.91 million SAAR in April; Up 11.4% YoY

Wards Auto estimates sales of 15.91 million SAAR in April 2023 (Seasonally Adjusted Annual Rate), up 7.4% from the March sales rate, and up 11.4% from April 2022.  (…)

Regional Bank Stocks Close at Lowest Since 2020 Shares of a number of midsize lenders fell sharply Tuesday following the collapse of First Republic Bank, a sign that investors are still worried about the industry’s health.

Banks that took a hit following the March collapse of Silicon Valley Bank fell the most. Los Angeles-based PacWest dropped 28%, while Phoenix-based Western Alliance fell 15%. Metropolitan Bank, based in New York, declined 20%.

A broader index of regional-bank stocks fell more than 5% to its lowest close since 2020. Citizens, Truist and U.S. Bank each shed about 7%. The biggest banks also fell but the declines were less severe. Bank of America and Wells Fargo slid a respective 3% and 4%, while JPMorgan was down nearly 2%.

Stocks were broadly lower, with the three major indexes each losing about 1%. (…)

Many banks reported modest declines in deposits and lowered their profit forecasts, saying they would have to pay higher interest on savings accounts and certificates of deposits to keep customers around.

“The failures created an inflection point for the industry,” Huntington Bank Chief Executive Steve Steinour told The Wall Street Journal.

The KBW Regional Banking Index has lost 8% this week to hit its lowest since 2020.

• Bank Pain Is Just Getting Started, Ex-Fed President Kaplan Says

(…) “I’d prefer to do what’s called the hawkish pause, not raise but signal that we are in a tightening stance, because I actually think the banking situation may well be more serious than we currently understand,” Kaplan, whose career has also included time as a senior executive at Goldman Sachs Group Inc., said in a Bloomberg Television interview.

Kaplan went on to say that bank equities have been marked down solely because of their over-investment in US Treasuries, while the credit phase, which is “normally more serious,” is yet to unfold. (…)\

“It is more important to be able to sustain the current rate for an extended period of time, longer than the market thinks, than to get another 25-50 basis points and risk having to cut again. I think that will be very troubling,” said Kaplan, who left the Fed in 2021 after disclosures about his trading activity that drew criticism for potential conflicts of interest.

To combat inflation, the US need fiscal restraints and actions outside the authority of the Federal Reserve, “so I will pause here,” he added.

Toronto home sales jump 27 per cent in April, home prices spike Number of new listings was up 6.5 per cent after adjusting for seasonal influences, but is still well below the 10-year average

The weak stuff getting weaker

Russell looks to be falling below the lower part of the huge range. Note we have not closed this low since October last year. (The Market Ear)

Refinitiv

Druckenmiller Warns US Debt Crisis Worse Than He Imagined

(…) “honestly, all this focus on the debt ceiling instead of the future fiscal issue is like sitting on the beach at Santa Monica worrying about whether a 30-foot wave will damage the pier when you know there’s a 200-foot tsunami just 10 miles out.” (…)

The big issue is entitlements such as Social Security, Medicare and Medicaid, which without cuts today will have to be slashed in the future, he said. (…)

Spending on seniors will reach 100% of federal tax revenues by 2040 based on Congressional Budget Office estimates, he said, including interest expense. What’s more, the current $31 trillion US debt load doesn’t account for future entitlement payments. Accounting for the present value of that burden, the debt load is more like $200 trillion, he estimated. (…)

BTW: “The federal government missed out on locking in low long-term rates in recent years, causing interest payments to surge.” (The Daily Shot)

Gavekal Research

Copper Mine Flashes Warning of ‘Huge Crisis’ for World Supply

(…) “There’s no way we can supply the amount of copper in the next 10 years to drive the energy transition and carbon zero. It’s not going to happen,” adds Kirwin, now an independent consulting geologist. “There’s just not enough copper deposits being found or developed.”

Analysts at Wood Mackenzie estimate a greener world will be short about six million tons of copper by next decade, meaning 12 new Oyu Tolgois need to come online within that period.

But they aren’t — there are simply not enough new mines, much less enough large ones. The result is a gap: BloombergNEF estimates appetite for refined copper will grow by 53% by 2040, but mine supply will climb only 16%. (…)

Building mines, as opposed to buying them, is still too painful a headache. Prices are not shiny enough to cover rising costs, and risks abound. Take Oyu Tolgoi, where construction has involved adding a 200km labyrinth of concrete tunnels to the open pit, but also roads, an airport, power transmission and water infrastructure. Never mind Mongolia’s largest canteen, for 20,000 or so workers — and, Mongolia hopes, an eventual power plant. (…)

“Oyu Tolgoi is now 20 years old, and it’s just getting started,” he said. “It doesn’t matter whether the copper price is $3 a pound or $30 a pound, you can’t speed up the process materially.” (…)

“Mines are getting older, mines are getting deeper, and mines are getting lower grade,” said David Radclyffe, managing director at Global Mining Research. “Then you’ve had the added complications of the need to conform with the shift in terms of environmental requirements. And political risk on top of that.” (…)

“The uncertainty out of both Chile and now ongoing in Peru, that’s just added an extra level of complexity that the market never expected, and that hasn’t really been resolved.” (…)