FIRM, BUT FLEXIBLE!

High Interest Rates Are Working, Fed’s Williams Says Expects inflation will resume easing in second half of 2024

(…) “With the economy coming into better balance over time and the disinflation taking place in other economies reducing global inflationary pressures, I expect inflation to resume moderating in the second half of this year,” Williams said Thursday in prepared remarks at the Economic Club of New York.

“The behavior of the economy over the past year provides ample evidence that monetary policy is restrictive in a way that helps us achieve our goals,” he said, adding later that a rate increase is unlikely. (…)

“I don’t feel any urgency or need that we have to make a decision now,” he said.

Williams said he didn’t view recent price data as a sign that inflation is no longer heading lower. Williams said earlier this month that monetary policy is in a good place and he wants to see more evidence to be confident inflation is falling to the central bank’s target.

Data out earlier Thursday showed the US economy grew at a slower pace in the first quarter than initially reported, underscoring a loss of momentum at the start of the year. (…)

Williams said he sees inflation — as measured by the personal consumption expenditures price index — falling to about 2.5% by the end of this year before moving closer to 2% next year. He sees the unemployment rate reaching about 4% at the end of this year then falling toward 3.75%.

“How I think about it is, monetary policy is currently well positioned but we have also the time, and ability, given where the economy is, to collect more data,” Williams told reporters following the event, adding the US is on a “reasonably good track” to taming inflation without an economic downturn. (…)

“The policy that we put in place is working,” Williams said. “But, the view on what is the appropriate path for policy is adjusting with the change in the outlook.” (…)

“The data we have through the first part of this year, there’s no sign of the neutral rate yet having risen,” he said. “Doesn’t mean it won’t.”

Speaking with reporters after the event, Williams added that the factors that have held interest rates down over the last decade are still in play, pointing to things like demographics and a willingness to hold US Treasuries.

Atlanta Fed President Raphael Bostic indicated last week that officials are rethinking their estimates of neutral and “there may be reasons to think the baseline steady state” is higher. Williams’ predecessor at the New York Fed, Bill Dudley, wrote earlier on Thursday he believed the neutral rate had risen substantially.

By contrast, Fed Governor Christopher Waller said he still thinks the neutral rate is relatively low. (…)

• Fed’s Logan Says Policy May Not Be as Restrictive as Believed

(…) “It also may be that policy is just not as restrictive as we think it might have been relative to the level of interest rates before the pandemic,” Logan said Thursday at an event in El Paso, Texas. “It’s really important to keep all options on the table and that we continue to be flexible.” (…)

Logan also said the so-called neutral interest rate — the level of rates that neither stimulates nor weighs on the economy — has probably risen, adding to a broader debate on the topic. Logan cited increased demand for investment — from the energy transition, nearshoring and AI — as potentially shifting the neutral rate higher.

“There’s some good reasons to believe it’s higher than it was before the pandemic,” she said. (…)

The FOMC meetings must be very lively!

US Pending Home Sales Gauge Slumps to a Four-Year Low on Rates

The monthly decline was steeper than all estimates in a Bloomberg survey of economists and the worst since February 2021. All US regions saw decreases from a month earlier.

“The impact of escalating interest rates throughout April dampened home buying, even with more inventory in the market,” NAR Chief Economist Lawrence Yun said in a statement. (…)

New data suggest buyers aren’t getting any relief on costs, either. Prices in 20 major US cities actually picked up the pace in March, rising 7.4% from a year ago, according to a S&P CoreLogic Case-Shiller index.

Price increases should finally taper off when more inventory hits the market, Yun said in a release Thursday, although for now, the 1.2 million homes on the market are well below prepandemic levels.

“The prospect of measurable home price declines appears minimal,” Yun said. “The few markets experiencing price declines will be viewed as second-chance opportunities for buyers to enter the market if those regions continue to add jobs.” (…)

• Realtor.com Reports Active Inventory Up 36.5% YoY; Most Homes For Sale Since July 2020

(…) For April, Realtor.com reported inventory was up 30.4% YoY, but still down almost 36% compared to April 2017 to 2019 levels. (…)

According to Zillow’s research, new listings were up 15.5% YoY in April but still 24.7% below pre-pandemic levels. Total inventory levels were 35.7% lower than typical pre-pandemic levels for the month.

BTW, Zillow also says that asking rents rose 0.6% MoM in April and are up 3.6% YoY. These are new rents. The BLS’ All-Tenent-Rent-Index was up 5.5% QoQ annualized in Q1’24 (+5.3% YoY, unchanged from Q4’23).

China Factory Activity Shrinks in Surprise Hit to Growth Outlook

The official manufacturing purchasing manager index fell to 49.5 in May, the National Bureau of Statistics said on Friday. That compares with a reading of 50.4 in April, and a forecast of 50.5 in Bloomberg’s economist survey. Any number above 50 points to an expansion. (…) China’s exports posted solid growth in the first four months of the year. But the PMI sub-index for new export orders contracted in May for the first time in three months. A measure of input prices climbed to the highest in eight months, reflecting rising commodity costs. (…)

In a statement accompanying the data release, NBS analyst Zhao Qinghe pointed to “a high base of comparison led by previous fast expansion in the industry” and “insufficient effective demand” as reasons for the May slowdown. (…)

There are signs that the policy may be having an impact. Production in the general equipment and computer and telecommunications industries expanded for a third straight month while new orders placed for railway, shipping and aviation devices and electric machines continued to increase in May, according to NBS data.

The non-manufacturing measure of activity in construction and services came in at 51.1, the statistics office said. That compares with a forecast of 51.5, and an April reading of 51.2.

The sub-gauge of construction activity fell to 54.4 from 56.3. That slowdown came after a strong rebound the previous month, said Bruce Pang, chief economist for Greater China at Jones Lang LaSalle Inc. (…)

China’s 60 Million Homes Are Hard to Sell Even in Big Cities Housing inventory is at a historic high, S&P analyst says

The country has the equivalent of 60 million unsold apartments, which will take more than four years to sell without government aid, according to Bloomberg Economics. The oversupply is dragging down prices at the fastest rate in a decade, giving people less reason to buy a home. The situation is worst in the capital city. (…)

As of April, about 80% of China’s cities had an inventory absorption pace that was worse than a “warning line” of 18 months, according to CRIC. That’s even after developers refrained from offering new projects amid lackluster sales, leading new supply to shrink 20% from March.

The challenge looks just as daunting when measured by floor space. Residences completed by developers but unsold expanded to 391 million square meters nationwide as of April, the highest since 2017, official data show. Including properties that are almost finished and approved for presale, the stock is much larger at about 1.8 billion square meters, JPMorgan Chase & Co. estimates. Most of the excess sits in lower-tier cities, according to S&P. (…)

US Is Slowing AI Chip Exports to Middle East by Nvidia, AMD US is worried about the technology getting diverted to China

US officials have slowed the issuing of licenses to chipmakers such as Nvidia Corp. and Advanced Micro Devices Inc. for large-scale AI accelerator shipments to the Middle East, according to people familiar with the matter, while officials conduct a national security review of AI development in the region.

It’s unclear how long the review will take, nor is there a concrete definition of what constitutes a large shipment, said the people, who asked not to be identified because the discussions are private. Officials are particularly focused on high-volume sales, the people said, as countries including the United Arab Emirates and Saudi Arabia look to import massive quantities of the chips used in AI data centers.

AI accelerators — a category pioneered by Nvidia — help data centers process the flood of information needed to develop artificial intelligence chatbots and other tools. They’ve become essential equipment for companies and governments seeking to build an AI infrastructure. (…)

Eurozone Inflation Rises as ECB Considers Rate-Cut Path The pickup in inflation is unlikely to mark the beginning of a sustained acceleration in the pace of price rises since it partly reflects a change in German public transport charges

Consumer prices were 2.6% higher in May than a year earlier, an increase in the inflation rate from the 2.4% recorded in April, the European Union’s statistics agency said Friday. That was slightly above expectations from a consensus of economists polled by The Wall Street Journal.

The pickup in inflation is unlikely to mark the beginning of a sustained acceleration in price rises since it partly reflects a 2023 change in German public transport charges. However, inflation also picked up in Spain and France, an indication that the expected return to the ECB’s 2% target is likely to be uneven. (…)

With energy prices having fallen over recent months, and food prices also cooling, ECB policymakers are increasingly confident that inflation will settle around their target from the middle of next year, and have indicated that they will lower their key interest rate to 3.75% from 4% on June 6. (…)

Annual services inflation climbed to 4.1% in May from 3.7% the prior month, and concerns over pressures in the sector have been underlined by a series of recent data releases. (…)

Layoffs, Pricing Power Driving S&P 500 Profits to Highest In 16 Years Net margin beats at highest level in at least two years

S&P 500 companies are on track to be more profitable than they have been in over a decade, boosted by layoffs, lower commodity prices and continued pricing power.

The index’s average net income margin is projected to surpass 13% in the second half of the year, according to analyst estimates compiled by Bloomberg Intelligence, and then continue to rise into next year to almost the best on record since 2009.

Firms have largely opted not to pass on savings from falling commodity costs. To further lower expenses, many are also cutting their workforce and turning to artificial intelligence. (…)

Tech companies have outstripped the broader index in terms of profitability — the so-called Magnificent Seven companies enjoyed an average profit margin of 24% in the first quarter, double the S&P 500’s 12% average. Apple Inc. and Amazon.com Inc. have undertaken significant headcount reductions in recent months, reversing years of aggressive hiring. (…)

Among 481 S&P 500 companies that have reported this quarter, 72% posted net income margins that came in above analyst estimates. (…)

I added Bloomberg’s 14% margin estimate for Q2 on the Yardeni chart. Profit margins have almost tripled since the 1990s (charts courtesy of Ed Yardeni).

For a sense of how this happened, IT margins almost tripled since 2004:

Significantly outperforming other industries:

  

  

  

Hmmm…

U.S. Allows Ukraine to Carry Out Limited Strikes Inside Russia With American Weapons Washington still rules out use of long-range ATACMS missiles beyond Ukraine’s borders.

France’s Macron Prepares Plan to Send Military Instructors to Ukraine Initiative risks running up against red lines set by U.S. and Germany at the start of the war to prevent the conflict from escalating.

(…) Macron is pushing the envelope in other areas. He recently cleared the way for Ukrainians to use powerful cruise missiles supplied by France to strike inside Russia on the condition that the weapons are only used to take out military sites that have fired on Ukraine.

The U.S. on Thursday revised its policy prohibiting the use of American-provided weapons against targets inside Russia. Under the new policy, Washington will allow Ukrainian forces to use artillery and fire short-range rockets from Himars launchers against command posts and arms depots and other assets just across the border in Russia that are being used by Russian forces to carry out their attack on Kharkiv in northeastern Ukraine.

But the new U.S. policy doesn’t give Ukraine permission to use longer-range ATACMS surface-to-surface missiles against targets in Russia.

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Thanksgiving Week

Memorial Day reminds me to thank donators to Edge and Odds, something I too often neglect to do, buried in my rather busy schedule, which includes self-imposed leisure time away from the laptop to keep some level of sanity.

I am embarrassed to say that this neglect seems to go back to the spring of 2022. Sincere apologies. Time does fly, even more than we think. My late mother-in-law used to say “the slower I get, the faster time goes by”. So true.

I know I will not be able to find time to personally thank all of you, so here’s my public thank you to (in no particular order):

Hopefully, I did not forget anybody for whom I have the basic info. Others I will need to contact directly (or you send me your full names to edgeandodds [at] gmail.com).

Sincere thanks.

Denis

Fed’s Beige Book Points to Modest Growth in US Economy, Prices Business contacts say consumers pushing back on higher prices

The US economy expanded at a “slight or modest” pace across most regions since early April and consumers pushed back against higher prices, the Federal Reserve said in its Beige Book survey of regional business contacts.

“Retail spending was flat to up slightly, reflecting lower discretionary spending and heightened price sensitivity among consumers,” according to the report released Wednesday. “Overall outlooks grew somewhat more pessimistic amid reports of rising uncertainty and greater downside risks.”

Employment rose at a slight pace with eight of twelve districts reporting “negligible to modest job gains.” Several districts reported wage growth at, or moving toward, pre-pandemic levels.

Prices increased at a “modest pace” over the period with business contacts noting consumers pushed back against additional price increases.

June BoC Preview: A Clear Case for a First Cut

From Goldman Sachs:

• The April CPI report was soft for the fourth straight month, thereby confirming that disinflation is well underway in Canada. A wide range of underlying inflation measures have fallen below the BoC’s 2% target on a three-month annualized basis (and stand only slightly above 2% on a six-month annualized basis), and inflation progress in Canada is well advanced relative to its DM peers. We therefore expect that the BoC will determine that downward inflation momentum has been sustained and cut its policy rate by 25bp to 4.75% at next week’s June meeting.

• The main arguments against cutting next week are that 1) improving activity data might lower the urgency to ease and 2) the BoC might prefer to cut for the first time when they update their forecasts at July’s Monetary Policy Report (MPR) meeting. While these factors raise some risk that the BoC could delay cutting, activity levels remain subdued and the BoC has been willing to pivot policy at non-MPR meetings in the past, so we see only modest risks of a delay.

• Looking ahead, we expect that the BoC will provide only weak guidance on future cuts, perhaps noting that they are conditioned on further evidence that downward inflation momentum is sustained. Given our expectation that inflation progress will continue and that growth should recover to near-trend pace in 2024H2, we forecast that future cuts will proceed at a quarterly pace (with 75bp of cumulative easing by end-2024) until reaching a terminal rate of 3.25%. Our baseline forecast is dovish relative to market pricing, as is our risk-adjusted forecast that accounts for different policy scenarios.

This Record Stock Market Is Riding on Questionable AI Assumptions Just four giant technology stocks added more market value than the rest of the S&P 500 put together this month. More than half of the gain came from Nvidia.

Nvidia, Microsoft, Apple and Alphabet between them have added over $1.4 trillion this month, more than the other 296 stocks that rose put together. Half of the gain was just one company, chip maker Nvidia.

Behind the rises in the biggest stocks this month and this year are two trends, which have already run a long way: Artificial intelligence and higher-for-longer interest rates. Any trend can always go further, but there are challenges to both.

To see what could go wrong, note that this isn’t the usual speculative mania (though there was a mini-AI bubble last year). Nvidia’s profits are rising about as fast as its share price, so if there is a bubble, it’s a bubble in demand for chips, not a pure stock bubble. To the extent there is a mispricing, it’s more like the banks in 2007—when profits were unsustainably high—than it is to the profitless dot-coms of the 2000 bubble.

The threat to Nvidia’s share price is therefore about threats to its earnings. There are four risks:

1) Demand falls because AI is overhyped. The International Monetary Fund says AI will “transform the economy.”President Biden says AI is “the most consequential technology of our time.” And leading suppliers of AI—including the chief executive of OpenAI—said in a joint letter that “Mitigating the risk of extinction from AI should be a global priority.”

Yet, large language models remain limited. I’ve yet to meet someone who is pleased to be faced with a customer-service chatbot—the main use case of which seems to be to try to figure out how to get past it to speak to an actual human.

It helps programmers, but few outside the coding community got excited when, for example, GitHub transformed software development, long before ChatGPT came along. Microsoft’s Copilot can help beginners improve PowerPoint presentations, which might make office life a little less dull. And helping users with Excel is important. But again, a better “Help” function wouldn’t normally get investors’ pulses racing.

Don’t get me wrong. I’m deeply impressed by the progress of large language models, the technology behind ChatGPT. But all of my attempts to use it for work came with errors that took more time to fix than if I had just done it myself. It’s like having a 12-year-old help out.

Many LLMs fail basic tests, often in amusing ways—Google advises adding glue to pizza, for example. Copilot highlights the risk of being eaten by a cabbage when asked how to cross a river with a goat. Are they really ready for prime time? Perplexity is a great AI-assisted search engine, but the promise of AI goes a lot further than a better Google. The technology has yet to live up to the hype, and the risk is it takes much longer than buyers of Nvidia chips believe.

2) Competition reduces prices. Nvidia rules supreme in the high-end graphics processing units used for AI. But it faces competition from well-funded customers such as Alphabet and Meta Platforms, a slew of startups, and traditional rivals such as Intel trying to catch up. Even if they aren’t as good, they should limit Nvidia’s ability to charge pretty much what it likes.

3) Nvidia’s biggest supplier, Taiwan Semiconductor Manufacturing, might want a bigger slice. TSMC actually makes the chips. If it jacked up the price it charges Nvidia, no one else could step in to replace it in any reasonable time period. It might not want to risk its long-term relationship. On the other hand, it might want some of the cash pouring into Nvidia.

4) What if scale doesn’t matter? The designers of AI models think there is an advantage to getting big quickly. More use gathers more data, which makes the models better, which attracts more users, in a virtuous circle. The big should get bigger. Such a frenzy fuels the demand for AI chips.

If the argument is right, a lot of people who invested in the models that prove to be the losers will have wasted their money. The current boom in demand for chips should also die down once the also-rans give up. That is a way off but is a threat to future Nvidia sales.

If the scale-matters argument is wrong, and what businesses actually want are smaller, dedicated AI models trained in large part on their own data, or that startups can do AI just as well as the giants, a lot of money will have been wasted.

Investors assume continued rapid growth from Nvidia, with the stock on a multiple of 38 times forward earnings. Superfast commercialization of LLMs has become the baseline for investors who have pushed up other stocks that should benefit, such as suppliers of electricity, cables and data centers. It is another sign of just how much investors have swallowed the hype that they are willing to bet on such distant potential beneficiaries of the AI boom.

I fear the market is paying too little heed to the risks. AI may be a big deal, but it’s unlikely to pan out the way people seem to think.

Today only:

• Klarna Marketing Chief Says AI Is Helping It Become ‘Brutally Efficient’
• PwC Set to Become OpenAI’s Largest ChatGPT Enterprise Customer
• Palantir Wins $480 Million AI Computer Vision Deal With US Army
• OpenAI Strikes Licensing Deals With The Atlantic and Vox Media
• OpenAI CTO Says Generative AI’s Economic Impact Only Starting

OpenAI’s latest GPT-4o model, which helps users generate content such as text, presentations and videos, is becoming more intuitive to use and that’s spurring its adoption, Murati told Singapore’s Asia Tech X conference via video on Thursday. People are increasingly using AI tools for tasks such as coding, writing and administrative work, she said.

“We don’t quite realize the impact that this is going to have in businesses and at work because it is just starting,” she said. “But what we’ve seen so far is that over a very short amount of time, these AI systems have entered the workforce as collaborators.” (…)

Gleaned in 10 minutes:

• 10 startups harnessing the power of AI The 2023 MIT Digital Technology and Strategy Conference featured startups that help companies anticipate disruptive technologies, boost customer service metrics, and improve last-mile deliveries.
• New work from MIT Sloan researchers shows how generative AI can be deployed in the enterprise today.
• Workers with less experience gain the most from generative AI
• How generative AI can boost highly skilled workers’ productivity
• 15 Unexpected Ways AI Technology is Being Used Today

I spent 3.5 weeks in Singapore watching my son and some of his associates use AI helping various clients in industries such as energy, mining, retailing, coding, finance, etc. and it was amazing how efficient they were, yet only beginning to fully use rapidly evolving AI tools.

BTW, here’s one way Bloomberg uses LLMs in finance, courtesy of Apollo’s Torsten Slok::

Quantifying Fed Sentiment

The Bloomberg natural language processing model analyzes Fed speeches and currently shows FOMC members moving toward a tightening bias. Note how the model never predicted rate cuts in 2024. Instead, Fed sentiment has simply been less hawkish in 2024 than in 2022 and 2023.

The bottom line is that this Fed sentiment model using data back to 2009 shows that Fed communication continues to favor Fed hikes rather than Fed cuts.

Xi Lays Out Vision for Greater Cooperation With Arab States

Chinese leader Xi Jinping outlined a range of areas including finance and technology in which his nation can enhance cooperation with Arab nations, underscoring Beijing’s push for greater influence in Middle East.

“China will work with the Arab side as good partners to make our relations a model for maintaining world peace and stability,” Xi said Thursday in a speech to the China-Arab States Cooperation Forum in Beijing. He listed artificial intelligence, green tech and finance as sectors open for greater collaboration. (…)

Beijing-based Lenovo Group Ltd. has announced a deal to sell $2 billion of convertible bonds to Saudi Arabia’s sovereign wealth fund, and build research and production facilities in the kingdom. State oil firm Saudi Aramco is in talks to buy a $1.5 billion stake worth in a Chinese petrochemical firm, while carmaker China FAW Group is part of a push to make electric vehicles in Egypt. (…)

As the Biden administration backs Israel in the conflict, China supports an immediate cease-fire and recognition of a Palestinian state. That alignment with Arab states is helping Beijing to extend its political sway in countries that until recently saw China chiefly as an economic partner — and win new allies in its global contest for influence with the US.

Under Xi, China has pushed to build an alternative world order to challenge the US, embracing Russia and emerging economies in the so-called Global South. Beijing has cast itself as the leader of the BRICS bloc, which it has worked to expand. Iran, the UAE, Ethiopia and Egypt all accepted invitations to join this year. (…)

China also said it would expand industrial investment in Egypt in areas including electric vehicle and solar panel manufacturing.

Speaking on the sidelines of the forum, the Palestinian envoy to China, Fariz Mehdawi, described Beijing as friendly with nearly every nation in the region.

It “has no problem with anybody, not like our American friends, unfortunately, I’m sorry to say that,” he said. “But this is what makes China more eligible to play a constructive, positive and not controversial role.” (…)

China gets more than one-third of its crude from members of the six-nation Gulf Cooperation Council, with the lion’s share coming from Saudi Arabia. (…)