THE DAILY EDGE: 24 NOVEMBER 2022: Very Weak U.S. Flash PMI

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U.S. FLASH PMI

Demand weakness weighs further on private sector business activity in November

November saw a solid contraction in business activity across the US private sector, according to latest ‘flash’ PMI™ data from S&P Global. Lower output was seen across both manufacturing and service sectors amid increasingly steep downturns in demand. The overall fall in activity was the second-fastest since May 2020 as inflation, rising borrowing costs and economic uncertainty weighed on demand.

The headline Flash US PMI Composite Output Index registered 46.3 in November, down from 48.2 at the start of the fourth quarter. The rate of contraction signalled was the sharpest since August and among the quickest since 2009.

Demand conditions worsened as the fourth quarter progressed, with new orders across the private sector falling in November at the fastest pace since the initial pandemic wave in May 2020. With the exception of the early stages of the pandemic, the decrease in total new sales was the sharpest since 2009. Manufacturers and service providers alike recorded steeper declines in new business, with many firms stating that the impact of inflation and interest rates had led to greater hesitancy and postponements by customers in placing orders.

The pace of decline in new export orders also gathered momentum, with manufacturing weakness being met by a dwindling service sector performance in external markets.

On a more positive note, inflationary pressures eased further in November. Private sector input cost inflation softened for the sixth month running, increasing at the slowest rate since December 2020. Although still rising at a pace well above the series average, firms noted that decreases in the price of some key components including lumber, steel and plastic, as well as reduced freight costs, led to a softer overall uptick in expenses.

Reflecting the slower growth of input costs, firms raised their selling prices at the slowest rate for just over two years. The pace of charge inflation was notably softer than seen earlier in the year. Some firms stated that concessions and discounts were made to entice customers to place orders amid the weak demand environment.

Meanwhile, lower new order inflows led to a strong reduction in levels of outstanding business at US firms. The fall in backlogs of work was the sharpest in two-and-a-half years, with manufacturers reporting the steeper decline in work-in-hand. A more consistent supplier performance and weak demand allowed firms to work through their incomplete business, according to panellists.

In line with subdued demand, firms increased their workforce numbers only marginally in November. Hiring reportedly continued as firms tried to fill open vacancies for skilled workers, but the non-replacement of leavers (in an effort to cut costs) weighed on employment growth.

Despite challenging demand conditions, firms reported a pick-up in output expectations for the coming 12 months in November. Manufacturers and service providers both signalled greater confidence in the outlook. Improvements in supply chain stability and hopes of greater client demand following new product launches were key factors spurring greater optimism. Growth expectations nonetheless remained well below levels seen this time last year.

The S&P Global Flash US Services Business Activity Index posted 46.1 in November, down from 47.8 in October. Excluding the initial pandemic phase in the first half of 2020, the rate of decline was the second-fastest on record. Panellists often stated that the impact of inflation and interest rates on customer disposable income had dented demand conditions.

In line with weak demand, new business fell at a solid pace in November. The second successive monthly decrease in new orders was the sharpest seen since May 2020.

On the price front, input costs rose at a slower pace midway through the fourth quarter. The increase in cost burdens was the softest in almost two years, as firms noted lower prices for some key inputs.

At the same time, the rate of inflation for prices charged for services eased for the seventh successive month and was the softest since October 2020. Firms often noted that slower price hikes were linked to efforts to remain competitive and drive new sales.

A solid reduction in backlogs of work and capacity pressure at service providers led to only a marginal uptick in employment. Where hiring was successful, firms linked this to the filling of long-held vacancies.

Nonetheless, firms remained upbeat in their expectations for activity over the next year. Confidence picked up from October and was reportedly driven by hopes of further easing in price pressures and investment in service lines.

At 47.6, down from 50.4 in October, the S&P Global Flash US Manufacturing PMI signalled a renewed decline in operating conditions at manufacturers in November. The deterioration in the health of the sector was solid and the first since June 2020.

Contributing to the decrease in the headline figure was a renewed fall in output and a sharper decline in new orders. Demand conditions were stymied by inflation and economic uncertainty, according to panellists, with new sales falling at the quickest rate since May 2020. Alongside challenging domestic demand conditions, new export orders contracted at a sharper pace.

Nonetheless, there were positive developments in November, as firms signalled the first improvement in supplier performance since October 2019. Faster lead times were, however, often linked to reduced demand for inputs. Moreover, purchasing activity fell at the sharpest pace since May 2020 as firms reportedly worked through excess inventories.

In line with shorter delivery times for inputs, firms recorded a slower rise in cost burdens. Average input prices increased at the softest rate for two years amid reports of lower costs for key inputs including lumber and plastics.

Although historically elevated, factory output price inflation also eased in November. Firms sought to drive sales and entice customers, with selling prices rising at the slowest pace since January 2021.

Difficulties in finding skilled labor remained apparent in November, however, which – combined with concerns over weakening demand – caused the rate of employment growth to slow to only a marginal pace. Backlogs of work fell sharply in part due to firms receiving inputs in a more timely manner, but new orders also declined at an increased rate.

Finally, business confidence in the outlook for output over the coming year improved from October’s recent low. Although still below the historic series average, optimism stemmed from shorter lead times for inputs and hopes of stronger client demand.

Chris Williamson, Chief Business Economist at S&P Global Market Intelligence: “Business conditions across the US worsened in November, according to the preliminary PMI survey findings, with output and demand falling at increased rates, consistent with the economy contracting at an annualised rate of 1%. (…)”

• US resilience may mean the Fed has to talk tougher

ING sees resilience in nominal capex orders:

The good news is that the durable goods report is solid and points to business capex holding up well in the fourth quarter. We always ignore the headline number, which rose 1% month-on-month versus the 0.4% consensus expectation as it gets buffeted around by Boeing aircraft orders, which were decent at 122 planes versus 96 in September.

The Fed tends to look more at the non-defense capital goods orders ex aircraft as a cleaner measure of what is happening in the corporate sector. It rose 0.7% MoM versus expectations of 0.0%. Admittedly the September number was revised a little lower to -0.8% from -0.4% and, as the chart below shows, it is trending towards slower growth, but it is not suggesting companies are looking to retrench imminently.

US core durable goods orders and business investment

The problem with ING’s chart is that it compares a series in constant dollars (GDP- equipment investment, orange) with one in nominal dollars (capex). When deflating capex with the implied deflator in the GDP-equipment investment series (red), we see that real capex growth was about flat in Q2 and likely turned negative in September and October.

Add November’s flash PMI findings of

• “increasingly steep downturns in demand”
• “the decrease in total new sales was the sharpest since 2009”
• “new export orders contracted at a sharper pace”

and the resiliency looks much more fragile, particularly when reading about only “marginal increases” in both manufacturing and service employment.

Speaking of employment, ING continued:

The not-so-good story was the rise in initial jobless claims to 240k from 223k (consensus 225k) while continuing claims rose from 1503k to 1551k, suggesting that there is evidence of a cooling in the US labour market. (…) The consensus for next Friday’s payrolls number is for a 200k jobs gain and we doubt expectations will shift much for that, but the rising lay-off story is something we will be closely following and could hint of early signs that the jobs numbers in early 2023 being softer.

This chart shows unemployment claims with the scale set to reflect levels between 2014 and 2019. The horizontal line is the average for that period. The low in claims was in March. Based on continuing claims, 245k workers having lost their job in May have yet to find another one.

This “data-dependent” Fed next meets December 13-14. They will get a new CPI report on December 13. Will they then have enough data to conclude that demand is waning rapidly, that employment seems to be slowing fast and that inflation looks set to pause for a while?

The WSJ Nick Timiraos sums it up well (my emphasis):

Fed Minutes Show Most Officials Favored Slowing Rate Rises Soon Policy makers have signaled plans to dial back the pace of interest-rate increases, while warning rates could rise to somewhat higher-than-anticipated levels next year

Their discussion at the meeting, described in minutes of the gathering released Wednesday, suggests they could downshift to a rate rise of 0.5 percentage point, or 50 basis points, at their meeting next month.

“A substantial majority of participants judged that a slowing in the pace of increase would soon be appropriate,” the minutes said.

(…) the discussion revealed some were more anxious about the possibility of overdoing the increases, while others worried they might not be making enough progress to warrant a downshift.

Some from the first camp said the risks were rising that the Fed’s rate increases might ultimately “exceed what was required to bring inflation back” to their 2% goal. A few also warned that continuing to raise rates in 0.75-point increments “increased the risk of instability or dislocations in the financial system,” the minutes said.

A small minority believed it might be better to wait to slow increases until rates were “more clearly in restrictive territory and there were more concrete signs that inflation pressures were receding significantly,” the minutes said. (…)

The minutes said that officials thought that high inflation and the strong labor market would call for raising the benchmark federal-funds rate next year to a level “somewhat higher than they had previously expected.” (…)

The central bank’s staff saw a U.S. recession next year “as almost as likely” as their baseline projection of weak growth, the minutes showed. That represented a downgrade of the economic outlook due to the tightening of financial conditions that had occurred this fall. (…)

This summer and fall, several Fed officials suggested they would want to see evidence that inflation is declining toward their 2% goal before slowing or stopping rate increases. But at a press conference on Nov. 2, Mr. Powell suggested a sequence of slower inflation readings had never been “the appropriate test” for slowing or halting rate rises. (…)

Recall that at his last FOMC presser, Mr. Powell sounded more hawkish than the official communique, even saying that “I control the messaging, that’s my job”. I have not seen any commentator pick up on this rather bizarre statement.

From the minutes:

In discussing potential policy actions at upcoming meetings, participants reaffirmed their strong commitment to returning inflation to the Committee’s 2 percent objective, and they continued to anticipate that ongoing increases in the target range for the federal funds rate would be appropriate in order to attain a sufficiently restrictive stance of policy to bring inflation down over time.

Many participants commented that there was significant uncertainty about the ultimate level of the federal funds rate needed to achieve the Committee’s goals and that their assessment of that level would depend, in part, on incoming data.

Even so, various participants noted that, with inflation showing little sign thus far of abating, and with supply and demand imbalances in the economy persisting, their assessment of the ultimate level of the federal funds rate that would be necessary to achieve the Committee’s goals was somewhat higher than they had previously expected.

(…) A number of participants observed that, as monetary policy approached a stance that was sufficiently restrictive to achieve the Committee’s goals, it would become appropriate to slow the pace of increase in the target range for the federal funds rate. In addition, a substantial majority of participants judged that a slowing in the pace of increase would likely soon be appropriate. A slower pace in these circumstances would better allow the Committee to assess progress toward its goals of maximum employment and price stability. The uncertain lags and magnitudes associated with the effects of monetary policy actions on economic activity and inflation were among the reasons cited regarding why such an assessment was important.

A few participants commented that slowing the pace of increase could reduce the risk of instability in the financial system. A few other participants noted that, before slowing the pace of policy rate increases, it could be advantageous to wait until the stance of policy was more clearly in restrictive territory and there were more concrete signs that inflation pressures were receding significantly.

It seems safe to conclude that:

• A pause is not contemplated just yet.
• Mr. Powell’s insistence in his presser that rates would rise more than previously expected did not reflect the view of a majority of participants. “Various participants” (rarely used in minutes) see the need for terminal rates “somewhat higher than they had previously expected”.
• Mr. Powell is clearly among these “various participants”. He made it clear in the presser that the policy needed to get clearly in restrictive territory, a view shared only by “a few participants”.
• This FOMC is divided and Powell is the boss controlling the message.

This will likely get worse in December.

For their part, equity investors need to decide if a Fed pivot (slowing, not yet pausing) is more significant than potentially declining profits.

Personally, the odds currently favor the fixed income side.

Retailers’ Holiday Discounts Are Steeper This Year, CFOs Say Markdowns help clear excess stock and attract Black Friday shoppers, but they crimp profit margins

(…) Among retailers in the S&P 500 that reported financial results through Nov. 22, the average margin on earnings before interest and taxes declined to 10.7% in the third quarter from 13.2% in the year-earlier period, according to S&P Global Market Intelligence. (…)

U.S. Poised to Grant Chevron License to Pump Oil in Venezuela The move would come just as Western sanctions on Russia threaten to tighten global supplies.

China’s Record Covid Surge Hits Recovery Hopes The prospect that Beijing’s zero-tolerance approach to Covid-19 persists well into next year means the world can’t rely on China to be a locomotive of growth as the U.S. and European economies slow.

• Postal Savings Bank of China to provide $39 bln of property sector financing Postal Savings Bank of China has agreed to provide a total of 280 billion yuan ($39.17 billion) in financing to property companies including Vanke, Longfor and Country Garden

Wait, wait! Here’s the FT: Chinese lenders to pump $162bn of credit into property developers