Inflation Expands Beyond Supply-Chain Struggles to Service Sector Core service prices jumped in September, driven by shelter, medical care and car insurance.

(…) While costs to transport goods have declined and supply-chain snarls are easing, prices are now rising briskly in services.

Core service prices, which exclude energy, jumped 0.8% in September from August, the Labor Department reported Thursday, driven by shelter, medical care and car insurance. Core goods prices, which exclude food and energy, were flat. For the 12 months ended September, core service prices were up 6.7%, the fastest since 1982. They are now rising faster than core goods prices, which rose 6.6% the same month, down from a peak of 12.3% in February.

Services made up 74% of the 12-month increase in the core consumer-price index in September, the most in 18 months, according to investment bank UBS. That is up from around 50% earlier this year. (…)

Here’s the main table showing the damage: core CPI jumped 0.6% with no change in core goods and a 0.8% gain in core services which follows 6 consecutive rises averaging 0.6%. Why the surprise?

Service-providers have two principal cost components: labor and energy. Core services inflation (blue line below) is intimately correlated with wages. The Employment Cost Index – Wages and Salaries (red) has been accelerating since Q1’21 reaching +5.7% in Q2’22.

Private hourly earnings (black), released monthly, are also well correlated with core services inflation but can suffer from compositional bias like during the pandemic. Interestingly, hourly wages have been decelerating from +5.6% in March to +5.2% in June and 5.0% in September. As I wrote Monday,

Actually, the fact that hourly wages rose only 0.3% MoM in each of August and September, a 3.6% annualized rate, is indicative of restraint on the part of business leaders. Indeed, 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.

The ECI for Q3 will be out in 2 weeks and, if in sync with hourly wages, it should also decelerate a little to the 5% YoY range. If so, September could be the peak in core services inflation unless energy prices shot up again.

But what about rentflation that everybody is now talking about?

• Inflation’s Storm From the Shelter The Fed can probably look past how housing costs are pushing up inflation, but it can’t ignore everything else

The upward pressure that housing costs have been putting on inflation can now probably be safely ignored. If only there was nothing else going on but the rent. (…)

Part of why prices rose by so much last month was that shelter costs, which account for about a third of the Labor Department’s overall consumer-spending basket and about two-fifths of core spending, rose by 0.7% in September from a month earlier. Excluding shelter, overall prices would have risen a more muted 0.2%, and core prices 0.5%.

And excluding shelter costs, or at least putting less weight on them, seems appropriate. That is because shelter costs largely reflect rents, and the Labor Department’s read on rents is lagging what actual rents are doing.

Rents themselves only account for about 7% of the Labor Department’s consumer-spending basket, since more people own than rent. To measure owners’ shelter costs, the Labor Department uses rent prices to calculate “owners’ equivalent rent”—what it deems people would need to pay if they rented homes equivalent to ones they own. It is somewhat controversial, and even supporters have parroted Winston Churchill’s line on democracy, saying it is the worst way to measure housing costs, except all the others that have been tried.

The issue now, however, is that the Labor Department’s measure of rents reflects what renters at large are paying—both those that have just signed leases, and those that signed them awhile ago. So when rent prices on new leases heat up, it takes time for the Labor Department’s measure to reflect the rise, because it takes time for people’s old leases to come up for renewal. By the same token when rent prices cool, it takes time to show up, too.

And right now, rent prices are cooling. Data from Zillow, for example, show they rose by 0.3% in September from August, which compares with a gain of 1.6% in September of last year. Rent figures from CoreLogic, from property-management-software provider RealPage and from rental marketplace Apartment List all similarly show rent prices moderating. It will take a while for the cooling to show up in the Labor Department’s consumer-price figures, but it will show up.

None of this is a secret—plenty of people, including Fed economists, know all about the lagged effect of rent prices in the inflation data, and additionally shelter costs carry less weight in the Fed’s preferred measure of inflation from the Commerce Department than they do in the Labor Department’s gauge. Looking at inflation excluding shelter costs might cause optics problems for the Fed, but it still makes sense. (…)

• Rents are falling, contrary to CPI data (Axios)

Two reports came out yesterday showing that rents nationwide declined in September from the prior month, Emily writes. And both datasets, from Redfin and Realtor.com, found year-over-year rent growth decelerating.

(…) private-market data from the real estate companies covers new rental contracts only; while CPI captures rents more broadly.
(…) It could take as long as a year for the CPI data to reflect this deceleration, according to research published by the Labor Department last week and tweeted by Summers.

• The authors of the paper conclude that taking a broader measure of rents, as the CPI does, is the right way to understand price growth — but when it comes to monetary policy they’re less sure.
• They seem to imply the Fed might need to watch the private market data to get a sense of where inflation is right now and react accordingly.

Data: Redfin; Chart: Erin Davis/Axios Visuals

Redfin: “The median U.S. asking rent rose 9% year over year in September to $2,002, the slowest growth since August 2021 and the first single-digit increase in a year. September was the fourth-consecutive month in which annual rent growth decelerated, with rents climbing at half the pace they were six months earlier.”

Realtor.com: “The median rent growth across the top 50 metros slowed to 7.8% year-over-year for 0-2 bedroom properties. It is the lowest growth rate in 16 months but is still more than two times faster than the growth rate seen just before the pandemic hit in March 2020. The median asking rent was $1,759, down by $12 from last month and $22 from the peak.”

We have all suddenly become rent specialists, understanding the BLS methods, the leads and lags, the supply of housing and household formations or deformations.

In reality, its all wages, because, at the end of the day, renters can only afford what their wages allow. People trade up or down based on their needs but also, mainly, on affordability. From realtor.com:

• In 2021, the average median monthly household income among the top 50 metros was $6,277 and the monthly median listed rent for rental units with 0-2 bedrooms was $1,553, suggesting rents made up 24.7% of a typical household income. In August 2022, the rent share was 26.4% (vs. 25.7% in August 2021), showing that the nation’s rental affordability has worsened.
• Two-thirds of renters (66.2%) say that rent increases have forced them to consider moving to a more affordable residence.
• While more than seven in ten landlords still plan to raise rent within the next 12 months, the share of landlords planning to raise rent plateaued in July, after increasing from January to April. The amount by which landlords are planning to increase rent also appears to be on the decline. Among landlords planning to raise rent, only one in five landlords (20.8%) plan to raise rent by more than 10%, down from 25.4% who planned to raise rent by more than 10% in April. 

This chart plots YoY trends in core services (black) with CPI-shelter (red), CPI-rent (blue) and CPI-OER yellow).

Correlations since 1984 (since 2001):

• CPI-shelter with core services: 93% (92%)
• CPI-shelter with CPI-rent: 86% (93%)
• CPI-shelter with CPI-OER: 98% (97%)
• CPI-rent with CPI-OER: 84% (94%)

This last chart plots CPI-shelter with ECI-wages: correlation: 71%.

We should therefore all focus on wages. The Atlanta Fed wage tracker adjusts for compositional biases. July and August data suggest a peak. Job stayers’ wage growth slowed from 6.1% to 5.3% (3-m m.a.) and the recent big declines in job openings should ease the pressures from switchers.

Mortgage Rates Hit a 20-Year High The sharp rise in borrowing costs, to 6.92% for a 30-year fixed mortgage this week, has cooled the housing market and put homeownership out of reach for many.

Mortgage rates are up from 2.8% in July 2021 to 6.9%, a 410bps jump. Meanwhile, 10Y Ts rose from 1.2% to 3.9%, a 270 bps increase. The spread is at an 18-year peak, above that in the GFC when mortgage risk was substantially higher than now. Looks like QT effect.

• America’s Red-Hot Warehouse Market Shows Signs of Cooling A pandemic-driven boom in warehousing demand is showing signs of slowing, as companies grow more cautious about leasing in an uncertain economy.
• Canada’s Housing Agency Sees ‘Modest’ Recession With 15% Price Drop
• Traders See Bank of Canada Hiking to 4.25% on Hot US Inflation

World Faces New Threats From Fast-Mutating Omicron Variants

Since emerging in late 2021, the highly transmissible omicron strain of SARS-CoV-2 has splintered into a dazzling array of subvariants that are now driving fresh waves of Covid-19 cases around the world. The proliferation of such a diversity of variants is unprecedented, and pits numerous hyper-mutated iterations against each other in a race for global dominance. That’s turbo-charged Covid, making it one of the fastest-spreading diseases known to humanity, and further challenging pandemic-mitigation efforts in a global population already weary of frequent booster shots, testing and masking. (…)

Some mutated strains have acquired both a striking ability to evade antibodies, including those developed to treat Covid, and an enhanced ability to infect human respiratory cells, making them more adept at spreading from person to person. (…)

Although some of the newer omicron variants have caused local spikes in Covid cases, hospitalizations aren’t going up at nearly the same rate they did during previous waves. This suggests that the immunity generated from prior infections and vaccination is protecting against severe illness in some people. Still, even mild infections in vaccinated individuals can lead to long Covid in some cases, which means vaccination alone may not be enough to reduce the long-term health consequences of the pandemic.

CPI for all items rises 0.4% in September as shelter and food increase, gasoline falls

(…) The index for all items less food and energy rose 0.6 percent in September, as it did in August. The indexes for shelter, medical care, motor vehicle insurance, new vehicles, household furnishings and
operations, and education were among those that increased over the month. There were some indexes that declined in September, including those for used cars and trucks, apparel, and communication.

The all items index increased 8.2 percent for the 12 months ending September, a slightly smaller figure than the 8.3-percent increase for the period ending August. The all items less food and energy index rose
6.6 percent over the last 12 months.

U.S. Producer Prices Show Unexpected Strength in September

The Producer Price Index for Final Demand increased 0.4% during September after falling 0.2% in August, revised from -0.1%. The 0.4% July decline was unrevised. During the last 12 months, the PPI increase moderated to 8.5% from an 11.7% March peak. A 0.2% September PPI gain had been expected in the Action Economics Forecast Survey.

The Producer Price Index less food, energy & trade services increased 0.4% (5.6% y/y) following unrevised gains of 0.2% in August and 0.1% in July. The PPI excluding just food & energy rose 0.3% last month. A 0.3% increase had been expected.

The rise in the September PPI was paced by a 1.2% increase (11.9% y/y) in food prices after they eased 0.1% in August. (…)

Energy prices rose 0.7% (24.2% y/y), following two straight months of sharp decline. (…)

The PPI for goods less food & energy held steady (7.5% y/y) in September following two straight months of 0.2% increase. These recent readings are the slowest since late in 2020. (…) Prices for private capital equipment improved 0.3% in September (8.8% y/y) after rising 0.4% in August. (…)

Services prices increased 0.4% (6.8% y/y) in September after a 0.3% August gain. Trade services prices improved 0.1% (12.7% y/y) after rising 0.5% in August. Services prices less trade, transportation & warehousing strengthened 0.6% (2.7% y/y) after rising 0.4% in August. (…)

Atlanta Fed’s Business Inflation Expectations Unchanged at 3.3 Percent

STRANGE EMPLOYMENT STATS

As seen last Friday, the U.S. economy added 263k jobs in September. Strangely, 355k new jobs were in the 55+ age group (341k men) after having lost a cumulative 98k between March and August. What prompted all these 55+ men to suddenly look for a job in September?

Some suggest that many “have to come back to work because the bear market has undermined their early-retirement calculations”. The American Staffing Association found that “More than three in 10 U.S. retirees say they would be motivated to rejoin the workforce if inflation continued to eat into their savings”.

It could also be statistical noise. The monthly chart above shows how erratic employment in this age group has been since March. The quarterly chart below is much quieter and suggests little job growth in this group over the past 6 months.

Employment below 55yrs actually fell 92k in September, the first down month since the pandemic started. Since March, the average monthly gain was 399k. Maybe September was also a statistical quirk for everybody…

Steelworkers Union Approves Contract With Cleveland-Cliffs United Steelworkers wants U.S. Steel to match wage increases provided in Cleveland-Cliffs’ contract.

(…) Cleveland-Cliffs and United Steelworkers agreed to a 20% increase in hourly wages over the life of the newly ratified contract [4 years], but the union and Pittsburgh-based U.S. Steel remain at odds over a similar wage increase that the union is seeking. (…)

U.S. Steel said it is offering wage increases of about 14%, with two years of 3% raises and two years of 4% increases, though it expects workers to receive additional compensation from profit-sharing bonuses. U.S. Steel said it expects to pay steelworkers about $20 an hour in profit-sharing for the time they worked during the quarter ended Sept. 30. (…)

“We need guaranteed wages,” said Don Furko, president of a union local for workers at U.S. Steel’s Mon Valley Works. “We’ve got members buying houses and buying cars and they can’t have incomes based on profit-sharing.” (…)

Fed Minutes Show Concerns of More Persistent High Inflation Officials last month revised up their expectations of future interest rate increases and said labor markets would need to weaken

(…) “Many participants emphasized that the cost of taking too little action to bring down inflation likely outweighed the cost of taking too much action,” the minutes said. (…)

Nearly all the policy makers who participated in last month’s gathering penciled in large interest-rate rises at each of their coming two meetings this year. The projections also suggested they would dial down the size of their rate increases by December and potentially end them by February or March. (…)

In a speech Monday, Fed Vice Chairwoman Lael Brainard cautioned against raising rates too rapidly to allow officials time to study how higher borrowing costs are coursing through the economy.

While her remarks didn’t directly push back against rate increases that are already anticipated by investors, they represented the most comprehensive effort by a senior Fed official this year to build the case against an even steeper path for further rate rises. (…)

The minutes showed officials’ growing concern about how long it has taken for supply-chain constraints to reduce prices for goods at the same time that tight labor markets could keep wages and prices elevated. (…)

The minutes also reveal that “most” participants want to see a broader impact:

Most participants remarked that, although some interest-sensitive categories of spending—such as housing and business fixed investment—had already started to respond to the tightening of financial conditions, a sizable portion of economic activity had yet to display much response. They noted also that inflation had not yet responded appreciably to policy tightening and that a significant reduction in inflation would likely lag that of aggregate demand.

Maybe most participants had seen this Axios note:

PepsiCo reported today that prices drove a 17% increase in net revenue growth, while organic volumes fell by only 1%. “The truth is that our brands … are being stretched to higher price points and consumers are following us,” PepsiCo CEO Ramon Laguarta said on a conference call.

That said, Conagra Brands reported last week that sales rose 9.7%, including +14.3% due to prices and a 4.6% decline in volume.

Meanwhile, Bloomberg tells us that “In the latest tit for tat, the US may ban Russian aluminum over its military escalation in Ukraine, a commodity that had been long shielded by previous sanctions. Three options are on the table: An outright ban, brutally punitive tariffs amounting to an effective ban, or sanctions on the company that produces Russia’s aluminum, people familiar said.”

Goldman Sachs:

We would view options (1) and (2) as limited in market impact given that Russia’s aluminium only represents 4% of US aluminium imports so far this year, which in turn represents just 1% of total US demand. However, if policy options (1) and (2) were followed by either/both the EU following suit as well as an LME ban, then that would still generate a significant tightening to the Western aluminium market.

If that sequence of events transpired, then we think the price upside seen since this latest announcement would prove to be relatively sticky though lacking in catalyst for a further significant leg higher.

However, if option (3) was followed, we believe that the upward pressure on price would be material given the dislocation it would generate in the market based on Russia’s significant supply role to the ex-China market (~15% total supply, 3.5Mty) and China’s current limited import capacity for primary metal imports (150kty ytd). In short, we believe this would generate an outsized supply shock to the Western market that could be solvable in the short run by higher prices.

Finally, the FOMC minutes also included this: “Many participants indicated that once the policy rate had reached a sufficiently restrictive level, it likely would be appropriate to maintain that level for some time until there was compelling evidence that inflation was on course to return to the 2% objective.”

In effect, the policy path is laid out more clearly:

• boost rates to a “sufficiently restrictive” level, (~4.5%), possibly by January 2023,
• pause until March-April to assess conditions,
• if there is “compelling evidence”, cut.

The debate will be on defining “compelling evidence”… The FOMC has never been very sharp on its inflation calls, has it?

The recession call is becoming more significant as this Bloomberg chart illustrates. The dispersion of potential returns is about to widen considerably. Profits always decline in a recession.

Source: Simon White, Bloomberg Markets Live Blog (via The Daily Shot)

Then the question becomes, how bad and how long?

It must be just a coincidence that the 2022 Fat Bear contest winner, “one of the biggest brown bears on Earth”, had also won the 2020 contest.

Lian Law/NPS photo

Evergrande’s Debt-Crisis Fallout: Losses, Layoffs and More Defaults The property titan’s financial troubles set off a chain reaction across China, causing businesses and individuals alike to suffer.

• China’s Bursting Housing Bubble Will Rock the Economy for Years

(…) An analysis by the International Monetary Fund this week showed that 45% of developers might not be able to cover their debt obligations with earnings, and 20% of them could become insolvent if their inventory value is marked to current property prices. (…)

While sales in big cities like Beijing, Shanghai, and Shenzhen saw a slight uptick in the first weeks of September, the overall market by dollar value at the 100 biggest developers was still down 25% last month from a year earlier. (…)

Housing supply needs to drop by about 25% to align with projected fundamental demand in 2031, according to Chang Shu, chief Asia economist at Bloomberg Economics. Fundamental demand strips out speculative buyers. (…)

Source: NBS, United Nations World Population Prospects, Bloomberg Economics

Bloomberg Economics estimates about 2.8 billion square meters of real estate is currently sitting empty — an area 47 times the size of Manhattan. (…)

“China as a country will get through the property downturn — it always does,” said Anne Stevenson-Yang, co-founder of research firm J. Capital Research Ltd., which is bearish on Chinese real estate. “But people will take losses and banks are going to be asked to take a haircut.”

“China as a country will get through the property downturn — it always does,” said Anne Stevenson-Yang, co-founder of research firm J. Capital Research Ltd., which is bearish on Chinese real estate. “But people will take losses and banks are going to be asked to take a haircut.”

• Chinese Local Governments Buying Houses to Aid Property Sector Some local governments in China are buying homes in bulk from developers or encouraging state-owned entities to do so in their latest efforts to prop up the real-estate market, the Securities Times reported Thursday.

(…) It’s unknown whether the purchases are endorsed by the central government, but governments at all levels are offering more help to try and arrest the slumping real-estate sector after mortgage-rate cuts and a flurry of relaxation measures failed to stimulate demand. China’s latest property policy package announced before the week-long holiday in October hasn’t ignited a sales turnaround, with residential transactions for the traditionally sales-friendly week plunging 38% from a year earlier in 20 major cities, according to China Index Holdings Ltd. (…)

In a sign of that weak outlook, domestic sales of excavators dropped almost 25% in September from a year earlier, according to media reports Thursday, the 18th straight month of declines.

Samsung Gets One-Year Exemption From New U.S. Chip Restrictions on China The semiconductor giant received a one-year exemption from new U.S. restrictions that block exports of advanced chips and related equipment to China.

The U.S. Department of Commerce granted Samsung authorization to continue receiving chip-making equipment and other items needed to maintain its memory-chip production in China, the people said. The South Korean firm operates chip facilities in two Chinese cities. (…)

The restrictions appeared to offer at least one concession to some of the allies, as the Commerce Department would review applications for certain exports to U.S. and U.S.-allied facilities operating in China on a case-by-case basis. Chinese-owned facilities, in contrast, would face a presumption of denial. (…)

Samsung dominates production of two major types of memory chips—DRAM and NAND flash. The South Korean tech giant operates a NAND flash memory-chip plant in Xi’an and a chip-packaging facility in Suzhou.

As of the second quarter of this year, Samsung accounted for 43.5% of global revenue for DRAM and roughly one-third of global revenue for NAND flash, according to TrendForce, a Taiwan-based tech-market researcher. It is the No. 1 player in both memory markets.

• TSMC Posts Record Profit, Gains Exemption From U.S. Chip Curbs on China

• U.S. Suppliers Leave Chinese Chip Maker Tool makers are pulling out staff and pausing work as they assess the impact of Commerce Department restrictions on semiconductor exports to China

State-owned Yangtze Memory Technologies Co. is facing a freeze in support from key suppliers including KLA Corp. KLAC -2.17%▼ and Lam Research Corp., LRCX -0.94%▼ the people said. (…)

The U.S. suppliers have paused support of already installed equipment at YMTC in recent days and temporarily halted installation of new tools, the people said. The suppliers are also temporarily pulling out their staff based at YMTC, the people said.

Chip-making equipment vendor Applied Materials Inc. on Wednesday slashed its sales projection for the current quarter by about $400 million, citing the restrictions. The company, one of the largest producers of chip equipment in the world, counts China’s leading chip-makers among its many customers. It generated more than 27% of its sales from China in the second quarter, or nearly $1.8 billion. A large portion of those sales go to multinational firms that operate in China and are expected to be exempt from controls targeting Chinese chip-makers.

Applied said it was pursuing export licenses and authorizations, but added that it expected a similar impact to sales in the first quarter of next year. (…)

The U.S. export control measures, which restrict companies sending chips and chip-making equipment to China, are some of the broadest the U.S. has enacted against China’s semiconductor industry. They veer from previous actions that often targeted individual companies and a narrower subset of technology. (…)

“I believe the U.S. government intends to force the more advanced production facilities of Chinese companies like SMIC and YMTC to shut down entirely,” Gregory Allen, a senior fellow at the Center for Strategic and International Studies, said. “However, the more advanced Chinese production facilities of South Korean and other internationally-owned companies will merely be prevented from expanding beyond their current production footprint.” (…)

American companies dominate the global chip-production equipment supply chain, with a combined share of 41%, while China’s is 5% or lower, according to a Boston Consulting Group analysis. (…)

• TSMC Cuts Capital Spending 10% in a Warning for Tech Sector

TSMC said it expects to spend about $36 billion in 2022 on capital equipment, down from at least $40 billion previously. The sharp reduction in expenditure — an important indicator of its own expectations for growth across sectors from smartphones to servers and electric vehicles — suggest the Taiwanese firm is bracing for a broader-than-anticipated downturn. (…)

“The company’s 10% cut in full-year capital spending target implies prolonged weakness in smartphone and PC chip demand,” Bloomberg Intelligence analyst Charles Shum said. (…)

The restrictions make it more difficult for chipmakers to move their inventories and hit TSMC more severely than previous actions by the US, Fubon Research analysts led by Sherman Shang said in a note this week. The curbs mean about 5%-8% of TSMC’s total revenue will likely be restricted, they said. Bloomberg Intelligence estimates TSMC could lose more than 10% of its annual sales because of the restrictions.

It’s “too early to provide a specific number, however the inventory correction will likely see its biggest impact sometime in the first half of 2023,” Chief Executive Officer C. C. Wei told analysts on a conference call. The impact of the US curbs will be manageable, he said. (…)