The US Economy Is Roaring!
On August 20, the BLS revised the number of jobs created over the 12 months ended March 2024 down by 818,000, 30% less than initially reported.
On September 18, having previously refocused on the labor market, the FOMC cut its Fed Funds rate 50bps.
On September 26, as Ed Yardeni explains,
the Bureau of Economic Analysis (BEA) released several very significant upward revisions to real GDP, real GDI, personal income, and personal saving. Collectively, they blew away the hard landing scenario. They didn’t leave much if any room for the soft landing scenario either. (…)
Q2’s level of real GDP was raised by 1.3% to a record high. More importantly, the level of real Gross Domestic Income (GDI) was revised up by 3.6%. The significant tightening of monetary policy from March 2022 through August 2024 did not cause a recession. There has been no landing, and certainly no hard landing. (…)
The personal saving rate was revised up from 3.3% to 5.2% (chart). Last week on Wednesday, September 30, Fed Chair Jerome Powell said at the National Association of Business Economics Annual meeting that the revisions reduced the downside risk to the economy. The higher personal saving rate also reduced the downside risk of consumers retrenching. He acknowledged that productivity growth might be stronger.
Powell and many commentators were worried that the Bureau of Labor Statistics’ recent downward revision of 818,000 in payroll employment over the past 12 months through March meant the economy is on a much weaker footing. The latest BEA revisions put a fork in that theory since the upward revision in real GDP combined with a downward revision in labor input mean productivity growth is stronger. This all confirms our thesis that the US is in the midst of the Roaring 2020s propelled by technology-driven productivity growth.
Last week, the August Personal Income and Outlays release revealed that Americans’ capacity to spend is not diminishing. Wages & Salaries income was up 0.5% MoM in August, +4.9% a.r. in the last 2 months. Labor income is the main driver for expenditures, pointing to ~5% growth in total spending with inflation below 2.5% (2.2% in August and +1.2% annualized in the last 4 months).
The Fed is happy seeing inflation near targets. The risk is that sustained real wage growth is fueling demand which could put unwanted pressure on prices.
Later today we get weekly unemployment claims and the U.S. Services PMIs. Tomorrow, September payrolls.
SERVICES PMI: Eurozone economy suffers fresh contraction at end of third quarter
The HCOB Eurozone Services PMI Business Activity Index signalled an eighth consecutive month of growth at the end of the third quarter. Registering above the 50.0 no-change mark, as has been the case since February, the latest figure indicated sustained growth in services output. However, falling to 51.4 in September, from 52.9 in August, the index pointed to an expansion that was only modest and the weakest for seven months.
Higher business activity levels were achieved despite the level of incoming new work decreasing. This was the first time since February that demand for services has fallen, although the contraction was only marginal. Outstanding orders provided services firms with a means to support activity. Backlogs of work fell for the fourteenth time in the past 15 months, and to the quickest extent since February.
Employment levels continued to rise across the eurozone’s service sector in September. While the rate of job creation was fractionally faster than in August, it was weaker than seen on average since data collection began in July 1998.
Services inflation cooled in the euro area at the end of the third quarter. Notably, rates of increase in input costs and output prices were their softest in 42 and 41 months, respectively.
Finally, expectations for growth over the next 12 months strengthened in September. This marked the first month since May that business confidence has improved. That said, the level of optimism was subdued by historical standards.
The seasonally adjusted HCOB Eurozone Composite PMI Output Index fell into contraction territory in September for the first time since February. Down from August’s three-month high of 51.0 to 49.6, the headline index was indicative of a marginal decrease in private sector business activity at the end of the third quarter. Trends at the sector level worsened in September. Euro area factory production recorded an accelerated decline that was the fastest in the year-to-date, while services growth slowed to a seven-month low.
The big-three economies of the currency bloc – Germany, France and Italy – all registered month-on-month contractions in business activity during September. Germany spear-headed the downturn, with private sector output here falling for a third month in a row and at the fastest pace since February. France suffered a renewed contraction, partly reflecting some payback following August’s boost from the Paris Olympic Games. Italy meanwhile saw its first month of decline in the year-to-date, although the pace of contraction was only marginal. Expansions were seen in the two other countries for which Composite PMI data are available – Spain and Ireland – with the former registering a sharp and accelerated upturn.
According to the latest data, the level of new business received by private sector firms in the euro area shrank for a fourth successive month. Additionally, the pace of decrease quickened to the steepest since January. A renewed (albeit marginal) deterioration in demand for services was accompanied by a rapid drop in new factory orders. Export* sales performances worsened, with the fastest fall in new business from non-domestic customers since last December providing a considerable drag on total order book volumes.
Surveyed businesses in the euro area recorded another monthly fall in their volumes of outstanding workloads, extending the current period of backlog depletion to a year-and-a-half. The rate of decrease was also slightly faster than seen on average over this sequence. Completion rates picked up in both the manufacturing and services sectors in September.
Eurozone firms stepped up headcount reductions at the end of the third quarter. Although the rate of job shedding was marginal, it was the joint-fastest since December 2020 (matching January 2021, as well as November and December 2023).Lower employment levels were entirely a reflection of the manufacturing economy as factory lay-offs were sufficiently strong to more than offset modest job creation within the service sector.
Meanwhile, euro area business confidence continued to weaken in September, marking a fourth month in a row that firms’ sentiment has deteriorated. Albeit still optimistic overall, 12-month expectations for activity were at their lowest in the year-to-date.
Finally, the HCOB PMI data revealed a further marked easing of cost pressures across the eurozone. Overall, the rate of input cost inflation was the second-slowest November 2020, with July 2023 narrowly undershooting that seen in September. The extent to which euro area companies raised their own prices also eased at the end of the third quarter. Overall output charges increased only modestly and to the weakest extent in just over three-and-a-half years.
Commenting on the PMI data, Dr. Cyrus de la Rubia, Chief Economist at Hamburg Commercial Bank, said:
“At first glance, the services sector in the eurozone seems to be holding up fairly well. It’s still growing, and the slowdown is not too steep just yet.
But when you dig a little deeper and look at individual countries, the picture is not as rosy – except for Spain. Here, we are rubbing our eyes in amazement. Service providers there are booming, with the index shooting up to 57 points. The situation in the other three leading eurozone economies is quite different.
In France, service providers’ business activity slowed down after the Olympics effect and in Germany and Italy, growth almost hit a wall in September. Even if Spain manages to avoid getting pulled down by the struggles of its neighbours, the eurozone’s services sector as a whole seems to be headed for more sluggish growth.
“On the ground, most service sector employees have not really felt the pinch yet. In fact, the hiring rate picked up in Spain and France, and even in Italy, jobs growth only dipped slightly. It is Germany where things look bleakest, with companies there actually cutting staff. This is where the recession in manufacturing is making itself felt, as in this environment the corresponding companies are placing fewer orders with the service sector.
“The situation in the service sector in the eurozone will continue to deteriorate. This is indicated by the decline in new business. For the first time since February, it has fallen in the eurozone compared to the previous month. The development in Germany and France is similar. Factoring in the ongoing contraction in industry, the eurozone economy is likely to have grown only at a marginal rate in the third quarter. Our GDP nowcast model, which takes into account the PMI indicators, also points to only minimal growth.
“On the plus side, operating costs in the services sector saw their slowest rise since early 2021, and inflation in selling prices is also easing off. Given the overall economic weakness, this is a good case for the ECB to cut interest rates in October. And indeed, only recently, ECB president Christine Lagarde did hint at a rate cut this month.”
A Beautiful Deleveraging with Chinese Characteristics? (Ray Dalio)
Last week, China’s leadership—including President Xi Jinping, the Politburo, the CSRC, and the PBoC—clearly 1) announced a reflationary barrage of fiscal and monetary policies and 2) made statements in support of free markets as a big step to end the deflationary deleveraging and to stimulate creative productivity. That happened at the same time as 3) Chinese assets were (and still are) very cheap, so it was a combustible combination of influences that set the markets on fire. It was a big week.
In fact, I think that it was such a big week that it could go down in the market-economic history books as comparable to the week Mario Draghi said that he and the ECB would “do whatever it takes,” if China’s policymakers, in fact, do what it takes, which will require a lot more than what was announced. (…)
In a nutshell, it all depends on whether Chinese policymakers do or don’t simultaneously a) restructure bad debts (thus eliminating zombie conditions of their institutions) and b) lower interest rates below inflation and nominal growth rates, or, if that proves impossible, monetize debt to get the rates below the inflation and nominal growth rates while weakening the currency to devalue the debt.
More specifically, for China’s policymakers to engineer a “beautiful deleveraging,” they have to lower debt burdens by simultaneously
a) doing debt restructurings that clean the bad debts out of the system (which is deflationary) while also
b) creating money and credit (which is stimulative and inflationary) in a balanced way so that debt service burdens are reduced and there is neither unacceptable deflation nor unacceptable inflation.
This beautiful deleveraging can only be done in countries that have most of their bad debts denominated in their own currencies and have most of the debtors and creditors as their own citizens, which is the case for China. Doing a deleveraging in this way not only reduces debts without triggering either unacceptable deflation or unacceptable inflation, but it also allows viable businesses to get back to business unencumbered by their old debts and it eliminates the “pushing on a string” problem of having scared people, companies, and other entities holding cash in safe banks and government debt assets.
It does this by making cash a poorly performing asset class relative to the major alternative asset classes that are doing well because of the reflation. Doing these things starts to rekindle “bottom fishing” and “animal spirits.” We are clearly seeing that happen now.
Also, pro-market and pro-entrepreneurial policies are stimulative and, in this case, especially good because there is such enormous power in President Xi’s policy-indicating statements. In this case, supportive comments came from the highest levels (from President Xi Jinping, the Politburo, the CSRC, and the PBoC) encouraging officials and people to adopt innovative and bold approaches to support the economy, and included President Xi reassuring officials that they would not be punished for well-intentioned mistakes made in the process of implementing new policies. These statements matter a lot.
While there’s no doubt that all of this is bullish for the markets, as part of the beautiful deleveraging there will have to be difficult and painful changes in the following areas:
The debt restructurings will be especially difficult both because they are complex and because they are politically charged because they will have huge effects on people’s wealth. Debts at the local government levels—especially between local governments which paid for their spending through land sales and by borrowings from companies and people in their provinces—are especially difficult situations to handle.
Imagine the situation of a perfectly good company that lent to the local government and/or is dependent on local government spending facing the current situation. Who should do what in what amounts to deal with this situation? Who will determine such things and how? These things are not clear. Because similar problems have been faced and dealt with throughout history (including the 1990s in China with Zhu Rongji and many people helping him who are still alive and lucid) in ways that are both effective and painful, this can be done if the courage and capabilities are mustered, but it will be very difficult.
The tax system for collecting money to spend on shared expenditures and needed remediations and social programs is deeply in need of reform. As things stand, getting and distributing money is highly ineffective at the national, provincial, and local government levels. More specifically there are not effective income taxes, real estate taxes, inheritance taxes, or most other taxes (other than VATs, especially at the production level). This set of conditions makes the last problem I mentioned – the local government debt
and financial problem – more challenging.Though there was a recent minor change in policy, the demographic problem—especially the early retirement age (on average 53) and relatively late death age (the average 53-year-old dies at 83)—leaves many people with a long time with little income and one child to take care of them. At the same time, the working population is declining rapidly.
So, while last week we saw great actions and words that I am sure will be followed by highly stimulative policies that will help a lot and will support asset prices, I think that there are several important other things to keep an eye on to see how well China’s domestic debt-money-economy challenges will be handled.
Of course, these observations are about just one of the five big forces (the debt-money-economy force) in one of the big countries (China), and it’s important to remember that the other big forces (the internal political conflict force, the external geopolitics conflict force, the acts of nature force, and the technology force) are also affecting China, other nations, and the entire world.
Last week was filled with comparably important developments pertaining to all of these things, and these developments seem, to me, to be broadly tracking the big cycle that will have big impacts on what the changing world order will look like.
Is China Circumventing U.S. Tariffs?
(…) U.S.-China relations have been tense for some time due to diverging strategic priorities and geopolitical differences; however, we can pinpoint the inflection point—at least for trade—as the implementation of Trump-era tariffs and the broader trade war that originated in 2018.
To that point, China’s trade surplus with the United States saw a meaningful dip when tariff rates ramped up over the course of 2019. Successive years have seen China’s trade surplus slip even further, and as of the end of 2023, China’s trade surplus with the United States was essentially half of what it was relative to before the trade war—both in terms of U.S. and China GDP.
Source: IMF and Wells Fargo Economics
We can point to many other metrics to indicate the U.S.-China trade linkage is not as robust as it once was; however, a deeper dive into global trade flows tells an interesting story. One that suggests the overall U.S.-China trade relationship may not necessarily be weakening as much as data suggest. The same global trade data also suggest that China may be circumventing U.S. tariffs, and still benefiting from U.S. demand and the United States as a final export destination. (…)
As far as tariff revenue, at least for the United States, the U.S. is collecting a sizable amount of revenue derived from the tariffs imposed on China. As of mid-2024, the trade-weighted average tariff rate (i.e. tariff revenue as a percent of the total value of U.S. imports from China) on China is ~9.5%, a notable step up from the tariff rate prior to the trade war [<3%]. (…)
As reflected in the narrowing China trade surplus, the U.S. is importing less from China, the United States’ main source of tariff revenue. Instead, the U.S. is sourcing an increased amount of goods from other nations in Asia as well as across Latin America and Europe.
Relative to 2017, the U.S. is importing significantly more goods from countries such as Vietnam, Mexico, South Korea, Turkey, Thailand and India. Essentially, countries not subject to China-style tariffs. At the same time, global trade data reveal that China has also boosted trade relations with those same nations. As of the end of 2023, and relative to before the trade war started, China is exporting more goods to those very same countries.
Source: IMF and Wells Fargo Economics
Coincidence? Probably not.
Take Mexico for example. Mexico is widely considered to be one of the top nearshoring destinations for U.S. corporations looking to shift critical supply chain links out of China. As U.S. multinational corporation interest in nearshoring picked up after tariffs were imposed and surged again after COVID-19, so has Chinese foreign direct investment (FDI) into Mexico. Without knowing for certain, there is a high likelihood China is actively putting infrastructure on the ground in Mexico as an intermediary to accept Chinese made goods before ultimately sending on to the United States.
Source: IMF, NL Analytics and Wells Fargo Economics
Indeed, given the shifting composition of trade flows and China’s increased foreign direct investment activity, we would argue the evidence strongly suggests that a perceptible portion of China-U.S. trade flows are being re-routed via proxy countries. The Biden administration indeed took notice of these tactics, and recently applied tariffs to certain Chinese goods making their way into the U.S. via Mexico.
China using proxy nations as means to avoid U.S. tariffs will likely retain the attention of the current administration and a potential Democratic administration post-elections, but could also be at the core of former President Trump’s proposed “global tariff.”
Should a tariff on all exports to the United States apply to all nations, the ability for China to completely circumvent export duties would be diminished.
While a U.S. global tariff would place downward pressure on global growth and upward pressure on global inflation, as well as potentially damage relations between the U.S. and most trading partners, the genesis of former President Trump’s global tariff proposal could still be aimed at disrupting China’s rise. Combined with Trump’s proposed 60% tariff on exports to the U.S. directly from China, China’s ability to tap U.S. consumer demand could be at risk should U.S. trade policy turn more protectionist in the near future.
With exports propping up China’s economy for the time being, a global tariff alongside tariffs imposed directly on China could have a more severe impact on China’s economy relative to existing tariffs. (…)
