Note: I am travelling in Asia until April 24. Limited equipment and different time zones will limit the frequency and depth of my postings.

 Must watch: https://research.gavekal.com/content/webinar-forward-to-the-1970s-investing-for-an-inflationary-age/

SURVEY SAYS

The Fed’s Beige Book (On or before April 8)

• Overall economic activity expanded slightly, on balance, since late February. Ten out of twelve Districts experienced either slight or modest economic growth—up from eight in the previous report, while the other two reported no changes in activity.
• Consumer spending barely increased overall (…). Several reports mentioned weakness in discretionary spending, as consumers’ price sensitivity remained elevated.
• Manufacturing activity declined slightly, as only three Districts reported growth in that sector. 
• Residential construction increased a little, on average, and home sales strengthened in most Districts. In contrast, nonresidential construction was flat, and commercial real estate leasing fell slightly.
• The economic outlook among contacts was cautiously optimistic, on balance.
• Employment rose at a slight pace overall, with nine Districts reporting very slow to modest increases, and the remaining three Districts reporting no changes in employment.
• Most Districts noted increases in labor supply and in the quality of job applicants.
• Wages grew at a moderate pace in eight Districts, with the remaining four noting only slight to modest wage increases. Multiple Districts said that annual wage growth rates had recently returned to their historical averages. On balance, contacts expected that labor demand and supply would remain relatively stable, with modest further job gains and continued moderation of wage growth back to pre-pandemic levels.
• Price increases were modest, on average, running at about the same pace as in the last report.
• Another frequent comment was that firms’ ability to pass cost increases on to consumers had weakened considerably in recent months, resulting in smaller profit margins.
• On balance, contacts expected that inflation would hold steady at a slow pace moving forward. At the same time, contacts in a few Districts—mostly manufacturers—perceived upside risks to near-term inflation in both input prices and output prices.

Contrast that with S&P Global’s latest PMI survey (12-26 March 2024):

• The seasonally adjusted S&P Global US Manufacturing  Purchasing Managers’ Index™ (PMI®) was above the 50.0 no-change mark for the third successive month in March, thereby signalling a further monthly strengthening in the health of the sector. That said, at 51.9 the index was down from 52.2 in February, pointing to a slightly less pronounced improvement at the end of the opening quarter of the year.
• Manufacturers recorded a solid and accelerated rise in production during March, with the rate of growth the sharpest in almost two years. Respondents mentioned signs of improving demand conditions. Stronger demand was also evident in data for new orders, which showed an increase for the third month running. The pace of expansion was solid, but softer than that seen in February.
• Although modest, the pace of job creation was the most pronounced since July last year.
• Input costs increased sharply, with the rate of inflation ticking up from that seen in February.
• Meanwhile, the impact of rising labor costs was mentioned as a factor pushing up selling prices at a number of manufacturers. As a result, the rate of output price inflation quickened for the fourth month running to a sharp pace that was the fastest in just under a year.
• The seasonally adjusted S&P Global US Services PMI® Business Activity Index ticked down to a three-month low of 51.7 in March from 52.3 in February. That said, the index remained above the 50.0 no-change mark and therefore signalled a rise in business activity for the fourteenth consecutive month.
• The rate of growth in new orders also eased in March, to a modest pace that was the slowest since last November.
• Service providers continued to expand their staffing levels in response to higher new business volumes, the forty-fifth successive month of job creation. The latest increase was only slight, however, and the weakest since last November. Some companies indicated that cost considerations had led them to hold off on hiring.
• In fact, higher wages were a key factor behind the latest increase in input costs, according to respondents. Panellists also reported rises in transportation and material prices. As a result, input costs increased sharply during the month, with the rate of inflation accelerating to a six-month high. The latest rise was also sharper than the series average as
  23% of companies recorded inflation over the month.
• In turn, the pace of output price inflation also quickened markedly from that seen in February to the fastest since July 2023 as companies passed higher input costs through to their customers. As with input prices, the rise in charges was also faster than the average since the survey began in 2009.

It seems that the Fed district staff are not talking to the same people as S&P Global does. The only area of agreement is on slower employment growth. S&P Global’s survey is much less optimistic on wages and inflation.

CONSUMER WATCH

Bank of America data confirm my contention that March retail demand was not as strong as generally thought after Monday’s release (Roaring Lion???). It also looks like services were also on the weak side in March.

Bank of America aggregated credit and debit card spending per household rose 0.3% year-over-year (YoY) in March, following the 2.9% YoY rise in February, which was boosted by the extra day due to the leap year. Looking through the monthly swings, Exhibit 1 illustrates that consumer spending momentum remained soft but stable.

  

March was also impacted by calendar effects due to a relatively early Easter this year, as the holiday fell on March 31 compared to April 9, last year. This pulled some holiday-related spending into March from April, likely inflating spending somewhat at the expense of next month.

In fact, on a seasonally adjusted (SA) basis, total card spending per household fell 0.7% month-over-month (MoM) in March, following the 0.4% rise in February.

Spending on services fell 1.1% MoM SA in March, with weakness in both lodging and restaurant spending, while retail spending (excluding restaurants) decreased by 0.3% MoM. But looking at the level of spending over time, services spending still appears to be trending higher and was well above 2019 levels (Exhibit 2).

BofA data also support my views that rent growth is stabilizing in the 4.5% range.

Looking at Bank of America deposit account data on customer payments for monthly rent and mortgage payments, we find that the YoY growth in the median rent payment has slowed significantly over 2023-24, following the surge in 2021 and 2022 (Exhibit 8). Rent growth is now at levels not seen since mid to late 2021 – while still higher than overall CPI (Consumer Price Index) inflation, rent growth is more in line with wage growth.

FYI:

Source: FinanceBuzz

SENTIMENT WATCH

Bank of America’s monthly global Fund Manager Survey shows just how sentiment has shifted on what has become the core question of the last year — will the economy make a hard landing, a soft one, or none at all? BofA has been asking managers to choose between these three options since last June, and the result beautifully illustrates why markets have moved as they have. A soft landing, with a mild economic slowdown needed to bring inflation back to target, has been the most popular option throughout. But a year ago, no landing was regarded as a somewhat extreme probability. Only 3% expected it, while 26% were braced for a hard landing. A soft landing has fewer adherents now than at any time since the BofA started asking, while no landing is favored by 36%. A third of fund managers have been won over from initial skepticism:

Note: I am travelling in Asia until April 24. Limited equipment and different time zones will limit the frequency and depth of my postings.

Fed Chair Jerome Powell Dials Back Expectations on Interest-Rate Cuts Inflation and hiring have been firmer than expected this year, weakening the case for pre-emptive rate reductions.

Firm inflation during the first quarter has called into question whether the Federal Reserve will be able to lower interest rates this year without signs of an unexpected economic slowdown, Chair Jerome Powell said Tuesday.

His remarks indicated a clear shift in the Fed’s outlook following a third consecutive month of stronger-than-anticipated inflation readings, which derailed hopes that the central bank might be able to deliver pre-emptive rate cuts this summer. Officials had previously said they were looking for greater confidence that inflation was returning to their target and were optimistic another month or two of data might meet that standard.

“The recent data have clearly not given us greater confidence and instead indicate that it is likely to take longer than expected to achieve that confidence,” Powell said at a moderated question-and-answer session in Washington. The remarks were his first public comments since an inflation report last week sent stocks sliding as investors recalibrated their rate-cut expectations. (…)

Powell indicated Tuesday the Fed wasn’t considering rate increases, either. Instead, Powell said officials would leave rates at their current level “as long as needed” if inflation proved more stubborn. He also said the Fed would be prepared to cut rates if the economy was slowing sharply.

“We think policy is well positioned to handle the risks that we face,” Powell said. “Right now, given the strength of the labor market and progress on inflation so far, it’s appropriate to allow restrictive policy further time to work.” (…)

Powell’s comments suggest the central bank will now need to see several more monthly inflation readings to regain the confidence that they had been looking for, effectively delaying rate cuts until later in the year and underscoring the difficulty of achieving a so-called soft landing. (…)

Powell in recent months has approvingly cited signs that labor market imbalances are easing. By maintaining that message on Tuesday, Powell suggested the Fed was only partially resetting its outlook.

A continued slowdown in wage growth is a likely requirement for policymakers to remain confident that inflation will improve over time. Wage pressures “continue to moderate, albeit gradually,” Powell said.

What If Fed Rate Hikes Are Actually Sparking US Economic Boom? A radical theory is spreading as economy defies expectations

(…) In other words, maybe the economy isn’t booming despite higher rates but rather because of them.

It’s an idea so radical that in mainstream academic and financial circles, it borders on heresy — the sort of thing that in the past only Turkey’s populist president, Recep Tayyip Erdogan, or the most zealous disciples of Modern Monetary Theory would dare utter publicly.

But the new converts — along with a handful who confess to being at least curious about the idea — say the economic evidence is becoming impossible to ignore. By some key gauges — GDP, unemployment, corporate profits — the expansion now is as strong or even stronger than it was when the Federal Reserve first began lifting rates.

This is, the contrarians argue, because the jump in benchmark rates from 0% to over 5% is providing Americans with a significant stream of income from their bond investments and savings accounts for the first time in two decades. “The reality is people have more money,” says Kevin Muir, a former derivatives trader at RBC Capital Markets who now writes an investing newsletter called The MacroTourist.

These people — and companies — are in turn spending a big enough chunk of that new-found cash, the theory goes, to drive up demand and goose growth. (…)

Muir and the rest of the contrarians — Greenlight Capital’s David Einhorn is the most high profile of them — say it’s different this time for a few reasons. Principal among them is the impact of exploding US budget deficits. The government’s debt has ballooned to $35 trillion, double what it was just a decade ago. That means those higher interest rates it’s now paying on the debt translate into an additional $50 billion or so flowing into the pockets of American (and foreign) bond investors each month. (…)

Einhorn notes that US households receive income on more than $13 trillion of short-term interest-bearing assets, almost triple the $5 trillion in consumer debt, excluding mortgages, that they have to pay interest on. At today’s rates, that translates to a net gain for households of some $400 billion a year, he estimates. (…)

Mark Zandi, chief economist at Moody’s Analytics, spoke for the traditionalists when he called the new theory simply “off base.” But even Zandi acknowledges that “higher rates are doing less economic damage than in times past.”

Like the converts, he cites another key factor for this resilience: Many Americans managed to lock in uber-low rates on their mortgages for 30 years during the pandemic, shielding them from much of the pain caused by rising rates. (This is a crucial difference with the rest of the world; mortgage rates rapidly adjust higher as benchmark rates rise in many developed nations.) (…)

I am not an economist, so I don’t have any theory. But I observe.

In April 2023, I wrote in Reacceleration:

• Public responses to the pandemic continue to influence the economy. Rising inflation and higher interest rates did not meaningfully impact consumer spending. Goods consumption has only flatlined and remains 6% above trend while services are slowly catching up but are still 1.7% below trend.
• The widely forecast U.S. recession has failed to materialize so far as the economy experienced rolling recessions in housing (strong) and goods production (mild) offset by recovering services.
• So, in an economy where goods now weigh half as much as services, goods-biased indicators can be misleading when services and employment stay reasonably firm.
• U.S. manufacturing employment keeps rising and could actually grow in 2023 helping sustain related services employment (e.g. transportation, restaurants, banking). KKR says that “in 2022 U.S. companies have revealed plans to reshore nearly 350,000 jobs, compared to 110,000 in 2019.”
• As I wrote in December, if KKR is right on reshoring and employers keep hanging on to their scarce employees, this could well be a soft landing after all. And here we are, 4 months later, with indications that manufacturing, far from crashing, is now about to contribute to growth, perhaps significantly given that supply chains have normalized, inventories are very low, labor supply is improving and consumer demand remains reasonably solid.
• Reshoring and nationalistic policies would only add fuel to this nascent fire. Keep in mind that manufacturing carries more economic pull than its weight suggests: high salaries and important collateral effects on many services such as transportation, restaurants and banking act as economic multipliers.
• So, if no major banking crisis, the Fed may well get its soft landing.

In September, in The Wealth Defect:

• At their core, American consumers are rational animals. They enjoy consuming but, over time, they spend what they earn. When they did not, it was either because of difficulties/uncertainty (e.g. recessions) or because their rapidly rising net worth allowed for splurging thanks to realized capital gains or increased borrowings against rising asset values. The chart below illustrate these trends. When  inflation-adjusted household net worth rose rapidly above trend like in the late 1990s, the mid-2000s and recently, expenditures grew faster than income. [The savings rate declined. The chart is updated to the latest data.]

• The Fed’s policies boosted household wealth 15.5% above their 2019 level and 35% above trend. Thanks to rising stock prices but, principally, to rising home values due to unusually low supply of existing homes due to Fed-supplied mortgage handcuffs.
• As much as it wants to reduce demand, the Fed is running against cratering [housing] supply by its own doing. Meanwhile, sales of new one-family houses jumped 27% in the past 12 months. Talk about mortgage rate sensitivity!
• From a monetary policy perspective, the wealth effect is now a wealth defect: rising interest rates have little impact on a very wealthy, under leveraged, consumer looking to enjoy life AMAP (as much as possible) post pandemic.
• Oddly enough, given interest rates relative impotence (sic), it may be that only rising oil/energy costs could dampen overall demand sufficiently for the Fed to achieve its targets. Would it be enough? Great buy-side strategists such as KKR’s Henry McVey, Fiera Capital’s Jean-Guy Desjardins and RBA’s Richard Bernstein think that demand is too resilient and that the Fed will need to do more or that inflation will rest at a higher level than most investors expect.

In December, in Slowing, Really?

• Stronger employment growth along with rising hours and accelerating wage gains propelled aggregate weekly payrolls up 0.75% after 0.0% in October. Averaging the last 2 months, the 4.6% annualized rate is only slightly weaker than the previous 3-month average of +5.0%. On a YoY basis, labor income is up 5.4% in November, up from 4.9% in October, suggesting steady, if not accelerating consumer spending given CPI and PCE inflation of 3.2% and 3.0% respectively in October.
• In a December 6 interview with CNBC, Walmart CEO Doug McMillon (who gets daily sales data every morning) said “I expected more softness by this time of the year than we’re actually experiencing” and “the volume of our nonfood sales are starting to come back”.
• In November, 532,000 Americans entered the labor force; all of them presumably found a job given the 747,000 jump in the household survey employment level that led to the sharp drop in the unemployment rate.
• The other surprise is the sharp decline in energy prices owing to the unexpected jump in U.S. production. Gasoline prices are back to their October 2022 lows, freeing significant disposable dollars and reducing cost pressures economy-wide but particularly for service providers.

That said, I also wrote 2 months ago American Exceptionalism: Don’t Extrapolate:

• One additional source of growth has emerged since 2008: the U.S. government has significantly intervened in the economy, boosting its expenditures from 21% of GDP to its current 25.5%, doing so with borrowed capital as opposed to higher revenues. The jump in leverage since the GFC has been nothing short of spectacular: the federal public debt exploded from 62% of GDP in 2007 to 120%, in 15 years!
• The American stars (and stripes) neatly aligned themselves after the 2008-09 GFC. The federal budget exploded under both Democrat and Republican governments (R.I.P. the Tea Party) while interest rates were brought to zero. Corporate tax rates were drastically cut in 2018. The pandemic prompted the U.S. government to further boost spending and the Fed to flood the economy with liquidity. Americans merrily spent their pandemic bounty. Meanwhile, broken trade channels and the trade dispute with China are inciting businesses to reshore production, encouraged by significant government subsidies and increased protectionism. Manufacturing construction doubled (+$110B) since mid-2022, ten times faster than GDP, while manufacturing shipments and new orders stagnated. Actually, manufacturers spent twice more building plants in 2022-23 than during all previous 20 years.
• Looking ahead, many important changes are likely:
• Consumer spending will normalize, with increased volatility. Since 1959, the personal savings rate has only been lower than the current 3.7% during the 2005-08 period when Americans splurged on housing, and briefly in 2022, in total only 7% of the time. Before the pandemic, the savings rate ranged between 5.0% and 8.5%.
• Construction spending will also normalize. Since 2010, total construction spending grew 50% faster than GDP, carrying a high economic multiplier.
• Government spending ex-interest expense will measurably slow down.
• The unemployment rate is at a historical low. Employment growth will slow.
• American politics are getting increasingly toxic and inefficient.
• Investors are paying top valuations for large cap stocks, clearly extrapolating the past without appreciating that the true American exceptionalism actually is all the exceptional factors that boosted its economy since 2009 and oblivious to the rising risk from its indebtedness as interest rates normalize.

It took less than 2 weeks for the bumps on the road to kick Mr. Powell off the wagon. Even before getting his favored PCE inflation data.  On April 3rd, before the March CPI, he said: “The recent data do not…materially change the overall picture, which continues to be one of solid growth, a strong but rebalancing labor market, and inflation moving down to 2% on a sometimes bumpy path.”

I don’t know if the retail sales data, or the almost unanimous “too strong” reaction, had anything to do, but why hurry to reset expectations so radically?

I did not see the retail sales data so strong (Roaring Lion???) and the labor market is indeed “strong and rebalancing”. February’s job openings were about unchanged from January but Indeed job postings have since declined 3.2% through April 11.

Goldman Sachs’ Jan Hatzius:

Despite the recent upside inflation surprises, we think the broader disinflationary narrative remains intact. One key reason is that the labor market continues to rebalance nicely. Our jobs-workers gap is down to 2.0 million, the quits rate is below pre-pandemic levels, and the wage news remains favorable. As of March, average hourly earnings and the Atlanta Fed wage growth tracker are consistent with year-on-year wage growth of just over 4%, and we expect the more reliable employment cost index to show a similar pace for Q1. Over the next year, we see wage growth converging to 3.5%, the pace we estimate is consistent with 2% assuming a productivity trend of 1.5% and stable profit margins.

Most everybody were expecting a rate cut in June or later. Why the rush Mr. Powell? A bumpy road also has potholes. Here’s a visible one:

Business Leaders Survey Covering service firms in New York State, northern New Jersey and southwestern Connecticut

Activity remained steady in the region’s service sector, according to firms responding to the Federal Reserve Bank of New York’s April 2024 Business Leaders Survey. The survey’s headline business activity index was little changed at -0.6. The business climate index rose seven points to -19.0, suggesting the business climate remains worse than normal, though to a lesser extent than in recent months. Employment inched just slightly higher, and wage increases moderated. Input price increases were little changed, while selling price increases slowed modestly.

How California’s Huge Raises for Fast-Food Workers Will Ripple Across Industries Fed must take heed of California pay increase, economists say

Michaela Mendelsohn, who owns six El Pollo Loco locations serving grilled chicken and tacos in California, recently found herself raising managers’ pay by over 10% to more than $83,000 a year.

With the state’s new law mandating a $20 minimum wage for fast-food workers taking effect April 1, a separate rule requiring salaried staff to earn double the minimum wage has triggered a chain reaction.

“They’ve gotten a big pay increase,” Mendelsohn said of her managers, who had typically made just over $70,000 a year. (…)

The law is already creating spillover effects from janitors to hotel cleaners, as well as higher-paid workers within the fast-food business.

That’s just the start. As many as 5 million of the state’s low-wage workers, both in fast food and adjacent industries not covered by the law, could also get raises, according to Bloomberg Economics. Given California’s huge population — No. 1 in the country — that would amount to about 3% of the entire US workforce. (…)

There are early indications that pay raises are spreading from fast-food joints to other California employers. School cafeteria workers in Sacramento will be paid $20 an hour come July, a raise spurred in part by anticipated competition for labor from restaurant workers, a move reported earlier by the Associated Press. (…)

“The floor has been lifted,” he said. “Lower-wage workers across the board are saying, ‘We deserve the same.’” (…)

Price increases are another big way the new law’s effects are rippling through the economy, which is adding to inflationary pressures for consumers. McDonald’s franchisee Scott Rodrick, whose 18 restaurants are mostly in the San Francisco area, has raised prices between 5% and 7%. (…)

At California locations of Chipotle Mexican Grill Inc., the price of a chicken burrito or bowl averaged $10.27 as of April 3, up from $9.50 on March 29, KeyBanc Capital Markets said in a report. Prices at Burger King rose about 2% from February to early April while Wendy’s started charging about 8% more, according to Kalinowski Equity Research, which surveyed 25 locations of each chain. (…)