CHINA, JAPAN MANUFACTURING PMIs

China: COVID-19 containment continues to restrict manufacturing output and demand

Chinese manufacturing business conditions deteriorated in October as COVID-19 containment measures weighed on both output and demand. That said, the decline was only marginal overall and weaker than in September.

Although levels of both production and new business fell during October, rates of decline eased. The latest survey data highlighted companies’ continued efforts to stimulate sales as output charges were reduced for a sixth month in a row. This came despite a renewed increase in operating costs, with panel comments suggesting this was primarily due to higher international prices for raw materials. Meanwhile, business confidence edged slightly higher during October.

The headline seasonally adjusted Purchasing Managers’ Index™ (PMI™) posted below the 50.0 no-change mark in October to signal a third successive deterioration in manufacturing sector conditions across China. However at 49.2, this was up from 48.1 in September and indicative of only a marginal decline.

Further declines in both output and new orders were seen at the start of the fourth quarter, with COVID-19 a principal factor behind lower client demand and disrupted factory operations. Nevertheless, decreases were only mild and slowed in both cases. All three monitored sub-sectors registered lower production and new orders in October. Intermediate goods makers registered the weakest reductions.

October survey data signalled another drop in new business from external markets. Slowing economic conditions abroad was noted as a factor, although some companies also experienced challenges in transporting goods overseas. Indeed, supplier delivery times lengthened again at the start of the fourth quarter. Limited vendor production capacity and shortages were linked to delivery delays.

Chinese manufacturers raised their purchasing activity in October, marking the first such increase since July. Where higher input buying was registered, this was linked to stock-building efforts. Similarly, pre-production inventories rose for the first time in three months during the latest survey period. Some companies reportedly secured inputs ahead of new product launches.

Elsewhere, there were continued signs of spare capacity at Chinese manufacturers as backlogs of work fell for the fourth time in five months. Some companies cited a build-up of incomplete orders due to COVID-19 disruption, although this was more than offset by the other businesses that were able to clear pending work on their order books.

Efficiency gains also led some Chinese factories to reduce their workforce numbers in October. Survey respondents reportedly lowered their headcounts due to the automation of some processes across the production line. Overall manufacturing employment has now fallen for seven months in a row.

Meanwhile, selling prices were reduced for a sixth successive month in October. According to firms, output charges were reduced in a bid to stimulate sales and improve competitiveness. Discounting came despite a renewed uptick in operating costs.

There was an improvement in business optimism during October, which recovered slightly from September’s 34-month low. Capacity expansion and new product launches were expected to support growth over the coming year.

Japan: New orders and output decline further in October

The headline au Jibun Bank Japan Manufacturing Purchasing Managers’ Index™ (PMI) fell to 50.7 in October, down from 50.8 in September signalling a weak overall improvement in the health of Japan’s manufacturing sector. The latest headline figure was the lowest reading for 21 months.

The positive PMI reading in October masked a further contraction in Japanese manufacturers’ production volumes. The latest downturn in output was the fourth in as many months and reportedly stemmed from weak demand conditions.

In line with the picture for output, order book volumes decreased for the fourth month running in October. Anecdotal evidence suggested that cooling markets and weak underlying demand primarily drove the decline with some panel members specifically mentioning stagnation across the automobiles and semiconductors industries.

Demand was also weak on an international level, as signalled by an eighth consecutive monthly fall in new export orders. Sluggish economic conditions in some of Japan’s key export markets reportedly drove the latest downturn. Despite this, Japanese manufacturing firms increased their workforce levels in October, though at a softer rate than in September.

The current lack of demand enabled firms to work though levels of outstanding work and build up stocks of finished goods. Following a month of no change, the backlogs of work Index declined in October, albeit marginally. Meanwhile, Japanese manufacturing firms also signalled growth in post-production inventories for the fifth consecutive month.

The latest survey data showed a third monthly reduction in buying activity as firms downwardly adjusted their spending in line with current demand trends. That said, the rate of decline was the softest in the current sequence with some firms reportedly increasing input buying ahead of anticipated price increases. For similar reasons, Japanese manufacturers also expanded pre-production inventories.

Japanese goods producers continued to cite difficulties in sourcing raw materials, as signalled by a further deterioration in vendor performance. The rate of deterioration was, however, the softest since May 2021.

In terms of prices, inflationary pressures remained severe. Though easing from September, input price inflation remained well above the historical average amid rising costs across a broad range of inputs.

Japanese manufacturing firms increased their selling prices to reflect the increasing cost burdens. In fact, the rate of output price inflation accelerated from September and was among the sharpest on record. The current weakness of the Japanese yen also reportedly contributed to current inflationary pressures.

Despite this, Japanese manufacturing companies remained firmly optimistic in October. The degree of confidence rose to a nine-month high amid hopes for stronger demand, supply pressure improvements, and a sustained Covid-19 recovery.

Fed Meeting to Focus on Interest Rates’ Coming Path Another 0.75-point rise is likely this week, as the pace of future moves takes the spotlight

(…) Many investors this year have been eager to interpret signs of a less aggressive rate-rise pace as a sign that a pause in rate increases isn’t far off, but a sustained market rally risks undoing the Fed’s work of slowing down the economy.

Any discussion by Mr. Powell about how officials see the potential for a higher rate path could temper any market exuberance about a slower pace of increases, economists said. “It is now about the destination, not the journey,” said Michael Gapen, chief U.S. economist at Bank of America, in a report Monday.

• Traders Expect Higher Interest Rates to Stay Wagers on rates remaining higher for longer have crept upward most of the year and are now nearing their highest levels since 2013.

Ahead of the Federal Reserve’s next decision on Wednesday, derivatives markets show the federal-funds rate sitting at around 3.5% for the long run. That is a full percentage point higher than the central bank’s own latest forecast. Those wagers have crept higher throughout most of the year, and are now nearing levels not seen since the 2013 bond-market rout known as the “Taper Tantrum.” (…)

Futures contracts tied to the policy rate now show fed funds peaking at about 5% around May or June, and remaining lofty from there. Earlier in the year, traders had centered around the idea that rates would peak in March, to be followed by significant rate cuts.

Smaller rate increases from the Fed might not actually mark a pivot in policy, said Nomura managing director Charlie McElligott in a Monday note. The more important shift is “a lengthening-out of the hiking horizon,” he wrote. (…)

• Why Mortgage Rates Are So Darn High Interest rates are rising all over the place, but mortgage rates have gone up especially quickly. The list of whom to blame is long.

(…) For the past decade, the spread between a measure of average national mortgage rates and 10-year Treasury yields has averaged 1.8 points, according to figures tracked by Autonomous Research. This year began right around that level. But with Treasurys yielding over 4%, the spread now at roughly 3 points is about as high as it has been this century.

Other times that the spread has seen comparable widening were in late 2008 and March 2020, when the financial crisis and pandemic, respectively, were driving investors to the haven of Treasurys. In both cases, the Federal Reserve stepped up to buy more mortgage bonds, bringing spreads and mortgage rates down, as spreads on mortgage bonds are a key component in the mortgage rates ultimately charged to borrowers.

This time, that isn’t happening: The Fed this year, as part of its plan to shrink its balance sheet, has stopped purchases of agency mortgage-backed securities. Those are packages of mortgage loans issued by government-sponsored enterprises such as Freddie and Fannie Mae.

On top of that, the Fed’s overall tightening of policy has contributed to a reduced appetite for bond buying by banks. As rates have risen, drastically fewer people are refinancing their mortgages and paying them off early. That increases the expected lifespan of mortgages and MBS. But the appeal of a longer-duration asset diminishes when banks’ deposits are more prone to quickly reprice in response to higher rates. (…)

Yet with the Fed both raising rates and no longer buying mortgage bonds, and with home prices generally in the central bank’s crosshairs, it is no wonder that few are stepping up so far to help keep mortgage rates in check.

Chip Shortages Still Plague Toyota, Some Other Auto Makers The Japanese car maker trimmed its full-year production plan by 500,000 vehicles, although it foresees record output.

Toyota Motor Corp. TM -0.51%decrease; red down pointing triangle on Tuesday lowered its Toyota and Lexus production target for the current fiscal year through March to 9.2 million units from a previous goal of 9.7 million, citing the risk of chip-supply issues.

The situation reflects prolonged underinvestment in certain older types of chips that are particularly needed by car makers. (…)

Analysts and chip executives say the supply-demand mismatch could drag on for years.

“If we look at each type of semiconductor, the supplies haven’t recovered to a satisfactory level,” said Kazunari Kumakura, Toyota’s head of purchasing. (…)

Toyota’s Mr. Kumakura said supply conditions have relaxed for certain types of chips that are used by both the automotive and consumer-electronics industries. “Overall, we have emerged from the worst of the situation,” he said. The 9.2 million vehicle forecast would represent an annual record if achieved. (…)

The problems particularly involve analog chips, which use older technology processing information with gradations, unlike digital chips that differentiate only between on and off signals. Executives at other Japanese auto makers have also said they are grappling with a tight supply of legacy chips.

Cars use hundreds of analog semiconductors for purposes such as moderating how much power is drawn from a battery, yet new investment has largely been funneled into developing more advanced chips.

A McKinsey & Co. report in October said that while manufacturers are trying to squeeze out more production of the legacy semiconductors, they are unlikely to keep up with demand through 2026. That is partly because of the rise of electric and hybrid vehicles that rely more on the chips, McKinsey said. (…)

Some Japanese auto-industry executives have highlighted the Dallas-based company as a source of current supply bottlenecks. A Texas Instruments representative said the company was working closely with customers to get them the parts they need and had a road map to build semiconductor capacity for decades to come.

Toyota’s current shortages are caused by chip makers having failed to increase capital investment in certain products, Mr. Kumakura said, without naming specific suppliers or types of chips. Due to the nature of vehicles today, “even if it’s just one type of semiconductor that’s in short supply, a car can’t be built,” Mr. Kumakura said. (…)

• Toyota profit plunges 25% on chip shortages and surging costs

Truckers Expect Softer Holiday Shipping on Waning Retailer Demand The outlook for a muted peak season comes as shipments and freight rates are already slipping

Several big operators say they are seeing freight demand drop off rather than pick up heading into what is typically their busiest period of the year. The downshift in business is sending rates in trucking’s volatile spot market downward and the weakness is starting to filter into the contract business that makes up the largest share of trucking volumes. (…)

“However, judging by the feedback from our clients, this peak will be muted versus historic norms. Beyond 2022, we do acknowledge the potential for a continued softening economy,” he said. (…)

The freight operators, in the midst of reporting third-quarter earnings results, are the latest in a host of companies in transportation sectors warning of slackening demand as inflation cuts into consumers’ buying power and triggers uncertainty in the direction of the economy. (…)

DAT Solutions LLC, a load board that matches trucks to available loads, said its index for spot market demand fell sharply from August to September, to the lowest point since February. The company’s measure of the average spot pricing for truckload vans fell from August to September for the first time since 2015.

“Things are definitely softening,” said Avery Vise, a vice president at freight research firm FTR Transportation Intelligence. (…)

Eurozone Inflation Rate Rises to 10.7%

(…) The European Union’s statistics agency Monday said consumer prices were 10.7% higher in October than a year earlier, the fastest rate of increase since records began in 1997, two years before the euro was launched. However, national records go back further, and Germany’s measure of inflation was the highest since December 1951. (…)

As measured by the Eurostat method, Italy’s annual rate of inflation jumped to 12.8% in October from 9.4% in September, while Germany’s inflation rate rose to 11.6% from 10.9%. By contrast, Spain’s inflation rate fell to 7.3% from 9%. (…)

“This raises the question of whether the talk of an ECB ‘pivot’ that followed Thursday’s meeting is premature,” said Paul Hollingsworth, an economist at BNP Paribas.

Klaas Knot, a senior ECB official, said on Sunday that the bank wasn’t even halfway through its campaign to reduce inflation. (…)

Eurostat said energy prices were 41.9% higher in October than a year earlier, while food prices were up 13.1%. But the core rate of inflation, which excludes those volatile items, also picked up to 5% from 4.8% in September. (…)

The influential IG Metall union, which represents some 2.2 million industrial workers, has demanded an 8% pay increase over 12 months to compensate for surging consumer prices. Its members started warning strikes over the weekend after failing to reach an agreement with employers. (…)

Biden claims oil companies are ‘war profiteering’ as he floats windfall tax

The Reddit crowd doesn’t exhibit significant participation in the recent equity bounce. (The Daily Shot)

U.S. Personal Spending Picks Up & Income Growth Firms in September

Individuals remain inclined to spend, but price inflation continued to eat into the real value of both spending & income last month. The 0.6% increase (8.2% y/y) in personal consumption expenditures followed a like rise in August, revised from 0.4%. A 0.4% increase had been expected for September in the Action Economics Forecast Survey.

The nominal gain in spending was inflated by price inflation. The 0.3% rise (1.9% y/y) in real sending repeated the August rise. Real spending on durable goods edged 0.1% higher (7.9% y/y) last month as spending on motor vehicle & parts rose 0.9% (1.4% y/y) after improving 0.2% in August. (…)

Inflation remined firm last month. The PCE chain price index rose 0.3%, the same as in August. The 6.2% y/y rise also was steady but remained below the June peak of 7.0%. It was nearly the highest rate of price inflation in over 40 years. A 0.5% m/m increase in the price index less food & energy also replicated the August gain. The 5.1% y/y gain was the biggest rise since the autumn of 1983. Food & beverage prices were up another 0.6% (11.9% y/y). Energy prices, in contrast, slid 2.4% (+20.3% y/y), the third straight monthly drop.

A second consecutive 0.6% rise (5.3% y/y) in the services price index powered the overall gain, driven by a 2.1% jump (16.4% y/y) in transportation prices. Housing & utilities costs rose 0.8% (8.0% y/y), following a 0.9% gain. (…)

Personal income rose an expected 0.4% (5.2% y/y) during September, the same as in the prior two months. The gain reflected a 0.6% rise (8.2% y/y) in wages & salaries, mirroring continued employment growth. (…)

The personal saving rate fell to 3.1% in September, nearly equaling the lowest rate since April 2008. The level of personal savings fell 8.5% and was 59.3% lower y/y.

Spending on Goods remains well above trend while spending on Services is slowly lifting toward its trendline.

On a quarterly basis, real expenditures rose 1.4% a.r. in Q3, after +2.0% in Q2 and +1.4% in Q1. Real Durables declined for the second quarter in a row. Real Services slowed to +2.8% a.r. in Q3 from +4.5% in Q2. Not a strong consumer, but neither a really weak one.

The Employment Cost Index rose at a 5.0% annualized rate in Q3 (private wages +4.7%) after +5.3% in Q2 (+6.3%) and 4.7% (4.8%) on average in the first half.

The Wages and Salaries component of personal income was up 0.6% in September after 0.55% on average in July/August. For all of Q3: +7.3% a.r. after +6.8% and 6.9% in Q1 and Q2 respectively.

Goldman Sachs’ composition-corrected wage tracker—which adjusts median weekly wages and average hourly earnings to control for workforce composition—now stands at +5.4% (YoY) in Q3 (vs. +5.5% in Q2). Its quarterly annualized composition-corrected wage tracker based on average hourly earnings and the Employment Cost Index stands at +5.2% (QoQ a.r) in Q3 (vs. +5.3% in Q2).

In all, labor costs look like they are cresting around +5%, maybe even softening a little.

PCE Services inflation (red bars below), intimately linked to wages, was +0.6% in each of August and September, +7.2% a.r., roughly in line with wages. Also cresting?

Actually, looked at quarterly data, PCE inflation is behaving encouragingly, hanging in around 4.5% with services inflation below 4.5%.

• Job Posting Declines Are Sharpest Among Pandemic-Era Leaders

(…) Job postings on Indeed were 48.8% above their pre-pandemic baseline as of October 21, signaling vigorous hiring intentions. New job postings, those that have been on Indeed for seven days or less, also reflect a healthy appetite for new hires, coming in at 55% above their Feb 1, 2020 level. (…)

Job postings on Indeed have declined by about 9% from December 31, 2021, through October 21 of this year, but the reduction has been more severe in certain sectors. Software Development job postings have dropped quite a bit over the course of 2022 as tech companies rein in hiring plans. Other high-wage sectors friendly to remote work, such as Marketing and Mathematics, the latter of which includes many data science jobs, have pulled back sharply as well.

Several sectors related to the production (Production & Manufacturing), transportation, and storage (Loading & Stocking) of goods have also experienced notable downturns in postings. (…)

While each sector is unique, the general trend suggests that a large portion of the decline in job postings is coming from sectors where employer demand has been satiated or as companies rethink expansion plans. (…)

A cooldown centered in the pandemic’s hottest hiring sectors is more likely to result in a normalization of the labor market than a rapid withdrawal which induces a downturn. (…)

As I showed on October 10,

(…) this table of the last 2-month annualized wage growth rates far from suggests we are near a wage/price spiral (number on left is % of total employment):

•   0.4% Mining & Logging: ……………………….-1.4%
• 10.4% Retail Trade ……………………………… 0.5%
• 16.1% Education & Health Services: …………. 1.0%
• 14.7% Professional & Business Services: ……. 1.2%
•   8.4% Manufacturing: …………………………… 2.9%
• 10.4% Leisure & Hospitality : …………………… 3.6%
•   3.7% Other Services: ………………………….. 4.3%
•   5.0% Construction: …………………………….. 4.4%
•   4.2% Transportation & Warehousing: ………… 7.4%
•   5.9% Financial Activities: ……………………… 8.0%
•   2.0% Information: ……………………………… 14.5%
• 14.2% Governments: ……………………………   5.3% (July/August)

Employees accounting for 50% of total employment saw wage gains of less than 3.0% annualized in the last 2 months. The next 19%: less than 4.5%. Transportation and Warehousing wages should slow down (e.g. FDX, WMT, AMZN); Financial Services will suffer from the bear markets and Information will be impacted by the tech slowdown.

Indeed’s data indicate that demand for the higher wage growth sectors is slowing fast.

Credit-Card Debt Returns to Prepandemic Levels Record card issuance and increased spending helped push total card balances to $916 billion last month.

Total card balances in the U.S. hit $916 billion in September, nearly identical to December 2019 levels, according to the credit-reporting firm Equifax Inc. EFX 2.61%increase; green up pointing triangle Balances are up 9% from January and about 23% higher than their pandemic low in April 2021. (…)

Missed payments on credit cards, while rising, remain below prepandemic levels. (…) Consumers had credit-card debt of $5,529 on average in September. That figure has been rising but remains below its prepandemic peak, according to the credit-score provider VantageScore Solutions LLC.

At JPMorgan Chase & Co., credit-card balances that are carried from month to month increased 15% in the third quarter from a year prior, but they remain slightly below prepandemic levels. (…)

Flush Consumers Could Mean Higher Rates for Longer Consumers and businesses buoyed by pandemic-fueled savings are proving less sensitive to tighter credit, which means more work for the Fed.

(…) Household, nonfinancial corporate and small-business sectors ran a surplus of total income over total spending equal to 1.1% of gross domestic product in the quarter of April to June, according to economists at Goldman Sachs Group Inc. Using a three-year average, the measure is healthier than on the eve of any U.S. recession since the 1950s.

U.S. households still have around $1.7 trillion in savings they accumulated through mid-2021 above and beyond what they would have saved if income and spending had grown in line with the prepandemic economy, according to estimates by Fed economists. Around $350 billion in excess savings as of June were held by the lower half of the income distribution, or around $5,500 per household on average.

Businesses were also able to lock in lower borrowing costs as interest rates plumbed new lows in 2020 and 2021. Just 3% of junk bonds, or those issued by companies without investment-grade ratings, mature over the next year, and only 8% come due before 2025, according to Goldman Sachs.

State and local governments are also flush with cash, leaving them in a far better position than after the recession of 2007 to 2009. (…)

Natural-Gas Prices Have Plunged Into Autumn A big driver of inflation is down more than 40% in two months as U.S. inventories have swelled since air-conditioning season.

(…) The decline is due to warm autumn weather, record domestic production and gas-storage facilities that have filled up fast since the end of air-conditioning season. Now, one of the big drivers of inflation costs roughly the same as it did a year ago. (…)

Natural-gas futures for December delivery ended Friday at $5.684 per million British thermal units, just 4.75% higher than a year ago. Early last week, futures slipped below $5 for the first time since March, when energy markets were jolted by Russia’s invasion of Ukraine.

Permian Basin producers in recent days swamped the Waha trading hub in West Texas, pushing prices into negative territory. In some cash trades, sellers paid buyers more than $1 per million British thermal units to take away gas that was fetching more than $8 at the start of September, according to S&P Global Commodity Insights. (…)

Goldman Sachs analysts forecast that benchmark U.S. prices would average $5 per million British thermal units in 2023. BofA Securities anticipates $4.50. Through Friday, natural-gas futures this year have averaged about $6.60 per million British thermal units, straining not just household budgets but also the gas-consuming makers of materials ranging from steel and cement to plastic and fertilizer. (…)

Between Sept. 9 and Oct. 14, 571 billion cubic feet of gas were added to stockpiles, the biggest build ever over five weeks. The deficit to normal levels shrank by more than half. As of a week ago, the volume of gas in storage was within 5.5% of normal levels for this time of year, according to the Energy Information Administration. (…)

A really cold winter, however, like the frigid season of 2013-14, which sucked nearly 3 trillion cubic feet from storage, could push prices north of $10, he said.

• Steel Companies’ Profits Hurt by Falling Prices

U.S. Pending Home Sales Fall Sharply in September

The Pending Home Sales Index produced by the National Association of Realtors fell 10.2% (-31.0% y/y) to 79.5 in September following a 1.9% August decline. The September decline was the tenth decline in eleven months. Pending home sales have fallen 37.9% since the August 2020 high.

Pending home sales declined everywhere in the country last month. Sales in the Northeast fell 16.2% (-30.1% y/y) following a 3.4% August shortfall. In the West, sales declined 11.7% (-38.7% y/y) after rising 1.4% in August. Sales in the Midwest declined 8.8% (-26.7% y/y) in September after dropping 5.0% in August. Sales in the South fell 8.1% (-30.0% y/y) after a 0.8% August slip.

The pending home sales index measures sales at the time the contract for the purchase of an existing home is signed, similar to the Census Bureau’s new home sales data. In contrast, the National Association of Realtors’ existing home sales data are recorded when the sale is closed, which is usually a couple of months after the sales contract has been signed. In developing the pending home sales index, the NAR found that the level of monthly sales contract activity leads the level of closed existing home sales by about two months.

China PMI shows weaker economy in October. November will probably be worse.

China’s official manufacturing PMI recorded a contraction in activity (49.2) in October, down from the very modest expansion (50.1) indicated in September. The non-manufacturing PMI index also registered a contraction, falling to 48.7 in October, down from 50.6 in September a month ago.

For the manufacturing PMI, almost every sub-index fell from last month’s reading. The exception to this was for raw material prices, which means even thinner profit margins for manufacturers. New orders were weaker, hinting at a further fall in activity levels in the coming months. New export orders remained in contraction, but slightly less so than last month. That makes it very hard to be optimistic about either manufacturing or exports for November and December.

In terms of the non-manufacturing PMI, the index was still dragged lower by real estate and construction. But adding to the gloom, the retail sector was also weaker, even though the first week of October was the Golden Week holidays. As a result, we believe that retail sales in October could be very soft.

All in all, October looks to have been a weak month for the economy, and November looks as if it will be no better than October. Compounding this is the fact that Covid cases are climbing again, and it is possible that we will see further small-scale lockdowns in China. We also expect a contraction in export demand in the coming months reflecting the weakening external environment.

We expect that the CNY will weaken further in the short term given the apparent weakness of the economy.  Together with more Covid cases and expected lockdowns, it becomes even more difficult to be upbeat about the yuan.

But the central bank does not want the CNY to weaken too fast. With the recent increase in macro-prudential parameters for cross-border finance, we expect that demand for the yuan should increase when USDCNY gets close to 7.4. It is therefore possible that the yuan will remain range-bound between 7.2 and 7.4. 

FED WATCH

Fed set for fourth consecutive 75bp hike – but a step down is coming

The market had been favouring a fifth consecutive 75bp hike at the December FOMC meeting up until late last week. However, a Wall Street Journal article last Friday by Nick Timiraos, who has gained a reputation as the Fed’s go-to guy when “senior management” want to guide the market more directly, helped alter the balance of thinking. His article hinted that some officials are concerned that things were moving too fast too quickly and they need to rein the market back a bit, which has re-opened the possibility of “just” a 50bp hike in December.

This was followed by comments from San Francisco Fed president Mary Daly, echoing sentiments from Fed governor Chris Waller that the Fed is “thinking about a step down [in the pace of hikes], but we’re not there yet”. Smaller rate hikes from Canada and Australia have added to a sense that bankers are looking to tone down the aggressiveness.

As Fed chair Jerome Powell has repeatedly admitted, monetary policy works with “long and varied lags” and after having hiked rates 375bp, it might soon be time to stop battering the economy so aggressively. The speed with which Treasury yields, mortgage rates and other borrowing costs have been rising in the economy is causing some economic stress, most notably in the housing market, but there is also concern that financial stresses could potentially be brewing in the system. Consequently, we do indeed expect the Fed to open the door to a slower pace through formal forward guidance, but it may not necessarily go through it. (…)

The current rate hike cycle vs. previous cycles – the orange circle marks where we currently are

Source: Macrobond, ING

The core CPI and PCE deflator continue to show prices rising 0.5% or 0.6% month-on-month, but to get inflation to trend toward the 2% year-on-year target we need to see month-on-month price changes of closer to 0.2%. So, while the recent commentary has offered some support to our current house view of a 50bp rate hike in December, the data doesn’t yet.

As such we have to keep the option open for a 75bp hike in December, even if the Fed language is a little softer next week. Indeed, the stickiness of inflation also suggests the risk is that our call for December to mark the peak (at 4.25-4.5%) is perhaps too early and it could be that we get a final 50bp in February that would then mark the top. This would leave a terminal rate of 4.75-5%. (…)

In his September presser, Mr. Powell told us that they are looking at trends in core PCE inflation on 3-6-and 12-month intervals “currently showing 4.8%, 4.5% and 4.8% annualized respectively.” One monthe later, these are 4.5%, 4.5% and 5.1%. Mission not accomplished yet.

He also listed 4 conditions for an easing in inflation:

• job openings need to decline significantly with rising unemployment;
• inflation expectations must remain well anchored;
• the various supply shocks will abate;
• real yields must be positive across the yield curve.

Not there yet either.

The Fed funds rate remains well below core inflation, not really restrictive yet. Demand is not contained yet although there are no signs of spiraling wages, so far.

• Morgan Stanley’s Wilson Says End of Fed Tightening Nearing

Indicators including the inversion of the yield curve between 10-year and three-month Treasuries — a recession indicator with a perfect record — “all support a Fed pivot sooner rather than later,” Wilson wrote in a note on Monday. “Therefore, this week’s Fed meeting is critical for the rally to continue, pause or even end completely.”

Goldman, having reviewed 85 prior hiking and subsequent easing cycles since 1969 across G10 economies, finds that

G10 hiking cycles lasted just over 15 months on average, and 70% of historical cycles lasted longer than a year. Cycles tend to be longer in the US but shorter in the UK, Canada, and Australia. Surprisingly, the length of hiking cycles is similar across high and low inflation episodes. (…)

75% of G10 hiking cycles featured a pause. (…) On average, hiking cycles ended when year-over-year inflation was within 10% of its peak (e.g. down from 5% to 4.5%). (…)

In the median cycle, the first cut came seven months after the last hike with a cumulative 200bp of easing within the first year. Across the G10, roughly 75% of the cycles involved a first cut within a year after the last hike. (…)

An important caveat to these findings is that the current post-pandemic cycle remains very unique.

• Goldman sees the Fed rate peaking at 5% in March

Good read from Steve Blumenthal: What Comes Next? The Fed is in the middle of a tightening cycle. In Bridgewater Associates’ recent research and insights note, Co-CEO Bob Prince shared his and his firm’s view on where we are in the cycle now and where we’re headed. “What comes next is weak economies and tough policy choices,” he says.

EARNINSG WATCH

From Goldman Sachs:

The S&P 500 rallied 4% this week despite disappointing earnings. On an aggregate basis, consensus expected 3Q EPS growth of 3% year/year at the start of the season. With 52% of companies having reported, that growth rate now stands at just 2%. 47% of S&P 500 companies have beaten EPS by more than a standard deviation of analyst estimates, in line with the long-term average but below the pace set in the last few quarters.

However, a potential downshift in the pace of Fed tightening, coupled with light positioning and anticipation of strong Q4 seasonality lifted the market.In 17 bear market rallies since 1970, the S&P 500 rose by an average of 15% over 44 days.

Per Refinitiv/IBES, we now have 263 reports in, a 73% beat rate and a +3.8% surprise factor

These 263 companies have reported actual earnings up 2.4% on a 11.7% revenue gain.

By comparison, after 279 reports in Q2, the beat rate was 78%, the surprise factor +5.2% and those 279 companies had reported actual earnings up 7.3% on revenues up 14.5%.

Q3 earnings are now expected up 4.1% (+4.1% on October 7). Ex-Energy: -3.5% (-2.6%).

Q4 earnings are now expected up 2.6% (+5.2% on October 7). Ex-Energy: -1.5% (+1.3%), the first time Q4 ex-E are seen declining.

Trailing EPS are now $221.18.Full year 2022: $221.27e. 12-m forward EPS: $229.54e. Full year 2023: $235.92e.

John Authers: Why Earnings Don’t Scare Stocks This Halloween

(…) Part of the problem is that the numbers are more varied than usual. Big tech companies generally disappointed, but there’ve also been some big successes. The aggregates don’t capture this. One idiosyncratic result particularly skewed the overall data. Amazon.com Inc. reported earnings twice their forecasts — and yet the retailer’s stock subsequently fell, because of its gloomy prognosis for holiday season sales. Include Amazon, and earnings per share for the quarter are beginning to turn up. Exclude it, and they’re flatlining, as illustrated by this chart from Deutsche Bank Asset Allocation’s Bankim Chadha: (…)

Aside from energy, only utilities and real estate (generally considered defensive) have risen so far in 2022, along with materials, where estimates have begun to fall as metals prices reduce (…).

(…) plenty of investors were worried about an all-out earnings crash. With the prominent exception of Meta, this hasn’t happened. (…)

The rewards for the good performers outside the tech sector show that optimism remains — and also that those good results in themselves imply that the economy is not in as dire straits as it appears to be. (…)

And earnings expectations for 2023 remain higher now than they were at the beginning of the year. (…)

In other words, the equity market is still implicitly pricing in a “soft landing” for next year, and the results for many companies imply that there’s a very good chance for it to come true. (…)

TECHNICALS WATCH

13/34–Week EMA Trend  (S&P 500 Index @ 3,875)

• For UBS Global Wealth Management, a Fed pivot is unlikely given the very high level of US inflation.
• Goldman Sachs: “In 17 bear-market rallies since 1970, the S&P 500 rose by an average of 15% over 44 days”.

DOG DAYS!

At San Francisco restaurant, pups chow on filet mignon

(…) Dogue, which rhymes with vogue, opened last month in the city’s trendy Mission District.

For $75 dollars per pup, doggie diners get a multiple-course “bone appetite” meal featuring dishes like chicken skin waffles and filet mignon steak tartare with quail egg.

It also includes a mimosa and a baked treat for the pup’s human. (…)

Massarweh says that since opening a month ago, he’s received overwhelming support from his customers who appreciate having a place to pamper their pups. (…)

On a recent Sunday, Dogue hosted three fur baby birthday parties simultaneously. (…)

Massarweh spends hours cooking and prepping for his service and says a similar menu for people could cost up to $500 in the expensive city and the ingredients he uses are not cheap. Everything is human-grade, although if you took a bite, you’d probably find the doggie dishes to be a bit bland for the human palate.

“When we make our food, it is a process. It is very time-consuming. There is a lot of technique. There’s a lot of method and detail to what we do,” he said. “Our pastries, for example, take about two days on average to make. I know they’re going to be eaten in two seconds.” (…)

Hmmm…something’s gonna happen…