Key Inflation Gauge Cools, US Consumer Spending Disappoints 

The personal consumption expenditures price index excluding food and energy, which Fed Chair Jerome Powell has stressed is a more accurate measure of where inflation is heading, rose 0.2% in November from a month earlier, Commerce Department data showed Friday. That matched estimates, but data for the prior month were revised higher.

From a year earlier, the gauge was up 4.7%, a step down from a 5% gain in October. The overall PCE price index increased 0.1% and was up 5.5% from a year ago, the lowest since October 2021 but still well above the central bank’s 2% goal.

Personal spending, adjusted for changes in prices, stalled in November, the weakest since July and below forecast. An increase in services spending, led by restaurants and accommodation, offset a decline in outlays on merchandise. New vehicles were the leading contributor of that decrease. (…)

The saving rate ticked up to 2.4% in November, the first increase since July but among the lowest readings on record, the Commerce Department report showed.

Inflation-adjusted outlays for merchandise dropped 0.6%, the worst since February, while spending on services rose 0.3%. (…)

Inflation-adjusted disposable income rose 0.3%. Wages and salaries, unadjusted for prices, were up 0.5% for a second month. (…)

The Fed must be pleased:

• Nominal wages and salaries are not slowing down, but, importantly, they are not accelerating per this particular measure (see below for other measures):

• Real wages are actually rising thanks to slowing inflation. Last 5 months, core PCE inflation averaged +0.2% per month and real disposable income is up 0.25% per month, more than 3% annualized.
• Goods are deflating, as expected: -0.2%/m since July and -0.4% in November.
• The particularly targeted durable goods are really deflating: -0.8% last month after -0.6% in October.
• Services prices rose 0.41% in October and 0.35% in November, still high but a welcomed stabilization below 5% annualized after reaching +7.3% a.r. in August/September.

November is the first month when the Fed’s drive to slow consumption and cool inflation shows convincing results. Real expenditures were flat in total and down 0.6% on goods (-1.5% on durables) while real services rose a steady, moderate 0.3%.

Core PCE inflation (blue bars) slowed from +0.55% in August, +0.46% in September, +0.26% in October to +0.17% in November.

Even PCE-Services prices (red) are behaving well.

Mr. Powell’s goal to see inflation slow over 12, 9, 6 and 3 months is currently met. Here’s the sequence: 4.6%, 4.3%, 4.3%, 3.6% respectively.

We’re not at 2% yet, but with the last 2 months at +2.6% a.r., the odds are very good that the sequence will be even lower by the time the FOMC meets next on Feb. 1.

In all, through November, the American consumer is slowing but not crashing. Actually, the Atlanta Fed’s nowcast of fourth-quarter real personal consumption expenditures growth increased from 3.4% to 3.6%. This with PCE inflation slowing across the board.

Real spending on durable goods has been flat in 2022, but not down as feared, holding well above pre-pandemic trends…

…critically sustaining retail sales, also slowing but still 15% above trend in nominal dollars:

The Atlanta Fed’s GDPNow model “estimate for real GDP growth (seasonally adjusted annual rate) in the fourth quarter of 2022 is 3.7 percent on December 23, up from 2.7 percent on December 20,” substantially above private forecasters’, with one month of data to go.

Americans are not losing their jobs, still see plenty of demand, enjoy wage increases of 5-6% (and large +8.7% cost-of-living adjustments on social security benefits impacting 70 million Americans) with inflation quickly receding below 4% thanks in part to a 38% drop in oil prices since June.

So far, the effects of the Fed’s aggressive tightening are limited to housing and an ongoing inventory correction, nowhere near what nasty recessions looked like. We seem to be in 1970, or 1990 or 2001, not in 1974, 1980-82 or 2008-09.

This next chart is pretty amazing, showing how industrial production (red) has uncharacteristically lagged durables consumption (black) and new orders (blue) since mid-2020. In previous recessions, inventories (green) declined well after new orders creating or aggravating the economic downturn.

This time, orders and inventories have flatlined at a high level, unusually standing 10-15% above production.

Meaning?

• Americans’ splurge on durable goods mainly benefitted foreign manufacturers. Goods imports surged 21.5% in 2021 and 18.7% in 2022 while domestic manufacturing production rose only 5.8% and 3.7% respectively.
• Supply chains issues are surely to blame for slow production and rising inventories. For instance, vehicle production has outpaced sales by about 15% since February 2020 but manufacturers’ inventories are down 78%, suggesting a lot of unfinished vehicles awaiting scarce parts.
• As supply issues ease in 2023, deliveries of vehicles will jump, potentially allowing production to rise after 5 years of no growth.
• The U.S. inventory correction will thus mainly impact foreign manufacturers.
• U.S. manufacturing employment keeps rising and could actually grow in 2023 helping sustain related services employment (e.g. transportation, restaurants, banking). KKR says that “in 2022 U.S. companies have revealed plans to reshore nearly 350,000 jobs, compared to 110,000 in 2019.” That would boost manufacturing employment by 2.7% (+0.2% in total).

This chart illustrates how past jobs recessions are essentially due to manufacturing (red). Non-manufacturing employment (blue, 91.6% of all employment) generally only slows down without declining much on an annual basis:

If KKR is right on reshoring and employers keep hanging on to their scarce employees, this could well be a soft landing after all.

That is unless a resilient job market amid a continued shortage of workers keeps pushing wages up, forcing the Fed to get even more hawkish. These trends in average hourly earnings are problematic:

Another possible scenario is that the inflation dragon appears defeated, cyclically, in 2023, bringing the doves out, only to realize later that it was not dead, structurally, and that the worst has yet to come…

While we wait for a clearer picture (!):

The Philadelphia Fed’s December surveys suggest that the soft landing scenario should be gaining weight:

• 53% of manufacturing firms and 48% of nonmanufacturing firms indicated that labor supply was a moderate or significant constraint on capacity utilization, down from 66% and 55% respectively in September. Easing across the board and faster in manufacturing.
• 45% of manufacturing firms and 41% of nonmanufacturing indicated that supply chain disruptions were a moderate or significant constraint on production, down from 68% and 43% respectively in September. Easing fast in manufacturing.
• 2.6% of manufacturing firms and 29% of nonmanufacturing firms (vs. 2.5% and in 16% respectively in September) said that access to financial capital was a moderate or significant constraint on capacity utilization. Worse and worsening faster for non-manufacturing.
• 26% and 63% of manufacturing and nonmanufacturing firms respectively expected access to capital to have a larger impact on capacity utilization over the next three months. Worse but worsening faster for non-manufacturing.

If the Philly Fed region is representative, the economic impact so far is much less pronounced on manufacturers, contrary to most expectations. Given that goods are already deflating, lesser pressures on wages at service providers could ease overall inflation faster than expected.

• Restaurant Staffers Are Returning to Work After Covid Flight Industry employment nears prepandemic levels as pay and working conditions improve.

(…) This past month, restaurants and bars had nearly doubled the number of employees working at the pandemic low in April 2020, according to the Labor Department. The past month alone, restaurants and bars added 62,000 jobs.

Restaurant owners and workers attribute the return to a combination of factors including pay increases, improving working conditions and fewer opportunities elsewhere as the economy weakens.

All but 2.1% of the 12.2 million food-service and drinking-establishment positions that existed in the U.S. in November 2019 had returned as of the past month, Labor Department data show. Restaurants, hotels and other leisure and hospitality employers have lagged behind the broader labor market, which in July added back the total number of jobs lost during the pandemic. (…)

Restaurant owners say applications have increased and more prospects are showing up for their interviews rather than ghosting operators, as many did earlier in the pandemic.

The share of job seekers interested in food-service and restaurant jobs is rising close to prepandemic levels, according to Jobcase, a job board specializing in hourly work. In October, 6.2% of individuals on the platform clicked on ads for food-service and restaurant jobs, compared with 6.4% in October 2019 and 5% in October 2021. (…)

Fast-food workers earned an average hourly wage of $15.17 in October, up 26% from before the pandemic, Labor Department data show. Wages for workers at sit-down restaurants rose 21% to $18.70 an hour. Both categories increased faster than the average worker’s wages; across private-sector employers, average hourly earnings for rank-and-file workers were up 16%.

Some restaurants have managed to staff up faster than others. Fast-food restaurants employed 4.6 million workers as of October, around 1% more positions than before the pandemic. Full-service jobs remain down 7.3% compared with February 2019. (…)

Retention has improved sharply since earlier this year, he said, with turnover dropping from 35% in the first six months of 2022 to 20% over the past three months. (…)

Restaurants’ margins, which have also been hit by rising costs for food, ingredients and materials, have declined to an average of 13% from 21% before the pandemic, according to a survey of 800 operators by market-research firm Datassential. Some restaurant operators said their margins are far lower than that. (…)

This is a highly unusual, complex cycle. The Fed could get its wishes reasonably fulfilled with a soft landing and decent inflation trends. But if wages don’t decelerate soon, the pivot may not happen and corporate profit margins could disappoint. Then the economy, and equity markets, could really suffer.

KKR, one of the best informed and savviest investor, is also highly uncertain of how monetary policy may evolve, offering rather unattractive risk-adjusted equity returns, particularly when compared with credit markets:

Our Forecasts Show a Wide Dispersion in the Path of Fed
Funds, Especially Over the Next 12 Months

(…) From a fundamental perspective, we expect margins to come under pressure as a sharp slowdown in nominal GDP growth is likely to coincide with sticky wage inflation and weaker labor productivity.

This backdrop, we believe, will limit how much companies can continually raise prices to offset elevated input cost pressures. Moreover, our Earnings Growth Lead Indicator (EGLI) suggests that earnings will be challenged in 2023.

In fact, our forecast for -10% earnings growth in 2023 is actually less aggressive than the model, given our view that the energy input might be overstated.

 

The current consensus for S&P 500 EPS growth is +4.9%.

Meanwhile, America’s main trading partner is already suffering:

Canada: GDP is running out of steam (NBF)

October’s growth came entirely from the public sector, with the business sector stagnating during the month.

Taking into account preliminary estimate for November, which indicates a moderate growth, quarterly growth is currently hovering around 1.0% in Q4, a clear moderation from previous quarters and well below potential growth of about 2.0%.

In a context of extremely restrictive monetary policy and consumers being struck simultaneously by loss of purchasing power, an interest-payment shock, and an unprecedented negative wealth effect, we continue to expect near stagnation in the first half of 2023.