Fed Backs Away From Wages Focus, Bolstering Case for Rate Pause New research, recent commentary downplay wages-prices link
Federal Reserve officials are rethinking their view that wage gains are fueling inflation, a key intellectual shift that bolsters the case for a pause in their tightening campaign this week. (…)
Minutes of the Fed’s May 2-3 policy meeting hinted at a shift. When discussing services inflation in particular, only “some participants remarked that a further easing in labor market conditions would be needed” to bring it down, whereas minutes of the previous meeting in March suggested “participants generally judged” such cooling would be necessary.
“I do not think that wages are the principal driver of inflation,” Fed Chair Jerome Powell told reporters after the May meeting. “I think wages and prices tend to move together, and it’s very hard to say what’s causing what.”
Powell’s remark alluded to a crucial question in the emerging wages-versus-prices debate: Are wages a large driver of inflation, or is it more likely to be the other way around? Public comments from officials in recent months suggest the latter interpretation is gaining a following.
Meanwhile, new research from within the Fed system also supports that thesis.
A statistical analysis suggests faster wage growth has contributed only minimally to faster services inflation in recent years, San Francisco Fed economist Adam Shapiro said in an article published on the bank’s website last month. He noted businesses can “absorb” those costs via lower profits or by using automation and other methods to improve efficiency, adding that “recent evidence shows that wage growth tends to follow inflation, as well as expectations of future inflation.” (…)
“I think wages and prices tend to move together, and it’s very hard to say what’s causing what.” Mr. Powell, what’s the most logical?
- Let’s raise prices, see if it sticks, then lift wages? Or
- Our costs, like wages and energy, are rising, let’s see if we can offset with higher prices?
Or, how about simply asking business people? Like listening to conf. calls from time to time?
And, anybody who reads PMI surveys knows how it flows. Just from May’s surveys:
- In China: “Companies often mentioned that greater operating expenses stemmed from increased prices for labour and raw materials. The further strong rise in costs and improvement in demand conditions led service providers to hike their fees again during May.”
- In the USA: “Companies commonly stated that greater selling prices were due to the passthrough of higher costs to customers.”
Banking Update: Deposits Back to Growth (Moody’s)
After plummeting in March, deposits at small and midsize banks stabilized in April and, as of May, had begun growing. Small banks, as well as their larger counterparts, saw steady deposit growth in May.
Canada sheds jobs for the first time in nine months, unemployment ticks up to 5.2 per cent
- Employment decreased by 17k in May, after +41k in April and below consensus expectations for +21k.
- Job losses were entirely driven by the self-employed workers (-40k). Public employment (+10K) and private sector employment (+13k) rose.
- Employment increased by 23k in the goods-producing sector and declined by 40k in the services-producing sector.
- The unemployment rate increased by 0.2pp to 5.2%, the first monthly increase since August 2022.
- The participation rate ticked down by 0.1pp to 65.5%.
- Population growth was +0.26% MoM in May, the highest growth rate on record.
- Hourly wage growth of permanent employees was +5.1% YoY in May from +5.2% in April. The three-month annualized wage growth declined to 3.5% as the strong February print was dropped out.
- Monthly wage growth edged up to +0.4% from +0.3% in April.
Bank of Canada’s Beaudry Sees Signs of New Era of Higher Interest Rates The risk of high inflation continues to weigh on rate expectations, the official says
A senior Bank of Canada official cautioned it is likely that longer-term real interest rates will remain elevated relative to prepandemic levels and will be higher than Canadians are used to in the coming years.
Speaking a day after the central bank resumed lifting its policy rate amid still-high inflation and a resilient economy, Deputy Gov. Paul Beaudry on Thursday said there remains uncertainty but risks to long-term real rates are tilted to the upside. (…)
Beaudry said there are reasons to believe some of the factors that have weighed on long-term rates may be plateauing and could even change course.
“That makes it unlikely the real neutral rate will fall below prepandemic estimates and creates a meaningful risk that it could go up,” he said in a speech to the Greater Victoria Chamber of Commerce in British Columbia. (…)
“The accumulation of evidence across a range of economic indicators suggests that excess demand in the Canadian economy is more persistent than we thought, and this increases the risk that the decline in inflation could stall. That’s why we decided to raise the policy rate,” Beaudry said. (…)
In his speech, Beaudry noted that long-term interest rates in Canada and most other advanced economies fell steadily in the 25 years before the pandemic, thanks to a mix of aging populations, China and other developing countries joining the global economy, rising inequality and fewer attractive investment opportunities for business.
Those forces, he said, may have peaked and could reverse.
He said that in many countries, large portions of the population are no longer saving for retirement but are now retired, when they typically start spending their savings and could be a source of downward pressure on global saving and upward pressure on real rates. Also, Beaudry said some of the underlying drivers of inequality may be waning and causing less drag on real rates.
Beaudry said that at the same time the transition to a low-carbon economy is creating new investment opportunities in green technology and green infrastructure, while rapid advances in artificial intelligence may suggest a new era of public and private investment that could put upward pressure on real rates.
“In the bank’s view, that makes it more likely that long-term real interest rates will remain elevated relative to their prepandemic levels than the opposite,” he said.
Switzerland’s neutral interest rate may be a bit lower than that of other advanced economies, according to Swiss National Bank President Thomas Jordan.
The rate that neither slows nor accelerates output typically is “in the range of 2%-to-3% in developed countries, while in Switzerland it might be slightly lower,” Jordan told Swiss newspaper Corriere del Ticino in an interview published on Saturday.
While the president added that the neutral rate can only be an estimate, his comments suggest that the SNB might not be finished tightening after a likely 25 basis-point move to 1.75% later this month. (…)
US Will Buy 3 Million More Barrels for Emergency Reserve
The Energy Department announced Friday it planned to purchase 3 million more barrels of crude oil for the Strategic Petroleum Reserve.
A previous solicitation for about 3 million barrels resulted in contracts awarded to five companies, with the oil being purchased for an average price of about $73 per barrel, according to a DOE statement.
The move marks the agency’s attempts to begin replenishing the emergency reserve after it released more than 200 million barrels last year, in part to curb high energy prices. (…)
Nio Cuts Prices on All Electric Vehicles by $4,200 in China
EARNINGS WATCH
Of the 13 pre-announcements since May 26, 2 were positive and 9 negative.
Q2 ends in 2 weeks and guidance has improved compared with Q1. Yet, analysts are now expecting Q2 earnings to decline 5.4%, worse than the -3.9% expected on April 1. Q3e is now +1.7% vs +2.8% an Q4 +9.8% vs +10.5%.
If analysts are right, the earnings recession (ex-Energy) will have lasted 4 quarters. Its expected recovery would more than offset the coming slump in Energy profits.
Trailing EPS are now $220.04. Full year 2023: $220.75e. 12-m forward: $225.49. 2024: $246.68, +9.4%.
Macro Dissonance: This is an interesting juxtaposition — stock analysts expect earnings to go higher for longer, while the bond market is expecting rate cuts. Usually the Fed only cuts rates if there’s a recession. And at least in this window of history whenever the green line has moved sharply lower an earnings recession follows. Which is all to say, despite a big improvement in sentiment and technicals (that we just documented), the macro is still murky.
Goldman Sachs:
The S&P 500 has returned 13% YTD, but the rally has masked muted returns for most stocks. The equal-weighted S&P 500 has returned just 3% YTD. The five largest S&P 500 firms (AAPL, MSFT, AMZN, GOOGL, NVDA have rallied by 47% YTD and now comprise 24% of S&P 500 market cap. Excluding those five, the remaining 495 stocks have returned just 5%. However, since the start of June, breadth has widened slightly as the Russell 2000 has outperformed the S&P 500 by 5 pp (+8% vs. +3%).
(…) market breadth has recently narrowed by the most since the Tech Bubble. Following 9 other episodes of sharply narrowing breadth since 1980, the S&P 500 typically traded sideways during subsequent months as rotations continued within the market. In addition to below-average returns, drawdowns have also been larger than average in these experiences. Eventually, however, a “catch up” has been most common, with S&P 500 valuations and prices increasing alongside a reversal of intra-market momentum.
Valuations this year have risen beyond our expectations, but the combination of slowing inflation, healthy growth, and elevated market concentration suggests that the current multiple may persist. If economic growth data remain resilient and inflation continues to soften in line with our economists’ forecast, a declining equity risk premium will likely offset slightly higher real interest rates and support current equity multiples.
The five largest firms collectively trade at 29x vs. 17x for the other 495 stocks, which trade roughly in line with what had been our forecast for S&P 500 P/E.
The major downside risks to our S&P 500 outlook include an unexpected downturn in growth and stubborn inflation that triggers a hawkish Fed pivot. In a mild recession, we estimate that S&P 500 EPS would fall by 10% to $200, roughly in line with the 13% historical average decline in recessions. This would likely lead to a more moderate decline in the consensus estimates, which typically trough well after equity prices.
Given the recent trajectory of disinflation, we estimate the ability of the Fed to ease in a recession would support a trough P/E multiple of 15x. This 19% multiple contraction and a 9% reduction in consensus 2024 EPS to $223, from $246 today, would lower the S&P 500 to 3400 (21% below today).
If the US economy avoids a recession, inflation will remain as the most obvious downside risk to stocks. Our economists expect core PCE will end the year at 3.7% year/year, still well above the Fed’s 2% target. If the inflation outlook proves more challenging, expectations for a more hawkish path of policy rates would likely weigh on equity valuations.
Ed Yardeni:
This will be a head spinning week. It could also be another rollercoaster ride in the financial markets. Maybe we should go on vacation and come back on Friday following the deluge of economic indicators from Monday through Thursday, and a FOMC meeting on Tuesday and Wednesday to boot. (…)
Ed Yardeni’s advice merits consideration …so I will be on vacation for 2 weeks, posting when possible given less time, limited equipment and a different time zone…
FYI #1:
FYI #2:
S&P 600 Financials Sectors P/E S&P 400 Financials Sectors P/E
(yardeni.com)
Companies, Big Investors Sell Shares at Fastest Rate in Years There have been more than $24 billion of “follow-on” share sales since the end of April, boosted by the rebound in stocks.
Since the end of April, companies and private-equity firms have sold more than $24 billion worth of stock in so-called follow-on sales, according to Dealogic. More than $17 billion changed hands in May alone, well above the $6.9 billion monthly average last year. The sales were done at smaller discounts than usual, on average, reflecting a robust market.
Nearly half the sales have come from big shareholders like private-equity firms, which have been looking for creative avenues to sell companies—or parts of them—and return the money to the pension funds and others that give them capital. (…)
Intel this month sold more than $1.6 billion of stock in former unit Mobileye, more than the chip giant and its bankers had originally planned. General Electric sold roughly $2 billion worth of stock in its spinoff, GE HealthCare Technologies, while American International Group cashed out of more than $1 billion worth of stock in Corebridge Financial, the retirement and life-insurance business it carved out last year.
Typically, sellers must offer a discount to where shares recently traded in follow-on offerings in order to entice buyers. In 2020 and 2021, when demand for stocks was high, these discounts shrank, averaging 8.4%, according to Dealogic. Since the start of 2022, the average discount for follow-on offerings jumped to around 12%. In May, that discount started shrinking again, compressing to 8.3%, and in June it has been even tighter.
El Niño is back, ushering in record heat
El Niño is officially back after about a four-year hiatus, per the National Oceanic and Atmospheric Administration, Axios’ Andrew Freedman writes.
El Niño, the ocean and atmosphere cycle in the tropical Pacific, holds large sway over global weather patterns. It’s likely to increase global average surface temperatures and lead to an all-time record warm year in 2023 or 2024.
- El Niño will contribute to heat waves, droughts, floods and other weather extremes.
- It is influencing the North Atlantic hurricane season, making for an especially uncertain outlook.
“The global oceans are very warm right now, and I’m afraid that this is putting us into territory that we don’t have much experience with,” said Michelle L’Heureux, chief of Climate Prediction Center’s El Niño-Southern Oscillation team.
- The high cost of an El Niño in 2023 Scientists have announced the start of a potentially strong El Niño climate pattern in June 2023.
(…) Climate scientists have just announced that an El Niño weather pattern has taken hold and will strengthen through to the end of this year and the first months of 2024. And they are warning there is a good chance that it could be a particularly strong El Niño this year.
If that turns out to be the case, then the impacts could be significant. Scientists have already warned that with rising emissions and a strong El Niño there is a 66% chance the world will break through a key 1.5C global warming limit at least one year between now and 2027. But it could also bring damaging extreme weather such as heavy rainfall and flooding to communities in the US and elsewhere this winter.
“We expect El Niño to continue into the winter, and the odds of it becoming a strong event at its peak are pretty good, at 56%. Chances of at least a moderate event are about 84%,” wrote Emily Becker, associate director of the Univeristy of NMiami’s Coperative Institute for Marine and Atmopsheric Studies, on the National Oceanic and Atmospheric Administration’s (NOAA) blog.
The effects of this could also reverberate for some time to come – a recent study by researchers at Dartmouth College, Hanover, New Hampshire, estimates that an El Niño starting in 2023 could cost the global economy as much as $3.4tn (£2.7tn) over the following five years. And they say that following two previous very strong El Niño events in 1982-83 and 1997-98, the US gross domestic product was 3% lower half a decade later than it otherwise would have been. If an event of a similar magnitude was to happen today, it could cost the US economy $699bn (£565bn), they calculated.
It is worth noting that coastal tropical countries such as Peru and Indonesia, however, suffered a 10% drop in GDP following the same El Niño events, the researchers say. They project that global economic losses will amount to $84tn (£68tn) this century as climate change increases the frequency and strength of El Niño events.
“El Niño is not simply a shock from which an economy immediately recovers. Our study shows that economic productivity in the wake of El Niño is depressed for a much longer time than simply the year after the event,” says Justin Mankin, co-author of the study and assistant professor of geography at Dartmouth College.
“When we talk about an El Niño here in the United States, it means that the types of impacts that we’ll see, floods and landslides, aren’t typically insured against by most households and businesses,” says Mankin. In California, for example, 98% of homeowners don’t have flood insurance.
Other economic impacts in the US could include infrastructure damage from flooding, which would lead to supply chain disruption, and poor harvests caused by floods or drought, says Mankin.
While El Niño can bring intense periods of extreme weather to North America, it doesn’t always do so.
During El Niño, winds that usually push warmer water in the Pacific Ocean towards its west side weaken, allowing the warmer water to drift back towards the east and spread out over a larger area of the ocean. This leads to more moisture-rich air above the warmer ocean that alters the circulation of air in the atmosphere around the world. In North America, this typically causes Canada and the northern US to have a warmer, drier winter than normal while the southern states and Gulf coast tend to get wetter conditions, says DeWitt. (…)
El Niño also typically reduces the number of hurricanes in the Atlantic Ocean, but can lead to more hurricanes to the Pacific coast of the US. But all these effects largely depend on the strength of the El Niño that is driving them.
Southern states in the US are the most likely to experience severe impacts, including heavy rainfall and potential flash flooding, DeWitt warns. This would come after several years of drought following three consecutive La Niña seasons. (…)
The strong El Niño events of 1997-98 and 2015-16, for example, brought flooding and mudslides to California. The 1997-98 event was also associated with other unusual extreme events elsewhere in the country, such as severe ice storms in New England and deadly tornadoes in Florida. (…)
More Startups Throw in the Towel Startup shutdowns, fire sales and hard pivots are under way in the face of a venture market downturn.
Fresh capital from venture investors and bank loans is scarce and expensive. Going public is nearly impossible. Some business models that worked when cash was cheap are unsustainable now. That means venture-backed startups are running out of money and facing hard choices.
“The Mass Extinction Event for startups is under way,” said Tom Loverro, general partner at venture firm IVP, in a recent tweet. Loverro said in an interview that none of his portfolio companies has shut down recently, but it is early days in what could be a wave of startup failures. “It’s like the entire industry went out drinking and is now suffering the consequences,” he said about the venture boom of 2021 that he believes is heading for a bust. (…)
The yearly internal rate of return for venture firms was negative 7% in the third quarter of 2022, the lowest value since 2009, according to PitchBook Data. (…)
California startup Zume, which was developing a robotic pizza maker and was once valued at $2.25 billion, recently entered a wind-down process handled by Sherwood Partners, a restructuring firm, according to Sherwood’s co-founder and co-president Martin Pichinson. Zume representatives couldn’t be reached.
Sherwood’s business increased by 50% through April 30 this year compared with the same period last year, Pichinson said. “And the storm hasn’t even started,” he added. (…)
Venture-backed businesses in the U.S. raised $346 billion in venture capital in 2021, according to the PitchBook-NVCA Venture Monitor report. (…)
Startups in the U.S. raised $37 billion in the first quarter of this year, down 55% from the first three months of last year. (…)
North Korea’s Hacker Army Stole $3 Billion in Crypto, Funding Nuclear Program