EDGE AND ODDS’ Almost DaiLY CHAT (a totally AI generated chat on the day’s post courtesy of Google’s NotebookLM): November 1, 2024

Consumer Spending Intact, but So Too is Core Inflation

Broad personal spending rose 0.5% last month amid upward revisions to prior data. In real, or inflation-adjusted terms, spending was up a solid 0.4%.

The details reveal that households continued to spend broadly. Spending on autos was solid. Real spending in that category advanced 1.5%, somewhat reversing the August decline. At a time when financial markets are trying to better gauge where consumers are in terms of discretionary vs. non-discretionary outlays, spending at restaurants rose the most in a year and helped drive services consumption higher last month. (…)

Consumer purchases of nonessentials (i.e, “wants”) were up 3.3% year-over-year, a bit more than the 2.9% pace registered by non-discretionary purchases (i.e., “needs”).

Households have less to rely on now that household purchasing power has shifted away from pandemic-era sources such as excess savings and credit reliance. Income growth is the primary driver now. That makes the continued resilience of spending more reliant on the health of the labor when considering that durability.

The jobs market has certainly moderated, but income is still supportive of spending.

Households have also saved somewhat less to keep spending. Spending outpaced income growth (+0.3%) last month, which drove the saving rate down to 4.6%, the lowest in nearly a year and the third consecutive monthly drop. But as households continue to spend at a brisk clip, it’s difficult to imagine an environment where businesses let go of a large swath of workers. Indeed, separate data this morning showed initial claims for unemployment benefits remained in-check through late October. (…)

The PCE deflator, the Fed’s preferred inflation gauge, rose 0.2% in September, and improved on a year-ago basis, falling to 2.1%. Yet when excluding food and energy, the core PCE deflator rose a stiff 0.3%, the fastest pace in five months and is flat at 2.7% over the past year signaling stickiness in inflation.

Goods prices have contributed heavily to the decline in inflation so far this year, with prices down 1.2% on a year-ago basis, whereas services prices on the other hand continue to be stickier, up 3.7%.

While still an improvement, it is clear that services inflation will need to slow for the Fed to successfully hit its 2% target. Financial markets may have shifted their focus to the labor market, but the Fed is still keeping its eye on inflation progress as it thinks about the pace of monetary easing. (…)

Solid consumer:

• Wages and salaries rose 0.5% as in August, +5.7% annualized in Q3;
• PCE inflation rose 0.2% after +0.1% in August, +2.0% in Q3;
• Core PCE rose 0.3% after +0.2% in August, +2.8% in Q3;
• “Supercore” inflation (core services less housing) rose 0.3% and remained sticky at 3.2% YoY;
• Real expenditures rose 0.4% after +0.2% in August, +4.1% in Q3;
• Real Durable Goods rose 0.4% after –0.2% in August, +7.4& in Q3;
• Real Services rose 0.2% after +0.3% in August, +2.8% in Q3.

BTW: Initial jobless claims fell 11,000 to 216,000 in the week ended October 26. Normalizing after the hurricanes and strike-related layoffs by Boeing and Stellantis.

Happy Holidays!

Employment Cost Growth: The Sweet Spot

The latest reading on employment costs should boost policymakers’ confidence that the labor market is no longer a threat to returning inflation to 2%. The Employment Cost Index advanced at a 3.2% annualized rate in the third quarter, bringing the one-year change in wages & salaries and benefit costs down to 3.9%. Amid a pickup in productivity growth this cycle, that leaves labor compensation rising at pace consistent with both the Fed’s inflation goal and solid real earnings for workers.

The Employment Cost Index (ECI) grew 0.8% in the third quarter, bringing the year-over-year rate to 3.9%. That still leaves compensation costs rising faster than the high-water mark of the past cycle. However, accounting for productivity growth, which has trended higher this cycle, the ECI’s current run rate looks consistent with the Fed’s inflation goal, as productivity gains allow businesses to raise compensation faster than prices.

On an annualized basis, employment costs rose 3.2% in the third quarter, pointing to a further slowdown ahead in the year-over-year rate.

The ECI is the Fed’s preferred gauge of labor costs since it controls for compositional shifts in the economy’s jobs and is broader in scope than other measures. The ECI includes benefit costs in addition to wages & salaries; it also reflects compensation changes for public sector workers along with private sector workers.

Thus, the latest ECI print is likely to boost policymakers’ confidence that wages are not re-accelerating after average hourly earnings growth strengthened to a 4.0% annualized rate in Q3. Other measures also point to an ongoing slide in labor costs, including the Atlanta Fed’s Wage Growth Tracker and the share of small businesses raising compensation both slipping last quarter to levels last seen in 2021.

  

Source: U.S. Department of Labor and Wells Fargo Economics

Within the ECI, there was widespread cooling last quarter. Compensation among private sector workers increased 0.7%—the smallest quarterly gain since spring of 2021—amid a slight easing in wage & salary gains and a more pronounced step-down in benefits growth.

An array of new union contracts have pushed compensation growth for unionized workers over the past year up faster than that of non-unionized workers, who were able to more quickly capture the benefits of the exceptionally tight jobs market coming out of the pandemic. While strike activity still remains elevated relative to the past decade, there are some signs of upward pressures fading, with compensation growth for union workers also easing on a year-ago basis in the third quarter.

Labor costs for public sector workers, which has lagged private sector’s this cycle, also moderated over the quarter for both the wages & salaries and benefits components. (…)

MANUFACTURING PMIs

Note: the U.S. and Canada PMIs are out later today. The Eurozone is out Monday.

China: Manufacturing sector expansion resumes in October

The headline seasonally adjusted Purchasing Managers’ Index™ (PMI®) rose to 50.3 in October, up from 49.3 in September. Rising past the 50.0 neutral mark, the latest data signalled that conditions in the manufacturing sector improved following a brief deterioration in September.

Central to the latest advancement in manufacturing sector conditions was renewed new business growth. Incoming new orders placed with Chinese manufacturers increased at the quickest pace in four months, attributed to better underlying demand conditions and successive new business development endeavours. Export orders remained in decline, however, but saw the rate of reduction ease in the latest survey period.

As a result of higher new work inflows, manufacturing production expanded at an accelerated pace. Confidence about future output also improved among Chinese manufacturers, as optimism levels climbed from September’s low to the highest level in five months. Firms were generally hopeful that better economic conditions and R&D efforts can help to support sales in the year ahead.

Purchasing activity meanwhile rose in response to the uptick in new work, which led to further accumulation of stocks of purchases. Post-production inventory holdings had also increased in tandem as production expanded. Anecdotal evidence suggested that some firms started to rebuild safety stock in October, anticipating higher future demand.

Caution was extended towards hiring, however, with the non-replacement of job leavers resulting in the quickest fall in employment levels in nearly one-and-a-half years. In turn, the level of unfinished work rose in October amid the reduction in workforce capacity.

Turning to prices, average input costs rose for the first time in three months, albeit only fractionally. Higher input material costs, such as for metals, and energy prices were often mentioned by panellists as reasons for renewed inflation.

As a result, average selling prices increased for the first time since June as firms passed on higher input costs. Export charges continued to fall, however, as exporters faced higher competition. Furthermore, freight costs reportedly fell for some exports despite average lead times lengthening again in October.

Japan: Operating conditions deteriorate at sharpest rate forthree months

Posting at 49.2 in October, the headline au Jibun Bank Japan Manufacturing Purchasing Managers’ Index™ (PMI) fell from 49.7 in September to indicate a sharper deterioration in the health of the sector. (…)

Overall new orders fell for the seventeenth month in a row in October, and at moderate pace. Demand retrenchment was cited as a key factor behind the fall, notably in the automotive and semiconductor sectors. International demand was also subdued, as manufacturers noted the sharpest fall in new export business since March, with particular emphasis on weak demand from the US and mainland China. (…)

China Home Sales See First Monthly Rise in 2024 on Stimulus Value of new-home sales from biggest developers rose 7.1%

The value of new-home sales from the 100 biggest real estate companies rose 7.1% from a year earlier to 435.5 billion yuan ($61.2 billion), reversing from a 37.7% slump in September, according to preliminary data from China Real Estate Information Corp. Sales surged 73% from a month earlier.

The improvement came after China unleashed its strongest package of measures, including cutting borrowing costs on existing mortgages, relaxing buying curbs in big cities and easing downpayment requirements. That said, the recovery was lopsided, with state developer benefiting the most from the stimulus.

Home sales of six state-owned enterprises tracked by Bloomberg Intelligence rose an average 26%, while falling 24% for 13 private developers. This uneven recovery underscores how transactions are skewed toward secondhand homes and those developed by state-owned companies due to the lack of fiscal support, Bloomberg Intelligence analyst Kristy Hung said in a note on Friday.

In late September, the trading hub of Guangzhou became the first tier-1 city to remove all restrictions buying residential property. The other top-tier cities Beijing, Shanghai and Shenzhen allowed more people to purchase residences in suburban areas, while letting some others to buy more homes.

The People’s Bank of China also greenlit the refinancing of as much as $5.3 trillion of existing mortgages for millions of families.

Cash-strapped developers are counting on a sales revival to persuade debt holders. China Vanke Co. suffered another hefty loss in the third quarter, with its contract sales down 35% in the first nine months from the same period a year earlier. Country Garden Holdings Co. also won bondholder approval to extend onshore bond payments after failing to secure enough cash.

AI CORNER

Tech Giants See AI Bets Starting to Pay Off Microsoft, Google and Amazon report strong growth in cloud revenue, but warn of increased spending

Revenue from cloud businesses at Amazon, Microsoft and Google reached a total of $62.9 billion last quarter. That figure is up 22.2% from the same period last year and marked at least the fourth straight quarter in which their combined growth rate has increased.

Accelerating growth in cloud computing is the surest sign yet that spending by AI customers is beginning to justify the huge investments tech giants are making in infrastructure to power the technology.

“Demand continues to be higher than our available capacity,” Microsoft chief financial officer Amy Hood said on a call with analysts.  (…)

Amazon, Microsoft and Google parent Alphabet disclosed this week that they spent a total of $50.6 billion on property and equipment last quarter, compared with $30.5 billion in the same period last year. Much of that money went to data centers used to power AI.

All three companies warned Wall Street that their spending will go higher in the coming months, as did Meta Platforms, which invests in the infrastructure for its own AI applications on Instagram, WhatsApp and Facebook.

Meta plowed $8.3 billion into new property and equipment last quarter, up from $6.5 billion in the same quarter a year ago, as it seeks to build the world’s most-used AI assistant.

“Our AI investments continue to require serious infrastructure, and I expect to continue investing significantly there,” CEO Mark Zuckerberg said.

Skeptics say it remains unclear whether the current excitement over AI will sustain long-term growth that pays for all of the spending.

Nonetheless, investors saw some signs for hope this week in the robust growth at big cloud businesses, which rent computing storage and processing power in data centers to business customers. (…)

Google, which has long been in third place among cloud providers, reported its revenue from that business revenue grew 35% in the third quarter, well ahead of Wall Street’s expectations.

Amazon Chief Executive Andy Jassy said his company’s cloud AI business was on pace to draw billions of dollars in annual revenue and was growing at a triple-digit rate, faster than the overall Amazon Web Services business. (…)

Microsoft said that in the current quarter, sales of AI products and cloud services will surpass $10 billion on an annualized basis for the first time.

Microsoft, Amazon and Google are moving fast to develop their own AI products for consumers and businesses, such as Google’s Gemini and Microsoft’s Copilot. But their cloud businesses represent their primary efforts to profit from the technology’s adoption in the near term. (…)

Microsoft said usage of a service selling access to OpenAI’s technology through the cloud had doubled over the past six months, citing customers such as the AI startups Grammarly and Harvey.

Oracle, the fourth-largest U.S. cloud provider, is also spending heavily to capitalize on growing demand for AI infrastructure that the big three can’t meet. Oracle’s fiscal quarter ends in November, and it is expected to report earnings in December.

Strain on resources

On Sept. 23, I wrote Power Play to highlight the huge increase in energy demand stemming from AI.

Consulting Bain & Co. yesterday released its 2024 Technology Report squarely focused on AI. Some excerpts:

• Bain estimates that the total addressable market for AI-related hardware and software will grow between 40% and 55% annually for at least the next three years, reaching between $780 billion and $990 billion by 2027.

• The power demands and price tags of these large data centers will impose limits on how many can be
  built and how quickly. The scramble to acquire AI resources is already creating extreme competition for resources at the high end of the market, and growing data center requirements will further strain capabilities.
  Power consumption is one critical example. Utilities are already fielding requests from hyperscaler customers to significantly expand electrical capacity over the next five years. Their needs will compete with rising demand from electric vehicles and re-shoring of manufacturing, stressing the electric grid.
• Infrastructure providers and technology supply chains, including networking, memory, and storage, are also investing to meet the demands for high-performance compute from hyperscalers, digital service companies, and enterprises. Large data centers will push the limits and unleash innovation in physical design, advanced liquid cooling, silicon architecture, and highly efficient hardware and software co-design to support the rise of AI.
• Demand for construction and specialized laborers—as many as 6,000 to 7,000 workers at peak levels—will strain the labor pool. Labor shortages in electrical and cooling may be particularly acute. Many projects occurring at once will stress the entire supply chain, from laying cables to installing backup generators.
• Another issue is how to move more computing power closer to the edge for AI in environments with low tolerance for latency, like autonomous driving. The rise of smaller models and specialized compute capable of running these models at the edge are important steps in this direction. Meanwhile, the industry is rapidly developing new form factors for the edge, including edge AI servers, AI PCs, robots, speakers, and wearables.
• Accelerating adoption of AI across industries will pressure the supply of graphics processing units (GPUs) for data centers, as a seemingly insatiable demand for computing resources to train and operate large language models (LLMs) collides with supply chain constraints. In addition, the coming proliferation of AI-enabled devices appears poised to jumpstart a wave of purchases of new personal computers (PCs) and smartphones, which has major implications for the broader semiconductor supply chain.
• The semiconductor supply chain is incredibly complex, and a demand increase of about 20% or more has a high likelihood of upsetting the equilibrium and causing a chip shortage. The AI explosion across the confluence of the large end markets could easily surpass that threshold, creating vulnerable chokepoints throughout the supply chain.

If you missed it, you should really watch Jensen Huang’s interview with 2 tech savvy investors: https://www.youtube.com/watch?v=bUrCR4jQQg8

AI Models Replace Real People in Mango’s Fast-Fashion Ads Technology is being used to generate content more quickly

The Spanish fast-fashion chain Mango is eliminating some human models and using AI-generated avatars to create advertising campaigns more quickly, Chief Executive Officer Toni Ruiz said in an interview. The garments these AI models are wearing are real and available to customers for purchase. (…)

Some imagery appears on the Mango website with a disclaimer that AI was used to create the visuals. (…)

Mango joins other retail brands, such as Levi Strauss & Co., Louis Vuitton and Nike Inc. that have already teamed up with AI modeling companies. The financial benefits are clear, with AI models typically costing a fraction of the price of a human model. (…)

Mango’s use of AI goes beyond marketing and advertising. AI is also helping the company design collections, providing inspiration for fabrics and more. A bot is now capable of creating clothing that conforms to the Mango design aesthetic, Ruiz said. (…)

Q3 GDP Rises 2.8% on Strong Domestic Demand (GS)

Real GDP rose 2.8% annualized in the advance reading for Q3, 0.1pp below consensus expectations. The composition was strong, as real private domestic final sales increased by +3.2% annualized and the volatile inventories component subtracted 0.2pp from GDP growth this quarter (0.5pp below our expectations).

Consumption increased 3.7%, above expectations.

Business fixed investment increased +3.3%, reflecting an 11.1% increase in equipment investment, a 0.6% increase in intellectual property products investment, and a 4.0% decline in structures investment.

Government spending growth increased by more than we expected to +5.0%, reflecting a 9.7% increase in federal spending—driven by a 14.9% rise in defense spending—and a 2.3% increase in state and local government spending.

The GDP price index rose by +1.8% (QoQ AR), slightly below expectations and partly reflecting a slowdown in the consumption (+1.5%) and exports (-1.4%) deflators.

Core PCE prices rose +2.16% annualized in Q3, slightly above consensus expectations.

Weakening?

BTW, Consumer spending rose 3.7%, the strongest quarterly increase since Q1-2023, led by a 6.0% rise in goods spending.

BTW #2: Payroll processor ADP said its measure of private-sector job growth unexpectedly surged ahead in October. ADP said employers added 233,000 jobs in October, up from a revised 159,000 in September. That is the strongest job creation reported in 15 months, and it occurred despite major hurricanes in the Southeast that analysts expected would drag down payroll numbers. (Axios)

China Economy Picks Up on Stimulus Push Ahead of US Election Still-weak new export orders weigh on manufacturing sector

Factory activity unexpectedly expanded in October after five months of contraction, the National Bureau of Statistics said Thursday. The official manufacturing purchasing managers’ index rose to 50.1, higher than a forecast of 49.9 by economists. The non-manufacturing PMI showed activity in construction and services expanded after staying little changed the previous month. (…)

Data released Thursday showed new export orders for manufacturing companies remained weak and continued to contract this month, even as overall new orders stabilized. (…)

John Authers:

The fog around Beijing’s fiscal stimulus is slowly dissipating. Investors are beginning to believe that the economic rescue mission entails putting a floor under a potential crisis, rather than driving a new wave of growth. The challenge has never been in doubt — rather, it’s about the effectiveness and timeliness of the firepower to be deployed.

If reports are anything to be believed, a fiscal package of about $1.4 trillion, or 10 trillion yuan, falls below the initial estimates of up to $3 trillion as what’s required to make a meaningful impact on the Chinese economy.

Given the whatever-it-takes stance that officials signaled before the Golden Week break, investors shouldn’t be dismissive of the package, even if it falls short of what they they think necessary. With the rally in Chinese equities long halted, it’s possible that investors are just biding their time. Both the CSI 300 index of stocks quoted in Shanghai and Shenzhen, and the offshore “red-chip” companies in Hong Kong’s Hang Seng China Enterprises Index have been going sideways. (…)

Even without the government pressing heavily on the accelerator, the economy is recovering. That shows up in the latest PMI numbers, for October. Further, the research group China Beige Book shows that consumer spending rose in October, with a more active Golden Week than in 2023, suggesting that the splurge of reforms announced before the break had an impact. Among the consumer sectors, hospitality firms saw the strongest sales expansion while chain restaurants also improved:

The troubled property sector remains in the doldrums, however, despite the extra policy support, with firms reporting another monthly slowdown in sales prices. It has had a protracted slump that cannot be reversed overnight, but the point for policymakers is to put a floor under the sector. That means that evidence reported by China Beige Book that interest rates are actually rising, despite the central bank’s attempt to ease them, is disconcerting:

This is a risk, if stimulus turns out to simply mean more money for the supply side. October’s credit data had a surprise: Interest rates went up, not down, per firms on the ground. More evidence that Beijing’s credit transmission mechanism is not working as quickly as assumed — or possibly at all. Investors should remain skeptical of monetary easing boosting the economy.

It will garner little attention given next week’s other events, but the National People’s Congress Standing Committee will hold a meeting where the 10 trillion yuan fiscal boost could be approved. The package is expected to include 6 trillion yuan for debt replacement for local governments and 4 trillion yuan earmarked for buying property. If these impressive figures are passed, their overall impact could still be limited.

The debt exchange amount barely scratches the surface of overall local credit overhang. Bloomberg Economics’ David Qu and Eric Zhu argue that it’s inadequate, given that local government financing vehicles have massive “hidden debt.” The IMF estimate is 60 trillion yuan. Regardless, Gavekal Research’s Andrew Batson believes these efforts do show a new urgency:

To keep Local Government Financing Vehicles from defaulting, local governments need to prioritize supporting these hidden debts. One way they do that is by delaying other payments, creating another implicit debt that does not accumulate interest. LGFVs are, in turn, delaying payments to other companies, adding to a liquidity squeeze for the private sector. Any fiscal expansion would get diverted to dealing with these debt burdens.

(…)

China Is Becoming a Bigger Problem for Europe’s Profit Scorecard Industrials, tech among sectors warning about profit weakness

A broadening array of European firms is blaming China for glum earnings outlooks, as weak demand, government scrutiny and tariff spats with the trading partner put pressure on stocks.

Beyond China-reliant sectors such as luxury goods and miners, chip equipment giant ASML Holding NV, medical technology firm Royal Philips NV and French electrical-equipment distributor Rexel SA are among those that have raised concerns about Chinese demand.

Shares of all three are down in October after they cut guidance. Philips and ASML are set for their worst months in at least two years, buffeted by various headwinds including weaker demand, tighter regulations or the prospect of export restrictions.

“Weakness in demand from China started in a few sectors and has spread out beyond the consumer,” said Mark Schumann, head of European large-cap mutual funds at DWS. “The reasons for this weakness appear to be more complex and multi-layered,” he added, citing a prolonged property crisis in the country and higher regulatory scrutiny of US and European businesses.

An analysis by Barclays Plc found that European company executives had a negative tone 65% of the time when discussing China on post-earnings conference calls — the worst among topics that included the economy, profit margins and layoffs. That’s despite Beijing’s broad stimulus efforts unleashed in September to boost growth. (…)

While China accounts for about 8% of European firms’ overall revenue, some industries like luxury rely on it for up to a quarter of annual sales. Tech investor Prosus NV gets 74% of its revenue from there, while miners generate between 20% and 60%, according to data from Goldman Sachs Group Inc.

Many of these firms aren’t seeing much reprieve yet. Cosmetics maker L’Oreal SA said China’s beauty market continued to deteriorate, while LVMH warned consumer confidence was similar to the “all-time low reached during Covid.”

The world’s biggest brewer Anheuser-Busch InBev NV and Danish peer Carlsberg A/S both reported lower volumes Thursday, partly due to weak demand in China. (…)

An unprecedented rise in the 10-year Treasury yield

Over a rolling 30-day period, the 10-year Treasury yield has climbed over 65 basis points, a magnitude of change exceeded in only 4% of trading days since 1962.

Although a 65 bps increase over 30 days has occurred 47 other times when using a reset below zero to eliminate repeats, none took place in tandem with the Federal Reserve’s initial rate cut until now.

Whenever the 10-year Treasury yield rose by 65 basis points over 30 days, coupled with a Fed easing cycle featuring one to three rate cuts, the benchmark yield often decreased over the following months. From three to twelve months later, yields dropped in the 1980s, whereas post-1995, they tended to increase.

Except for an untimely signal in 1981, which occurred within the context of a bear market, a scenario unlike today, the S&P 500 rallied consistently across all time frames, culminating in a 100% win rate over the next year.

The market’s ability to absorb a sudden and sharp rise in rates suggests that economic fundamentals were healthy during these periods, providing a positive backdrop for equities. (…)

Many factors could be driving the sharp and sudden surge in the 10-year Treasury yield. Those include a resilient economy, Treasury issuance, or a technical bounce in yields following a decline. Regardless of the narrative, similar spikes in the 10-year Treasury yield near the outset of a Federal Reserve easing cycle have often reversed, leading to lower yields over the subsequent months.

Notably, these reversals have correlated with S&P 500 rallies, especially over the following year. This trend likely reflects a healthy economy that fuels corporate profits, fostering a more favorable stock market environment.

Meanwhile, from Goldman Sachs:

The borrowing estimates released on Monday showed $546bn in net borrowing for 4Q24 and $823bn for 1Q25, with assumed end-of-quarter cash balances of $700bn and $850bn, respectively.

While the borrowing numbers came in somewhat above our projection, once adjusted for TGA assumptions the discrepancy appears to reflect a more front-loaded (and only slightly higher overall) path for deficits than our projections.

Treasury’s cash balances and privately held borrowing estimates imply around $71bn and $382bn in net bill issuance to the public for 4Q24 and 1Q25, respectively.

1Q25 numbers assume a debt limit suspension or increase that quarter, but an extended debt limit impasse could see significantly more back-loading of bills supply in 2025 (and a larger TGA drawdown in H1.)

Most importantly, Treasury maintained the guidance on keeping nominal and FRN sizes unchanged for “at least the next several quarters,” but kept some flexibility by noting this guidance is “based on current projected borrowing needs.”

America’s stock market optimism

The largest share of Americans on record believe the run will continue, Axios’ Courtenay Brown writes.

The Conference Board, a business research group, asks consumers whether they expect stock prices to increase in the coming year. In October, slightly more than half said yes — the highest reading in the survey’s history.

Ed Yardeni’s chart on II Bulls & Bears is not quite as extreme: