Fed Minutes Show Expectations That Soft Inflation Will Be Temporary Several Federal Reserve officials raised concerns about what might happen if price pressures continued to hold at low levels.

(…) Officials didn’t specifically raise the prospect of an interest-rate cut, according to the minutes. (…)

On Wednesday, St. Louis Fed President James Bullard said the Fed may need to lower its benchmark rate, even if the economy isn’t slowing, “to help maintain the credibility of the [Fed’s] inflation target going forward.”

Persistently low inflation “is justification for deciding that our setting of monetary policy is actually restrictive and we need to make an adjustment downwards,” said Chicago Fed President Charles Evans last month in an interview.

Being so focused on inflation could make the FOMC miss on the more crucial trends. Prices don’t grow out of academic thin air, they reflect real world demand/supply relationships. Could it be that slowflation might be due to weakening demand?

Tuesday we learned that the Chicago Fed National Activity Index fell 0.45 in April with its 3-m average remaining negative at –0.32, its lowest point since May 2016. Advisor Perspectives’ charts from Doug Short illustrate the recent weakness in the U.S. economy. Recall that the CFNAI is broad composite of 85 monthly indicators:

The CFNAI is still away from the –0.70 level indication that a recession has begun. But it is at recession fear level.

If not a recession, a meaningful growth slowdown, a normally valid cause for slowing inflation:

The bond market is sniffing something: slow growth, lower inflation, or both?

FLASH PMIs

The CFNAI above was for April. Here’s a preview for May and it’s not pretty!

  U.S. business activity growth falters to three-year low

May PMI data revealed a further slowdown in U.S. private sector output growth in May, as a struggling manufacturing economy was accompanied by a notable downshift in gear in the service sector.

At 50.9 in May, down from 53.0 in April, the seasonally adjusted IHS Markit Flash U.S. Composite PMI Output Index indicated the slowest expansion in overall business activity since May 2016. The composite index is based on original survey data from IHS Markit’s PMI surveys of both services and manufacturing.

The muted rise in output was attributed to softer demand conditions and subdued growth of new orders. The rise in new business in May was the softest recorded since the series began in October 2009.

Consequently, firms put the brakes on hiring. The latest increase in employment was only marginal and the smallest for just over two years. Companies also noted little strain on capacity due to weak demand, and reported the first decline in backlogs of work since June 2017.

Input price inflation eased for the third month running in May, despite continued comments from panellists regarding the ongoing impact of tariffs. The slower increase in costs and greater competitive pressures underpinned a renewed fall in output charges, the first such decline since February 2016.

U.S. private sector firms meanwhile grew less optimistic of a rise in output over the coming 12 months. Business expectations fell to their lowest since the series began in July 2012. Reduced confidence was commonly attributed to hesitation among clients and increased uncertainty, which were both often linked to global trade tensions.

The seasonally adjusted IHS Markit Flash U.S. Services PMI™ Business Activity Index posted 50.9 in May, down from 53.0 in April, to indicate a notable slowdown in service sector business activity. The upturn was only marginal overall and the slowest since the current sequence of expansion began in March 2016.

In line with the slower rise in business activity, new orders increased only slightly, as the rate of growth eased for the third successive month amid softer demand conditions and intense competition. Subsequently, the level of outstanding business fell for the first time this year and employment growth dipped to a 25-month low.

Meanwhile, the recent trend of subdued inflationary pressures continued in May with input costs rising only slightly. At the same time, intense competition and a slower rise in costs led to the first fall in output prices since February 2016.

U.S. manufacturers also indicated a slower expansion in output in May amid further signs of relatively subdued demand conditions.

The seasonally adjusted IHS Markit Flash U.S. Manufacturing Purchasing Managers’ Index™ (PMI™) registered 50.6 in May, down from 52.6 in April. Although the index reading continued to signal an improvement in operating conditions across the manufacturing sector, the upturn was the least marked since September 2009 and only marginal. Underlying data indicated a broad-based slowdown in the rates of expansion for output, employment and pre-production inventories, while new orders declined for the first time since August 2009.

New orders were stymied by reports of weaker overall demand conditions and hesitancy among clients to place orders. The fall in new business was only fractional, but signalled a marked turnaround from the solid rise seen in April. Data suggested that demand from both domestic and foreign clients declined during the month, as exports also fell.

In contrast to the trend seen for the service sector, manufacturers raised their output prices in May. That said, the rate of increase was only slight. Factory input costs meanwhile rose at the weakest rate for nearly two years, in part reflecting increased price competition among suppliers amid signs of excess capacity developing.

Chris Williamson, Chief Business Economist at IHS Markit:

Growth of business activity slowed sharply in May as trade war worries and increased uncertainty dealt a further blow to order book growth and business confidence.

A decline in the headline ‘flash’ PMI to its lowest for three years pushes the survey data down to a level historically consistent with GDP growing at an annualised rate of just 1.2% in May. Worse may be to come, as inflows of new business showed the smallest rise seen this side of the global financial crisis. Business confidence has meanwhile slumped to its lowest since at least 2012, causing firms to tighten their belts, notably in respect to hiring. Jobs growth in May was the weakest seen for over two years.

The slowdown has been led by manufacturing, but shows increasing signs of spreading to services. The survey data have been consistent with falling manufacturing output since February, but suggest that the sector’s woes intensified in May to mean factories will therefore likely act as an increasing drag on the economy in the second quarter.

Trade wars remained top of the list of concerns among manufacturers, alongside signs of slower sales and weaker economic growth both at home and in key export markets. However, an additional concern is the spreading of the malaise to the service sector, growth of which slumped in May to one of the weakest since the global financial crisis. With the service sector’s performance being a key gauge of the health of domestic demand, this broadening-out of the slowdown poses downside risks to the outlook.

Eurozone flash PMI signals subdued business growth amid stagnant demand

The pace of eurozone economic growth remained subdued in May amid stagnant demand. Jobs growth slipped to the joint-lowest since 2016 as firms scaled back expansion plans in the light of weak sales. Optimism about the future meanwhile slumped to a four-and-a-half year low and inflationary pressures moderated as competition limited sellers’ pricing power.

The IHS Markit Eurozone Composite PMI® recorded 51.6 in May, according to the preliminary ‘flash’ estimate, up only fractionally from 51.5 in April. The weak reading puts growth in the second quarter so far on a par with the lacklustre gain seen in the first quarter and is among the lowest recorded since mid-2013.

After rising to a modest five-month high in April, growth of new business waned again in May to show only the smallest of increases. New export orders fell markedly again, down for an eighth successive month, though the decline was less steep than in the prior two months.

The lack of new business meant backlogs of work fell for the fifth time in the past six months, reflecting the near-absence of new business growth and indicative of spare capacity developing.

Manufacturing once again reported the tougher conditions, with output down for a fourth straight month and new orders falling for an eighth month, led by a further steep drop in goods exports. However, rates of decline of output, new orders and exports all eased for a second successive month.

The service sector continued to grow, but the rate of expansion was the weakest since January amid sluggish growth of new work. With the exception of the soft patch seen at the turn of the year, new business inflows were the lowest since 2014.

Looking ahead, companies reined-in their expectations of growth in the coming year to the lowest since October 2014. Expectations hit the lowest since 2014 in services and remained among the weakest since 2012 in manufacturing, despite lifting higher for a second month running.

With new orders near-stagnant and optimism deteriorating, companies pulled back on hiring, resulting in the joint-smallest gain in employment since September 2016. Manufacturing jobs fell for the first time since August 2014, lost at the fastest rate since November 2013. By comparison, service providers remained more confident to hire, yet the net rise in jobs cooled from April’s six-month high.

Input cost inflation across the two sectors moderated to the second-lowest since November 2016, often linked to suppliers offering more discounts (or not raising prices) in order to boost sales. Similarly, average prices for goods and services showed the smallest increase since July 2017 as intense competition limited pricing power.

Weak price pressures were especially evident in manufacturing, where input costs showed the smallest rise for nearly three years as suppliers increasingly fought on price for business. Factory gate selling price inflation also remained muted, the second-lowest since November 2016.

Input price inflation remained more elevated in services, largely reflecting higher wages. Average selling prices for services nonetheless rose at the slowest rate for just over a year.

Chris Williamson, Chief Business Economist at IHS Markit:

The eurozone economy remained becalmed in the doldrums in May, adding to signs that only modest growth will be achieved in the second quarter. At current levels the PMI is so far indicating GDP growth of only 0.2% in the second quarter.

A renewed deterioration in optimism about the year ahead suggests that the business situation could deteriorate further in coming months. Worries reflected concerns over lower economic growth forecasts, signs of weaker sales and rising geopolitical uncertainty, with escalating trade wars and auto sector woes commonly cited as specific
causes for concern.

Sector divergences remain marked, with manufacturing still in decline and the region therefore reliant on the service sector to support growth.

While some encouragement can be gained from the manufacturing sector showing signs of its downturn having bottomed out in March, the concern is that the slowdown is spreading to the service sector, where new business growth has slipped to one of the weakest seen since 2014.

Germany is on course for a 0.2% expansion of GDP in the second quarter while the survey for data France point to a meagre 0.1% gain. However, the bigger concern is for the rest of the region, which collectively saw growth falter amid the first fall in orders for almost six years.

Japan output cutbacks continue as domestic and international demand conditions remain fragile

• Flash Japan Manufacturing PMI® falls to 49.6 in May, from 50.2 in April.
• Output and new orders decrease for fifth successive month
• Businesses cast pessimistic outlook towards the coming year for the first time in six-and-a-half years

Following some tentative signs that the downturn in Japan’s manufacturing sector had softened in April, flash data for May revealed these were short-lived, as output and export orders fell at stronger rates. The re-escalation of US-China trade frictions has heightened concern among Japanese goods producers.

Underlying growth weakness across much of Asia led to struggling exports, which fell at the sharpest rate in four months. Difficulties on the international front merely add to uncertainties domestically, with upcoming upper house elections in July, and the impending sales tax hike later this year. Subsequently, sentiment turned negative in May for the first time in six-and-a-half years.

AT THE FRONT

China calls out U.S. ‘wrong actions’ as Huawei ban rattles supply chains Beijing said Washington needs to correct its “wrong actions” for trade talks to continue after the U.S. blacklisted Huawei, a blow that has rippled through global supply chains and battered tech shares as investors feared a looming technology cold war.

• Lighthizer Is Still Trying to Close the Deal

(…) According to lawyers who have worked alongside Mr. Lighthizer for years, for him the goal of negotiation isn’t to find a compromise or middle ground, but to pursue aggressively the best deal possible for his client. (…)

“Our objectives are to foster reform in China,” Mr. Lighthizer told Congress recently, saying the country’s state capitalism and technology thefts were an “existential problem.”

The insistence on changing Chinese law is sensitive for Beijing because it represents an imbalance in the agreement: U.S. law isn’t expected to change, because the Trump administration isn’t planning to submit any deal with China to Congress. (…)

• How Canada and Mexico ironed out an end to the U.S. tariff war

(…) In the end, the Trump administration dropped its most significant demand – that Canada and Mexico accept quotas capping the steel and aluminum they would export to the U.S. – and then made a string of further concessions culminating in Mr. Lighthizer’s final retreat in his Friday phone call with Ms. Freeland.

The behind-the-scenes machinations that culminated in the deal, detailed for The Globe and Mail by two Canadian officials with direct knowledge of the talks, turned on three key factors: the refusal of Mexican and Canadian negotiators to accept quotas; pressure from free-trade-loving congressional Republicans who threatened not to ratify Mr. Trump’s renegotiated North American free-trade agreement while tariffs remained; and the Trump administration’s desire to close one front of its global trade wars while intensifying its fight with China. The Globe and Mail granted the Canadian officials anonymity because they would not divulge confidential information on the talks otherwise. (…)

• FAA raises possibility of long delay to 737 Max approval Fractious global regulators meet to discuss grounded Boeing aircraft

(…) China, which was the first big regulator to ground the Max and a crucial market for Boeing, could be one of the last countries to lift its ban, aviation sources said. 

Chinese regulators are likely to insist on additional checks before they clear the plane to fly. That could erode the existing convention by which nations recognise safety certifications from the manufacturer nation, and someday provide an opening for Beijing to push for easier recognition of the planes it is developing. Chinese airlines and leasing companies account for at least 10 per cent of Boeing’s unfilled order book for the Max. (…)

• From Bloomberg:

(…) The U.S. business community sees that meeting as one of the last chances to reach an agreement before the 2020 election campaign makes doing so unfeasible. Trump has already hit out at potential re-election challenger Joe Biden, saying at a campaign rally Monday that Beijing wants the former vice president to replace him so it “can continue to make $500 billion dollars a year and more ripping off the United States.”

About a fifth of U.S. companies in China are considering moving some or all of their production out of the country to deal with the trade tensions, and a third are delaying or canceling investment decisions, according to a survey of 239 firms in the market by American business groups in China.

“There’s going to have to be blinking on both sides,” Myron Brilliant, executive vice president of the U.S. Chamber of Commerce, told Bloomberg Television on Wednesday. “They’ve boxed themselves in with the escalation of tensions, but at the end of the day this is too big a relationship to fail.”

• American Companies in China Consider Relocation or Investment Cuts

(…) Almost 40% of companies said the hike of U.S. tariffs announced on May 10 would have a strong negative impact on their business, and a third said the increase in Chinese levies would do the same. The report provides evidence of a decoupling of the two nations’ economies, with 35% of firms saying their main strategy for dealing with the tension was to restructure so their operations were more heavily ‘in China for China.’ (…)

U.S. firms reported greater damage from the trade war than their counterparts in the European Union. Only a few of the European firms are considering moving their supply chains, they said in a recent survey.

Another issue touched upon by the American Chambers’ survey was that whether China forces foreign companies to transfer technology and intellectual property to Chinese firms to gain market access. China denies that this happens, but it has been one of the main sticking points in the negotiations.

At least for the firms surveyed for the report, it doesn’t seem to be such an issue, with only one saying that this was the most important outcome in any trade deal. About 42% said a return to the status quo before the tariffs was most important for them.

The report on European firms doing business in China showed that forced technology transfer was a growing concern, with 20% of respondents saying they’d had to hand over know-how in order to maintain market access. That compares to only 10% in 2017.

Of the firms who have moved or are considering relocating manufacturing facilities outside China, the most popular destination wasn’t the U.S. but rather emerging markets such as southeast Asia and Mexico.

• Logistics Bottlenecks Hamper Efforts to Produce Less in China Firms looking to shift some production to other parts of Asia face poor infrastructure, shipping delays and increased costs

(…) Poor roads, sparse rail lines and congested ports in Vietnam, Thailand, the Philippines, Cambodia and other potential manufacturing destinations in Southeast Asia have stretched out delivery schedules and raised shipping costs, according to manufacturing and transportation company executives, even as companies have migrated some factory work to the region in the past decade in search of lower labor costs. (…)

“Trucks were waiting for four, five days to unload a container at Ho Chi Minh City Port. The road capacity is poor, there are huge traffic jams and limited rail links. Delays of up to a week for ships are not uncommon.” (…)

• An FT piece adds quotes from manufacturers and trade representatives:
• “There’s a reason we are in China today, that’s because of the vast amount of labour available in China, and the fact that all the raw material suppliers and support functions today are residing in China,” (Michigan-based footwear business)
• “As for reshoring back to America, Mr Priest said Mr Trump’s vision was simply a “pipe dream” in his sector, where more than 2bn pairs of shoes are imported from China every year. “The [US] capacity is gone, the skilled workforce that is needed for footwear production is only housed in a couple of enclaves,” said Mr Priest. US labour costs and the challenge of selling US-made shoes through chains such as Wal-Mart or Target made it simply too difficult, Mr Priest added. “You can’t have a $300 shoe that would normally be $120, with Americans willing to pay that price.”
• “finding alternatives to China was now a “reality” but also “very complicated and very costly” (Consumer Technology Association)

Hobbling Huawei: Inside the U.S. war on China’s tech giant

EARNINGS WATCH

We now have 469 companies in, a 75% beat rate, a +6.0% surprise factor and a +1.4% blended earnings growth rate for Q1’19 (+2.8% ex-Energy).

Corporate pre-announcements are not much worse than at the same time during Q1’19:

Q2’19 estimates are unchanged at +1.0% (+1.1%).

Trailing EPS are now $163.83.

Earnings are still ok but recession risks trump earnings.