U.S. Economy Shows Resilience During Delta Surge Americans increased spending at retailers last month, while employers have largely resisted the urge to lay off workers, both signs of strong demand in the economy.

Sales at the nation’s retailers rose 0.7% in August, rebounding from a drop in July, the Commerce Department said. With many schools, college campuses and offices reopening, consumers shelled out more for groceries and merchandise at big-box stores. Those purchases—along with higher spending on furniture and hardware—offset another big decline in car sales, which have suffered from a global computer chip-shortage that has crimped supply. (…)

Sales at restaurants were flat last month after rising briskly for most of this year. Economists believe fears of Delta were a factor. Despite the August pause, restaurant sales have climbed nearly 32% over the past year. (…)

Control sales are volatile but still very strong overall. August was up 2.6% after -2.0% and +1.6% in the previous two months. Last 3 months: +9.1% annualized. So much for the “spent up” thesis.

Sales, total and control, are holding up at a high level, +17.7% and +20.5% over their pre-pandemic level respectively.

Retail sales trends (blue) remain well above growth in labor income (black), indicating that consumers are still inclined to dissave:

The Chase card spending tracker suggest September is fairly solid so far. Typically, a strong back-to-school season precedes a jolly Christmas for retailers.

• Big-Box Retailers Battle for Inventory in Bet on Strong Holiday Sales Large merchants like Walmart and BJ’s Wholesale Club are competing for goods and shipping capacity to avoid empty shelves.

Best Buy Co. , Target Corp. and other large merchants are amassing more inventory compared with last year’s pandemic-depressed levels, in some cases logging double-digit percentage increases as the stockpiles also exceed 2019 values.

Covid-related factory shutdowns in Asia and global shipping bottlenecks have businesses jockeying for merchandise and vessel space to avoid losing critical fourth-quarter sales, a contest that tends to favor deep-pocketed big-box retailers over smaller competitors. (…)

Walmart’s consolidated inventories reached nearly $47.8 billion in the quarter ended July 31, a 16% increase from the year-ago period and up 8% from the same quarter in 2019. Walmart U.S. inventories were down 4.6% between the fiscal second quarter of 2021 and that of 2020, a spokesman said. (…)

The ratio of U.S. retailers’ inventories to sales fell this spring to the lowest level in U.S. Census Bureau records dating to 1992, and the measure has ticked up only slightly even as record volumes of container imports have flowed into the U.S. (…)

At the end of July, retail inventories were 15-20% below normal. Keep this in mind while you read the rest of this post.

• Rising Shipping Costs Are Companies’ Latest Inflation Riddle From Michelin tires to Pampers diapers, transportation expenses are working their way through global supply chains.

(…) “Sometimes the ocean freight now is actually more expensive than the cost of the product,” Chief Executive Officer Wade Miquelon said in a recent interview. The company hasn’t raised any base prices and is hoping the extra supply-chain expenses are temporary. “I think they probably are, but does transient mean six months or 24 months?” he said. (…)

“It has just gone up so rapidly that it is now becoming part of the narrative here of this supply-chain-driven price shock that is proving to be a lot more intense and a lot more durable than we initially thought back in the spring,” said Brian Coulton, chief economist at Fitch Ratings. (…)

Procter & Gamble Co. PG -0.70% has announced several price increases for products including Pampers diapers this year, but executives have cautioned that the speed and scope of freight and commodity-cost increases are too great to offset initially. The company is projecting $1.9 billion in added after-tax costs in its current fiscal year, which ends in June 2022. (…)

Dollar Tree warned investors last month that freight-market conditions continued to deteriorate and that costs would be “significantly higher than originally projected.” (…)

The extra costs and adjustments that have companies warning investors and working to preserve their profit margins are prompting some economists to shrug. The rebounding economy, they said, came with a surge in demand for goods, which caused a short-term supply crunch that will work itself out with time as higher prices quell demand.

“There is no more transitory price than transportation because the capacity can expand and shrink,” said Steven Blitz, chief U.S. economist at TS Lombard. Trains can get longer, more ships can be built, and truck drivers can be hired to meet the demand to move things, but it just takes some time to happen. Like many economists, Mr. Blitz expects that inflation pressures will fade. (…)

“I think the inflationary pressures are being juiced by the surge in transportation costs,” said Mark Zandi, chief economist at Moody’s Analytics. Using rough estimates, he said that consumer prices have risen 5.3% in the past year and that transportation costs contributed about 10% of that rise. (…)

Let’s hear it from the real transportation world:

• Cass Transportation Report

(…) The recovery [in shipments] after a skid in June and July amid further slowdowns in rail volumes suggests trucking is picking up slack from the railroads, currently snarled by the chassis shortage.

But shipment volumes remain limited by the capacity of the freight network, as shown by the backlog of 125 or so containerships at anchor off North American ports. SoCal just hit a new record of 49. This containership backlog clearly represents a stronger and longer than average peak season demand outlook.

The extent to which constraints on equipment and driver supply ease in the coming months will largely dictate volumes, with declines likely to continue in intermodal and more pressure on trucking to shoulder the load.

• Equipment. The intermodal chassis shortage, following tariffs totaling over 200% on key imported steel back in May, is a key reason chassis production has been dismal this year and the intermodal network has run short. Class 8 tractor and trailer supply chain challenges have also limited capacity.
• Drivers. Though driver capacity is still generally tight, the BLS trucking employment data have improved for three straight months and the ACT Research For-Hire Driver Availability Index continues to recover.

The expenditures component of the Cass Freight Index measures the total amount spent on freight. This index slowed a little more in August to 42% y/y growth from 43% in July. If normal seasonality were to play out for the rest of this year, the full-year increase in this index would be 35% in 2021, after a 7% decline in 2020 and no change in 2019. (…)

Tougher comparisons in the coming months will naturally slow these y/y increases further, but extraordinary growth rates will continue in the near-term, driven by increases in both shipment volumes and freight rates. (…)

Even as easing shortages become more likely, the number of broken or strained links in the supply chain has risen recently, including likely inflationary effects from Hurricane/Tropical Storm Ida, the Delta variant worsening the chip shortage, and the chassis shortage. With a still-tight supply/demand balance, we would suggest the uptrend isn’t over yet.

Though equipment production is still limited by parts and labor shortages, capacity is beginning to return as drivers respond to higher pay, utilizing parked equipment until parts shortages ease. This will gradually change the trajectory of truckload rates, but it will take time. (…)

Class I railroad trends have had a rough few months, lagging seasonal trends due in large part to worsening chassis shortages. ACT Research expects chassis production to be significantly limited for some time, and the intermodal network is unlikely to be able to adjust to a large shortfall in chassis quickly. Though some sizable orders have been placed and manufacturers are on it, we’d roughly estimate it will take six to nine months before chassis production gets to the point where the shortage starts to ease. (…)

Trucking isn’t subject to the same capacity constraints, and the truck driver recovery, though gradual, is likely to help the trucking industry continue to pick up the slack in the coming months. Eventually this will help rebalance the market, but several recent factors, including Hurricane Ida, the Delta variant and the chip and chassis shortages have been inflationary for freight rates, extending the cycle at the margin.

Freight demand fundamentals remain strong, based on a strong U.S. consumer balance sheet, inventory restocking, and an industrial sector struggling to grow into record orders with infrastructure stimulus likely on the way.

But the dynamics of tight supply and exceptionally strong demand which have characterized the past year or so will not last indefinitely. The chip shortage continues to be a key fulcrum on which much in the world economy depends. As discussed in depth in ACT Research’s monthly report, there’s good reason to hope easing will start in Q4.

The Fed Follows Misguided ‘Forward Guidance’ The central bank could bind itself to its own forecasts if it were good at predicting the future, but it isn’t.

(…) The most compelling explanation for the Fed’s refusal to adapt policy to buoyant economic data, then, has little to do with the interpretation of that data. It has to do with the determination of Fed officials to validate their previous predictions of their own future behavior. There is recent precedent for this practice, too.

In March 2018, then-Minneapolis Fed Bank president Neel Kashkari said he would have raised rates that month, had he “been sitting in the chairman’s seat,” because “we told the markets we were going to raise rates.” That is, he would have raised rates not because the data justified it, but because he didn’t want to be wrong.

And last year, Dallas Fed president Robert Kaplan revealed that his December 2020 rate projections would reflect “the forward guidance that we’ve given in September.” “[G]iven we made that decision,” he explained, “I think it’s important for Fed credibility.” That is, the Fed is credible when it does what it said it expected to do, even when those expectations were based on inaccurate economic projections.

This reasoning is flawed. The market is not looking for the Fed to be omniscient about its own behavior, which is mindlessly easy, but to remain dedicated to a sensible and clearly articulated policy framework. This means adapting policy to developments it did not foresee. And to the extent that “forward guidance” on policy rates is standing in the way of such adaptation, it should cease.

GM Plans to Idle Factories Longer Amid Chip Shortage The auto maker said it would add to scheduled downtime at seven plants in the U.S., Canada and Mexico.

(…) Some production lines at two of GM’s Michigan sites—responsible for work on models including the Chevrolet Traverse, the Buick Enclave and the Cadillac Black Wing—will now likely have downtime through September, the company said. At three factories in Canada and Mexico, production stoppages for the Chevrolet Blazer and Equinox SUVs have been extended as well. And at a plant in Kansas, the restart of Chevrolet Malibu production, which has been down since February, has been delayed to November.

Other global auto makers are facing similar challenges. Ford Motor Co. also held back production this month, with work slowing or stopping at factories in Missouri, Michigan and Kentucky. Toyota Motor Corp. said in August it planned to cut September production by 40% because of the semiconductor shortage. (…)

IHS Markit on Thursday cut its global light-vehicle production forecast by more than 13 million for 2021 and for 2022. “The two-and-a-half-month backlog that has built up since June will take time to clear and is anticipated to extend well into 2022,” analysts from the research firm wrote of chip-production shortfalls. (…)

U.S. Manufacturing

• Philadelphia Fed Manufacturing Index Rebounds in September
• U.S. Empire State Manufacturing Activity Strengthens in September

Strong retail sales and strong new manufacturing orders minimize the stagflation scenario, at least for the “stag” part of it…

U.S. Steel Plans New U.S. Mill as Prices Surge The steelmaker said it aims to put the new sheet-steel mill into production in 2024 to capture demand from a rebounding manufacturing sector.

(…) The U.S. Steel mill would increase new production capacity under construction or planned in the U.S. to about 12 million tons annually, or almost 21% of sheet-steel consumption in 2019.

The new mill represents a bet by U.S. Steel that demand will remain elevated for an extended time, keeping steel prices high even as competing steelmakers pursue their own expansions. The spot market price for sheet steel is nearly $2,000 a ton, up from less than $500 a ton during summer 2020, according to S&P Global Platts. (…)

“We have the winds at our backs. Steel prices seem to be sustainable,” Chief Executive David Burritt said in an interview. (…)

Quite a statement!

Particularly given that “Industry analysts say about seven million tons of steel capacity have been idled since the pandemic started last year. That amounted to about 12% of domestic steel consumption in 2019.” With 21% new capacity = 33% potential supply increase, about where I placed the blue dot below:

Pop Goes the Chinese Property Bubble? Evergrande may become the biggest casualty but it won’t be the last.

The WSJ Editorial Board:

(…) This is part of a broader campaign to impose credit discipline across the economy. Beijing tolerated defaults on $18 billion of debt in the first half of the year, a record, and is on track to hit a new record for all of 2021. State-owned enterprises are among the deadbeats.

Evergrande may be allowed to default on some bonds or bank loans, but Beijing probably has the capacity to avert a total collapse. China’s relatively closed financial system, state-owned banks and weak rule of law allow the government to stage-manage a restructuring to avoid a systemic meltdown. But this relatively benign scenario will still be painful for the economy in ways the Party won’t welcome.

The main problem is figuring out where the danger lies. Evergrande’s $89 billion in loans and bonds is only part of the picture. Far bigger are the liabilities the company owes to suppliers. Some of that debt must now be circulating through China’s financial gray market in which the sale of assets such as accounts receivable can substitute for normal bank credit.

Evergrande also owes new homes to the many individual buyers who paid in whole or part for homes that aren’t finished yet—and who may have borrowed to fund the purchases. It will take time and considerable effort for authorities to understand who is exposed to Evergrande and to what degree. (…)

The protesters include investors in so-called wealth-management products guaranteed by Evergrande—poorly regulated debt products in which households invest as an alternative to low-interest bank savings deposits. This is the sort of social instability Beijing dreads, even if for now the authorities have the means to tamp it down.

Now multiply this stress across the other property developers likely to run into trouble as Beijing’s housing cool-down continues—and add their suppliers, homeowners whose properties may sag in value, and banks that loaned them money. Talk of a Chinese “Lehman moment”—a financial collapse and recession akin to the failure of Lehman Brothers in 2008—is premature. But the credit correction that Beijing is launching may be harder to manage than the Party’s central planners think.

• China’s Nightmare Evergrande Scenario Is an Uncontrolled Crash

Protests intensify at China Evergrande Group offices across the country as the developer falls further behind on promises to more than 70,000 investors. Construction of unfinished properties with enough floor space to cover three-fourths of Manhattan grinds to a halt, leaving more than a million homebuyers in limbo.

Fire sales pummel an already shaky real estate market, squeezing other developers and rippling through a supply chain that accounts for more than a quarter of Chinese economic output. Covid-weary consumers retrench even further, and the risk of popular discontent rises during a politically sensitive transition period for President Xi Jinping. Credit-market stress spreads from lower-rated property companies to stronger peers and banks. Global investors who bought $527 billion of Chinese stocks and bonds in the 15 months through June begin to sell. (…)

Rather than allow a chaotic collapse into bankruptcy, they predict regulators will engineer a restructuring of Evergrande’s $300 billion pile of liabilities that keeps systemic risk to a minimum. Markets seem to agree: the Shanghai Composite Index is less than 3% from a six-year high and the yuan is trading near the strongest level in three months against the dollar.

Yet a benign outcome is far from assured. Beijing’s bungled stock-market rescue in 2015 showed how difficult it can be for policy makers to control financial outcomes, even in a system where the government runs most of the banks and can exert outsized pressure on creditors, suppliers and other counterparties. (…)

Even senior officials at state-owned banks say privately that they’re still waiting for guidance on a long-term solution from top leaders in Beijing. Evergrande’s main banks were told by China’s housing ministry this week that the developer won’t be able to make interest payments due Sept. 20, according to people familiar with the matter. (…)

The Evergrande endgame may depend largely on how Xi decides to balance his goals of maintaining social and financial stability against his multi-year campaign to reduce moral hazard. (…)

The only hazard Xi is worried about is him and the party losing control.

• China Adds $14 Billion Cash as Evergrande’s Pain Roils Markets

The People’s Bank of China added 90 billion yuan ($14 billion) of funds on a net basis through seven-day and 14-day reverse repurchase agreements on Friday, the most since February. Today was the first time this month it added more than 10 billion yuan short-term liquidity into the banking system on a single day. (…)

“A Lehman-style financial-market meltdown is not our top concern, but an extended and severe economic slowdown seems more probable.” (…)

• China Evergrande is not ‘too big to fail’, says Global Times editor

The editor-in-chief of state-backed Chinese newspaper Global Times warned debt-ridden property giant Evergrande Group (3333.HK) that it should not bet on a government bailout on the assumption that it is “too big to fail”.

It was the first commentary to appear in state-backed media casting doubt on a government bailout for the country’s No.2 property developer, whose shares fell on Friday for the fifth consecutive day amid concerns it is heading for default. (…)

Global Times’ editor-in-chief Hu Xijin said on his WeChat social media account on Thursday that Evergrande should turn to the market for salvation, not the government.

He said Evergrande’s potential bankruptcy was unlikely to trigger a systemic financial storm like the collapse of Lehman Brothers, because it was a real estate business not a bank and downpayment ratios on property in China were very high.

Global Times is a nationalistic tabloid published by the Communist Party’s People’s Daily. Its views do not necessarily reflect the official thinking of policymakers. (…)

 What about that chip shortage?

Twenty percent of Americans, one in five, believe a vaccine shot injects a microchip. Fourteen percent are not sure. Nearly 1 in 3 republicans believe that.