THE DAILY EDGE: 6 March 2024

US service sector reports sustained expansion in February

The seasonally adjusted final S&P Global US Services PMI Business Activity Index posted 52.3 in February, down slightly from 52.5 in January but up from the earlier released ‘flash’ estimate of 51.3. The latest expansion extended the current sequence of growth to just over a year and was the second-fastest since last July.

Panellists stated that greater output was due to a further rise in new business. February data indicated a sustained rise in sales volumes at service providers, as new orders expanded for the fourth month running. The rate of growth eased to the weakest in three months, however, as companies suggested that reduced purchasing power at some customers dampened demand conditions.

Growth in total sales was led by domestic demand, as foreign customer interest dwindled and drove a renewed fall in new export orders in February. Moreover, the pace of export decline was the quickest since September 2023.

Meanwhile, service sector firms recorded a slower rise in input prices midway through the first quarter. Although companies attributed cost inflation to higher wage and fuel bills, many stated that lower prices for materials led to a moderation in the overall pace of increase. Furthermore, the rate of cost inflation eased to the weakest since October 2020 and was slower than the long-run series average.

In contrast, efforts to pass higher costs on to customers led to a sharper rise in selling prices in February. The pace of charge inflation was among the slowest in the current near four-year sequence of increase, but it was in line with the series’ long-run average.

Service sector firms continued to hire additional workers during February. That said, anecdotal evidence suggested that hiring was focused on part-time and temporary staff amid cost-cutting initiatives which also hampered total job creation. The rate of employment growth slowed to the weakest since last November.

Firms were able to process incoming new business in a timely manner, as backlogs of work fell in February. Incomplete business declined for the seventh time in the last eight months, albeit at only a marginal pace.

Softer demand conditions also led to dampened expectations regarding activity over the coming year. Service sector firms recorded the lowest level of optimism for three months, and one that was historically muted. Weighing on business confidence were reports of reduced purchasing power at customers and efforts to cut costs.

The final S&P Global US Composite PMI Output Index posted 52.5 in February, up from 52.0 in January. The latest data signalled a thirteenth successive monthly expansion in business activity at private sector firms, supported by a renewed upturn in manufacturing production and further rise in service sector activity.

New order growth eased slightly, however, amid a softer increase in services new business in February. Nonetheless, the overall rate of expansion was the second-steepest since mid-2023. The overall upturn was aided by a renewed rise in new export orders for goods.

February data indicated a broad-based easing of cost pressures, as input prices rose at the slowest pace since October 2020. Firms sought to pass-through higher costs to customers, however, as selling price inflation quickened from January, albeit remaining the second-lowest since mid-2020.

Meanwhile, total employment growth remained only modest midway through the first quarter. Although manufacturers stepped up their hiring activity, service providers indicated a historically subdued pace of job creation amid cost-cutting initiatives and labor shortages.

The goods and services producing sectors are collectively reporting the sharpest growth since last June, hinting at a further quarter of solid GDP growth.

The acceleration occurred despite a cooling of growth in financial services, linked to the recent pull-back in rate cut expectations. Demand for consumer goods and services has, however, picked up further in February amid the easing of the cost of living crisis and healthy labor market conditions, meaning consumers are once again at the forefront of the economic expansion

A concern is that alongside this faster growth, the survey has seen price pressures revive. Although average prices are still rising at one of the slowest rates seen over the past four years, the rate of inflation picked up for goods and services alike in February to hint at some broad-based firming of price pressures that could worry policymakers about cutting interest rates too early.

• ISM Services Signals Less Runway for Patience

The ISM services index slipped to 52.6 in February as prices paid cooled more than five points. For the second time in three months, the employment component was in contraction territory. Attention now shifts to Friday’s employment report for confirmation that job growth is indeed cooling.

Source: Institute for Supply Management and Wells Fargo Economics

The prices paid component fell more than five points to 58.6, that is still consistent with rising prices, but at least higher prices are becoming less widespread. Between that and an employment reading that was in contraction for the second time in three months, the upshot is a bit less complacency around the timing of rate cuts. (…)

From Bloomberg:

At the same time, other demand measures strengthened. The gauge of new orders placed with service providers — a proxy of future demand — increased to 56.1, the highest since August. “The majority of respondents are mostly positive about business conditions,” Anthony Nieves, chair of the ISM Services Business Survey Committee, said in a statement.

ING:

However, employment was particularly soft, dropping into contraction territory at 48.0. This is the second sub-50 print in the past three months with the six-month moving average also now below the 50 line. Historically, there has been a very strong relationship between the ISM services employment index and the monthly change in nonfarm payrolls, but throughout 2023 and into January 2024 they have had an inverse relationship.

ISM services employment and nonfarm payrolls changes (000s)

Source: ING, Macrobond

The BLS will report February’s payrolls this Friday. Current consensus is +190k after +353k in January.

WHAT RESPONDENTS ARE SAYING

• “Business remains strong across the U.S. industrial construction sector. Construction materials levels have returned to pre-coronavirus pandemic levels, and the outlook for 2024 is strong.” [Construction]
• “Continued inflationary pressures and labor price increases are challenging, but we continue to push forward.” [Health Care & Social Assistance]
• “Employers remain cautious about hiring direct employees and are considering utilizing contract labor to cover project and interim work demands as concerns about the economy continue to be front of mind.” [Management of Companies & Support Services]
• “Production continues steady increase.” [Mining]
• “High demand for services, although inquiries from contractors for opportunities seem to be only inching upward. Layoffs in many large industries, but many businesses are desperate for workers. Lots of contradictions.” [Public Administration]
• “Business is good. Inflation is under control and trending downward. Pricing of commodities is going up at a slower pace. Manufacturing is good, with no sign of any change in the near future.” [Retail Trade]
• “Labor continues to be in highest demand. Finding qualified and available crews and administrative staff (is still) difficult. [Utilities]
• “Moderate increases in business activity so far. Improved supplier fill rates and steady pricing have resulted in increased levels of restocking as businesses prepare for spring and summer selling seasons.” [Wholesale Trade]

In all, the February PMIs confirmed that manufacturing is past the low point in the inventory cycle while services are gradually recovering towards their more normal trend rates.

Goldilocks soft landing or reflationary no-landing? How about a reflationary soft landing? February PMIs were mild enough on the inflation front to hope for the former. But the Cleveland Fed Inflation Nowcast pins February’s core CPI at +0.32% (red bar) after January’s surprise +0.39% print.

And watch wages, particularly in services.

As I wrote last Monday (Perfect Storm Forming?):

Real spending on services is almost back on trend after logging consecutive 0.4% monthly growth rates in each of the last 3 months, +4.9% a.r.. This is twice the “normal growth rate”.

The good news from that is that, as a result, services employment has accelerated from +182k on average between June and November (+1.6% a.r.) to +312k in December-January (+2.7% a.r.).

The potentially not-so-good news is that the only labor slack left in the U.S. economy is in services (unemployment of 5.2% in January compared to 2.9% in durable goods). If this slack gets quickly used up, growth in wages of service providers, responsible for the slowdown in total wage growth since the fall of 2022 (from 5.4% YoY to 4.4%), could accelerate towards goods-producing wages which have kept inflating 5.5-6.0%.

Recently:

• Germany’s Trade Surplus Widened in January Demand for German goods could be recovering.
• Exports SA (M/M): 6.3% (exp 1.5%; R prev -4.2%)
• Eurozone Industrial Production Unexpectedly Expands Amid Signs Recovery for Sector
• South Korea’s Exports Get off to Strong Start in 2024
• South Korea Inflation Reaccelerates, Backing BOK’s Hawkish Stance
• Canada GDP Rebounds in 4Q With 1% Growth
• #China Jan-Feb Exports Rose About 10% on Year, State Planner Says – DJ
• America’s top executives are strikingly more confident about the economy than they were three months ago, Axios’ Courtenay Brown and Neil Irwin write from the Business Roundtable’s quarterly gauge of CEO sentiment.

Credit Managers’ Index

The National Association of Credit Management’s seasonally adjusted combined Credit Managers’ Index (CMI) for February 2024 improved 1.3 points to 52.4. “The CMI improved this month, but the index remains stubbornly in a tight band just above the contraction line with no obvious trend,” said NACM Economist Amy Crews Cutts, Ph.D., CBE.

The big driver this month is the dramatic drop in the dollar amount beyond terms index, which went from being
deep in contraction to just above the neutral line, meaning the dollar amount owed on accounts beyond terms was
essentially unchanged from last month but at a level that is substantially higher than a year ago. I’ve been watching
this factor for a while as it is a strong leading indicator of business stress.

This indicator has been trending negatively since July 2021 and went into contraction in July of last year. Respondents have regularly noted that they are having trouble getting paid on time, a growing concern among credit managers. (…)

“Taken together, the sudden leveling off of the dollar amount owed that is beyond terms and the long run of a rising number of accounts being referred to collections, I think credit managers are tiring of promises to pay and cries for extensions. Instead, they are moving more accounts to collections to stem losses. This to me is the strongest indication yet of the deep stresses affecting businesses. We did not fall into formal recession in 2023 and we mightnot in 2024 but for many credit managers, it’s as if the recession is well underway.”

Canada: Business insolvencies surge to a multi-year high in January

At the industry level, the surge was the most important in the accommodation & food services, transportation & warehousing, professional/scientific/technical services, retail trade, and construction sectors. While January’s increase was certainly exacerbated by the end of COVID-era subsidy programs, restrictive monetary policy is certainly playing a role as well. It will be interesting to see how the Bank of Canada tweaks its guidance at tomorrow’s rate-setting meeting (the benchmark rate is expected to remain unchanged) to guard against a potential disappointment in job creation when the February employment report is released on Friday.

Tether’s $100 billion stokes stablecoin stability concerns

As Tether toasts $100 billion in circulation this week, the rapid rise of the world’s biggest stablecoin has highlighted concerns about potential risks to wider financial markets.

The digital dollar-pegged token is designed to keep a constant value, something Tether says that it does by holding dollar-denominated reserves for every token it creates.

Crypto traders say the tokens are essential for moving funds in crypto quickly, without using the regulated banking system. (…)

Tether is also growing fast. Around $29 billion worth was created in the last year, it said in a statement on Tuesday. (…)

But with Tether now holding nearly $100 billion worth of reserves in traditional banking institutions, Rajeev Bamra, Head of DeFi and Digital Assets Strategy at Moody’s Investors Service said “anything going wrong with Tether is going to impact those banking institutions at the end of the day”.

“I think the concentration risk in Tether is huge,” Bamra added, referring to Tether’s dominance within the crypto world.

S&P Global Ratings ranked Tether as a 4 in a stablecoin stability assessment last year, the second lowest on a scale of 1 to 5, citing a lack of information on custodians, counterparties or bank account providers of its reserves.

Tether agreed to quarterly reserve reports under a 2021 settlement with the New York Attorney General’s office.

At the end of 2023, Tether’s latest report says, its reserves held $63 billion of U.S. Treasuries, $3.5 billion of precious metals, $2.8 billion of bitcoin, $3.8 billion of “other investments” and $4.8 billion of “secured loans”.

Paul Brody, global blockchain leader at Ernst & Young, said that a reserve report does not constitute a full financial statement audit. (…)

Tether Holdings Ltd, which is registered in Hong Kong and owned by a company registered in the British Virgin Islands, says on its website it is “fully transparent”, but it does not give details about where its reserves are held. (…)

Bubbling? Memecoins have been surging as speculative fervor grips the market. This brings back memories of Cabbage Patch Kids, Furbys, Pokemon Cards, and Beanie Babies. (The Daily Shot)

VALUATIONS WATCH

Source: Goldman Sachs; @MikeZaccardi