Supplier Inflation Stayed Elevated in August The producer-price index, which measures what suppliers are charging businesses and other customers, rose 8.7% in August from a year earlier.

The producer-price index, which measures what suppliers are charging businesses and other customers, fell 0.1% in August from July, after a decline of 0.4% in July from June, the Labor Department said Wednesday.

On an annual basis, that left the PPI 8.7% higher in August than a year earlier, down from annual increases of 9.8% in July and 11.2% in June. (…)

The so-called core PPI—which excludes the volatile categories of food, energy and supplier margins—rose 0.2% in August from July, up from a 0.1% increase in July from June. (…)

The recent figures suggest the core PCE index was up 0.5% in August from July, according to Omair Sharif, head of the advisory firm Inflation Insights. That would mark a notable increase from the 0.1% gain in July from June, bringing the 12-month reading to 4.8% in August from 4.6% in July. (…)

More PPI data:

• Core finished consumer goods prices increased 0.5% (8.4% YoY) following a 0.6% July rise.
• Durable consumer goods prices gained 0.3% (7.7% YoY).
• Core nondurable consumer goods prices rose 0.6% (8.9% YoY).
• Services prices increased 0.4% (6.6% YoY) after a 0.2% July gain.

BofA Survey Shows Investors Fleeing Equities en Masse on Fear of Recession

A historically high 52% of respondents said they are underweight equities, while 62% are overweight cash, according to the bank’s global fund manager survey, which included 212 participants with $616 billion under management in the week through Sept. 8.

As concerns over the economy escalate, the number of investors expecting a recession has reached the highest since May 2020, strategists led by Michael Hartnett wrote in a note on Tuesday. Sentiment is “super bearish,” with the energy crisis further weighing on risk appetite, they said. A net 42% of global investors are underweight European equities, the largest such position on record.

The survey showed the market’s grim mood even before Tuesday’s report on US inflation, which ran hotter than estimates in August and cemented traders’ bets on a 75 basis-point rate hike by the Federal Reserve next week. (…)

Source: Bloomberg

The outlook for corporate earnings is also deteriorating. A net 92% of participants in the Bank of America survey now expect profits to decline in the next year, while the number of investors taking higher-than-normal risk has fallen to a record low.

Source: Bloomberg

• The most crowded trades are long US dollar, long oil and commodities, long ESG assets, short US Treasuries, long growth stocks and long cash
• A net 79% of participants see slower inflation in the next 12 months, while 36% say the Fed will stop hiking rates in the second quarter of 2023 (…)

Hmmm…

• Recall Bob Farrell’s rule #9: When all the experts and forecasts agree – something else is going to happen.
• Recall the fall of 2002. The low close on the S&P 500 was on Oct. 9 at 776, a trailing P/E of 17.7, down from 29.5 the previous March. The Rule of 20 P/E was 22.7, down from 32.0. Cheaper, but still not cheap. Yet, that was the low.
• But it was better (safer) to wait until March 2003 (low close of 804 on Mar. 12) when the R20 P/E touched 20.0 (trailing P/E: 16.8). Rising earnings, low inflation (2%) and a dovish Fed.

Ray Dalio Does the Math: Rates at 4.5% Would Sink Stocks by 20%

(…) “It looks like interest rates will have to rise a lot (toward the higher end of the 4.5% to 6% range),” the billionaire founder of Bridgewater Associates LP wrote in a LinkedIn article dated Tuesday. “This will bring private sector credit growth down, which will bring private sector spending and, hence, the economy down with it.”

A mere increase in rates to about 4.5% would lead to a nearly 20% plunge in equity prices, he added.

The rate market suggests traders have fully priced in a 75-basis-point hike next week by the Federal Reserve, with a slight chance for a full percentage point move. Traders expect the Fed fund rate to peak at about 4.4% next year, from the current range of 2.25% and 2.5%. (…)

Railroad Strike Averted as Tentative Deal Is Reached The agreement came after a night of late negotiations as strikes threatened to shut down a crucial vein of the U.S. economy and put fresh pressure on prices when inflation is near four-decade highs.

Biotech May Be the Next U.S.-China Battleground Investors in Chinese biotech—and perhaps their U.S. clients too—should be prepared for a rough ride

Shares of Chinese biotech companies, especially those with large revenue exposure to the U.S., tumbled after President Biden signed an executive order Monday to boost domestic manufacturing in the biotech industry. (…)

The executive order is relatively vague for now: It just kick-started a process wherein different departments make reports and come up with plans. But China looms large in the background. The order mentioned risks posed by foreign adversaries and strategic competitors in the biotechnology supply chain. U.S. lawmakers have long raised concerns about the reliance on China for drugs and medical supplies. The pandemic further intensified that worry.

China is a major manufacturer of active pharmaceutical ingredients, the key components in drugs. There is no readily available database tracking how much of these ingredients ultimately come from China. Complicated supply chains often obscure the picture: For example, China is a key supplier of APIs to India, which in turn is a major supplier of generic drugs to the U.S.

Increasingly, pharmaceutical companies are also outsourcing more research and development—especially costly and uncertain drug discovery and preclinical trials—to save costs. Biotech startups are also relying on Chinese companies’ services to avoid big capital outlays.

(…) the selloff—before any official sanctions or policy details have been announced—reflects the worry that something more ominous could be on the way. Chinese biotech could become a new battleground between the two superpowers, similar to what happened in semiconductors. (…)

Billionaire Patagonia Founder Gives Company Away to Fight Climate Change

Patagonia founder Yvon Chouinard and his family are giving away ownership in the outdoor apparel company he created almost fifty years ago to a trust and a non-profit devoted to fighting the environmental crisis.

Chouinard considered selling the company or going public, but decided on the unusual move to ensure the company’s profits will go to protect the environment. (…)

“Even public companies with good intentions are under too much pressure to create short-term gain at the expense of long-term vitality and responsibility.”

Chouinard, his wife and two children participated in the Patagonia transfer, which is valued at about $3 billion, according to the New York Times, which first reported the move.

“Instead of extracting value from nature and transforming it into wealth for investors, we’ll use the wealth Patagonia creates to protect the source of all wealth.” (…)

It’s the latest and most drastic move Patagonia has made to address global warming. The company gives away 1% of sales each year and became a certified B Corp and a California benefit corporation.

“While we’re doing our best to address the environmental crisis, it’s not enough,” he wrote. “We needed to find a way to put more money into fighting the crisis while keeping the company’s values intact.”

US Inflation Tops Forecasts, Cementing Odds of Big Fed Hike

The setting looked perfect:

• oil prices down and weakening;
• commodity prices down and weakening;
• supply chains mending;
• excess inventories requiring drastic cuts through discounting;
• house prices flattening out;
• airfares down;
• non-fuel import prices down for 3 consecutive months totaling -1.4% since May;
• the U.S. dollar strong and rising.

Yet, we got a surprisingly strong +0.6% core CPI inflation which, combined with July’s surprisingly low +0.3% print, keeps annualized core inflation in the 5-6% range.

What did the market get wrong?

1- Too much focus on goods when services inflation are the sticky part because of rising wages.

Services inflation was strong outside of airfares, which declined 4.6% (mom sa) on the back of lower oil prices. We would highlight the strength in cyclical and wage-sensitive services categories including shelter (rent +0.74%, OER +0.71%), food away from home (+0.9%), medical care (+0.8%), personal care (+0.7%), and education (+0.5%). Car insurance prices also rose 1.3%, similar to our expectations and reflecting higher replacement and repair costs. (Goldman Sachs)

Core Services rose 0.6% in August after +0.53% on average in the previous 3 months. They are up 6.1% YoY.

Services less rent of shelter: +0.6% after +0.57% on average in the previous 3 months. Unrelenting.

2- But core Goods inflation was also surprisingly strong at 0.5% after +0.2% in July which many thought was the beginning of several very soft, if not negative months given the setting described above.

Even after stripping 59% of the index, “All items less food, shelter, energy, and used cars and trucks” were up 0.5% last month, after +0.53% on average in the previous 3 months.

Betting on better goodsflation is not safe.

Betting on continued high Services inflation, 60% of the CPI and intimately tied to wages and energy, remains a good bet:

The Atlanta Fed’s Core Sticky-Price CPI is now up 6.0% YoY vs +3.5% last December:

The FOMC is far from “Mission Accomplished”.

ING offers some hope:

On the inflation side we feel that the weaker activity backdrop will dampen corporate pricing power and lead to a squeeze on profit margins. Indeed, the National Federation of Independent Businesses (NFIB) survey released [yesterday] morning suggests, in the small business sector, that inflation pressures are already softening with a clear drop in the proportion of companies looking to raise their prices further.

NFIB prices and price plans point to lower CPI readings ahead

Source: Macrobond, ING

With the outlook for the housing market deteriorating, we expect to see home prices move lower over the next 6-12 months, which will help to depress the rental components (that make up a third of the inflation basket). Meanwhile, supply chain improvements and lower used car prices will also be key factors that contribute to slower inflation next year. Add in weaker commodity prices, squeezed margins and the effects of dollar strength and we still see a strong chance that inflation hits 2% by the end of 2023.

ING omits services other than housing, still 36% of core CPI and up 7.4% YoY.

With wages rising 5-6%, service providers will keep raising prices until demand for services declines. That only happens in recessions.

Haver Analytics’ Joseph Carson:

At the start of the third quarter, there were 10 million job openings in the private sector, and seventy-five percent were in the service sector. The imbalance in the labor markets, especially for service workers, creates a nightmare scenario for the Federal Reserve. That’s because as it attempts to slow demand, dampen wage growth, and cool inflation, its monetary tools are much less effective in dealing with the less interest-rate sensitive service sector. (…)

Before the pandemic, the private sector service job growth was 1.5 to 2 million per year. So reducing the 7.5 million job openings in the service sector by half would take two years. But that would not mitigate wage pressures, the most significant source of service sector inflation.

The average wages for the private sector non-supervisory service sector workers are up 6.2% in the past year. Excluding the spike in wages in the early months after the pandemic, service sector wages are running at their fastest pace since the early 1980s. And, they are running roughly 100 basis points above the gains in the goods-producing industries.

Private service sector labor and price dynamics are the Fed’s most significant hurdles in its inflation fight. Creating slack in the labor market for service workers will require a much official rate and in place for an extended period than it would if inflation was only a goods sector phenomenon.

So Fed Powell’s warning that “a lengthy period of very restrictive monetary policy” will be needed to stem the inflation cycle is something investors should not ignore, as it signals a volatile market environment.

The only positive in the August CPI report is that my CPI-Essentials series was unchanged for the second consecutive month, thanks to the 5.0% MoM drop in CPI-Energy following -4.6% in July. It is still up 9.2% YoY, however vs headline CPI at +8.2% and core CPI at 6.3%.

CPI-Essentials vs CPI and Core CPI (YoY)

Some (rather small, perhaps only temporary) relief for the lower wage earners.

Some of them will be getting more relief, however, as the Economic Policy Institute told us last week. Twelve states and D.C. have policies that index their state’s minimum wage based on inflation. Most of those indexed increases are based on the August-to-August change in the Consumer Price Index [+8.3%].

The 12 states are: Alaska, Arizona, Colorado, Maine, Minnesota, Montana, New York, Ohio, Oregon, South Dakota, Vermont, Washington, and Washington D.C.. (Vermont and Minnesota cap increases to 5% and 2.5%, respectively). The raises will go into effect in January 2023.

Six other states (Connecticut, Florida, Missouri, Nevada, New Jersey, Virginia) also index yearly but in December.

• Amazon to Raise Pay for Delivery Drivers Amid Tight Labor Market The e-commerce giant will invest $450 million in increased wages and other benefits for drivers as it tries to ensure it has sufficient staffing for the peak holiday season. Other benefits as part of the new initiative include up to $5,250 a year for drivers to pay for educational programs, and financial support for a 401(k) investment plan for drivers.
• A UPS ad on Axios today boasts that “Full-time UPS delivery drivers average $95,000 per year, plus UPS contributes another $50,000 annually to health, welfare and pension benefits. After four years, a full-time UPS driver averages $42 an hour in wages.”

• NFIB: Pricing by firms continued to cool in August but remained quite elevated by historical standards. The percentage raising selling prices fell to 53% in August from 56% in July and 63% in June. This was the fourth monthly decline in the past five months. And the percentage expecting to raise selling prices in the next three months declined 5%-points to 32%, its lowest reading since January 2021, from 37% in July and 49% in June. Pressure on wages was mixed in August. A net 46% of firms were raising worker compensation in August, down from 48% in July. The series high is 50% reached in January.

Global Oil Demand Undermined by China Lockdowns Weaker demand for oil in China, as the economy faces stop-start Covid-19 lockdowns, is outweighing robust crude demand elsewhere in the world and will crimp oil demand growth this year, the International Energy Agency said.

In its oil-market report, the IEA lowered its forecasts for Chinese oil demand by 400,000 barrels a day this year to 15 million barrels a day, 420,000 barrels a day less than last year. For 2023, the Paris-based agency lowered its China demand forecasts by 300,000 barrels a day, but still expects demand to rise to 16 million barrels a day as Covid-19 pandemic restrictions are relaxed.

China’s economy, the world’s second-largest, is proving to be the global laggard in oil demand. Among other nations, oil demand has remained surprisingly robust despite high inflation, rising interest rates and slowing economic growth. Oil demand in the U.S. is proving stronger than expected, the IEA said, while Middle Eastern demand is also strong as hot temperatures prompt above-average demand for oil-fired electricity generation.

Meanwhile, in Europe, soaring gas prices—prompted by Russia’s halt to flows through the Nord Stream pipeline—are adding greater-than-expected levels of demand for oil as power plants switch to crude as a cheaper energy source. That trend should account for a 700,000 barrel a day boost for oil during the six months through March 2023, the IEA said, roughly 150,000 barrels a day more than it was expecting in last month’s report.

While most nations have all but removed their pandemic-era movement restrictions, China’s zero-Covid policy sees it continue to impose strict lockdowns in response to new cases, undermining economic growth and oil demand. China’s demand from domestic oil sources is suffering the most from the lockdowns, the IEA said, lowering its forecasts for the nation’s domestic demand by 890,000 barrels a day.

Still, China’s struggles are being countered by strong demand elsewhere and should have a limited impact on global oil balances, the IEA said. The agency lowered its global oil-demand growth forecasts for 2022 by a modest 100,000 barrels a day to 2 million barrels a day. The IEA expects total demand this year of 99.7 million barrels, in line with last month’s estimates.

The agency left its 2023 oil demand growth forecast unchanged at 2.1 million barrels a day and did the same with its total demand forecasts which stand at 101.8 million barrels a day. (…)

The drop in oil prices was also undermining Russia’s oil-export revenues, which fell by $1.2 billion in August, to $17.7 billion, the IEA said. (…)

In a report Tuesday, the Organization of the Petroleum Exporting Countries left its own global demand forecasts steady at roughly 100 million barrels a day this year and 103 million barrels a day in 2023.

OPEC’s own analysts have been less concerned about signs of flagging oil demand, despite such concerns driving sharp drops in oil prices. The cartel says demand concerns have been overblown and drops in oil prices heightened by market volatility and a lack of liquidity.

• Gas-to-Oil Switching (Bison Interests)

(…) Sufficient electricity generation is a major cause of concern for Europe. Faced with soaring natural gas prices and limited supply, European utilities may choose to burn refined oil products such as fuel oil, diesel and gasoline instead of natural gas for electricity generation. Doing so would be highly economic, as indicated by the price differential more than $250/barrel equivalent (boe) between Dutch TTF Natural Gas and Brent Crude:

(…) Asia is similarly affected by higher LNG prices, as gas has been drawn away from Asia to Europe by ultra-high prices. Asia and has the added benefit of existing oil burning power generators that had mostly been mothballed. Reactivating these and converting others to burning oil products will likely see a substantial uplift in oil consumption for power generation in Asia. (…)

Bison’s view is that the IEA and other analysts may be substantially underestimating the potential impact of gas-to-oil switching this winter.

We have conducted our own analysis of oil burning capacity among power facilities in Europe and Asia, and as a lower bound we estimate that there is approximately 810,000 boe/d of installed oil burning capacity in Europe and Asia alone that will come online before this winter—more than 2 times the IEA estimate:

As gas prices remain elevated and electricity remains in short supply in Europe and Asia, we expect installed oil and oil product burning capacity will be utilized near 100% this winter. There is an additional ∼8MM boe/d of upside to potential oil demand as non-operating plants are reactivated and operating plants are converted to burn oil. Even if only 10% of this capacity were to come online, it would imply a material 800,000 boe/d of surprise oil demand in addition to our 810,000 boe/d lower bound estimate. (…)

Based on our estimates, there is at least 450,000 boe/d of oil demand which will come online this winter not being considered by the IEA and other oil analysts. This is likely conservative, as our estimate does not consider countries outside of Europe & Asia that may see gas-to-oil switching activity upside as well. In addition to installed capacity demand, there is additional ∼8MM boe/d upside from reactivation of retired plants and the conversion of operating generators to have dual fuel capacity.

In the context of a very tight global oil market, 800,000 boe/d of oil demand at the low end is very material. This is particularly true as world oil markets remain in a structural deficit, which is projected to grow, and global inventories continue to be depleted as a result:

In 2021, global demand for oil was ∼97 million barrels per day. Our low-end estimate for gas-to-oil switching could rapidly increase global demand by 0.8, or almost 1% of total world demand. As the world oil demand continues to outpace production, supply deficits could widen further. In this scenario, small incremental changes in oil demand could have a disproportionately large effect on oil prices. (…)

As European gas prices remain elevated, we may see higher natural gas prices here in the US as new export capacity is added, bringing more gas into the higher priced global market. And as European and Asian utilities and industries continue to substitute oil for natural gas, we may see elevated oil prices—and higher profitability for oil and gas producers.

• Xinjiang Chafes at Covid Controls as China Readies for Party Congress Officials are aiming to keep a lid on outbreaks to avoid drawing criticism before the crucial twice-a-decade congress.

(…) That has led many to quickly impose Covid restrictions even with low case numbers and often without adequate planning to ensure sufficient supplies for residents. (…) Cities with districts under full or partial mobility restrictions climbed to 37% of gross domestic product as of Friday from less than 10% in June, according to Goldman Sachs Research. Nomura last week estimated that about 292 million people were affected by these measures, up from 161 million in late August. (…)

China hasn’t reported a Covid-related death in more than three months; Japan had more than 1,500 in the past seven days. Beijing says its policies reflect a greater respect for the value of human lives. (Sic!)

• Officials See Fading Prospects of Iran Nuclear-Deal Revival Soon Western officials are increasingly gloomy about the prospects of reviving the 2015 nuclear deal with Iran before the U.S. midterm elections.

US railroads are poised to stop shipments of key products as it braces for a possible labor strike.

Norfolk Southern will halt shipments of key crops from tomorrow, before potential industrial action on Friday. The railroad will stop accepting autos for transit later today and others may follow. A pause to movement of grains, fertilizer, fuel and other crucial items threatens to hobble the economy at a time of rampant inflation and fear of a prolonged global economic slump.
Food-supply chains are especially at risk as farmers gear up for harvest and need to get supplies to customers. Crops are in high demand due to shortages from the war in Ukraine and weather woes across the globe. (Bloomberg)

Gundlach Warns Fed May Overdo Rate Hike to Tackle Inflation Investor tells CNBC he prefers 25 basis points as market eyes bigger increase at next meeting.

The investor told CNBC that while he believes the Fed will likely do a 75 basis point rate hike at its next meeting, he prefers 25 basis points  because he is concerned the Fed might oversteer the economy and hasn’t paused long enough to see what effect the previous hikes have already had.

• Gundlach said he agrees with the calls, including from Guggenheim’s Scott Minerd, for a 20% decline in stocks by mid-October
• He has been relatively neutral on the S&P 500 for the last half year, and has been ultimately looking for a target of 3,000 on the index
• He would buy long-term Treasuries because the deflation risk is much higher today than it has been for the past two years
• He owns European stocks and would buy emerging markets once the US dollar breaks below its 200-DMA

Eurozone: sharp drop in industrial production July industrial production fell by 2.3%, reversing gains made in May and June.

JPMorgan warns of up to 50% drop in investment banking fees JPMorgan’s trading business is on track to be up about 5 per cent year on year in the current quarter. In the first six months of the year, trading revenue was up 4 per cent year on year.