12/11/2023
THIS WEEK’S HIGHLIGHTS⚠️ This report contains juicy details 👇
1. US ISM Services was released and showed ongoing expansion in the services sector. November’s reading came in better than expected at 52.7 (Exp 52, Prev. 51.8), marking the 11th consecutive month of expansion. Business activity 55.1 (Prev. 54.1) and employment 50.7 (Prev. 50.2) improved and continued in expansion. New orders 55.5 remained in expansion and unchanged from the previous month. Prices paid remained strongly in expansion at 58.3 down from 58.6, suggesting inflationary pressures receded marginally.
• The services sector is the largest sector in the US by a long way and thus is responsible for the biggest proportion of GDP, when compared to other sectors. In 2022 services accounted for almost 80% of US GDP.
2. US Consumer sentiment in the University of Michigan Consumer Survey improved markedly and inflation expectations fell alongside, a nice combo for the Fed. Sentiment improved to 69.4 (Exp. 62, Prev. 61.3), almost entirely reversing 4 months of decline. US consumers’ assessment of both the current state of the economy and their expectations for the future improved impressively. Current increased to 74 (Prev. 68.3), Expectations 66.4 (Prev. 56.8).
• Inflation expectations for 1 year ahead plummeted to 3.1% from November’s reading of 4.5%, the lowest since March 2021. On top of this, longer term expectations fell to 2.8% from 3.2% (Exp. 3.1%). The Fed will be glad to see this. Rising inflation expectations reduce real interest rates and promote spending, thus loosening monetary policy. This supports the argument the Fed will pause this week, not that the argument really needed supported further.
• Consumer sentiment is closely watched as it is used to gain insight into future consumer spending patterns; consumer spending makes up around 70% of US GDP.
3. Bank Term Funding Program usage surged the most since April with the 5th largest weekly increase since the facility’s creation. This is worth keeping a close eye on to monitor for stress potentially reappearing in the banking sector.
• When usage of the BTFP rises sharply it reflects that banks are having to access emergency liquidity from the Federal Reserve.
• The BTFP is a means by which financial institutions can borrow emergency liquidity from the Fed. It was created in response to the banking crisis in March this year. The BTFP offers lending for up to 1 year to financial institutions and is more generous than the much older the Discount Window. Banks can post collateral (usually in the form of US treasury bonds, agency mortgage-backed securities etc) at the Federal Reserve at par value, essentially meaning any price fluctuations in the assets used as collateral are ignored by the Fed. This was designed so that banks aren’t forced to sell asset portfolios at heavy losses, they can lend against them to meet immediate obligations and continue to hold. To top it off, interest on lending through the BTFP is done at Fed Funds Rate + 0.1%, which isn’t much (if any) of a haircut for banks.
BTFP top 10 weekly increases
4. We had an onslaught of employment data with JOLTS, Nonfarm payrolls, ADP employment change and jobless claims:
• Nonfarms payrolls beat consensus expectations coming in at 199K jobs added in November (Exp. 180K, Prev. 150K). The rise was dominated by jobs in healthcare +77K (Average 54K) and government 49K (Average 55K). On top of this, workers returning after UAW strikes added 30K to the headline print, without this the manufacturing workforce would have contracted.
• The Unemployment rate unexpectedly fell to 3.7% (Exp. 3.9%, Prev. 3.9%) and the U6 unemployment rate to 7% (Exp. 7.3%, Prev. 7.2%). The Sahm Rule recession indicator, which is when then 3 month moving average of unemployment rises 0.5% above its lowest point in the last 12 months, has not been triggered. It is still very possible that it will trigger in the coming months, however.
⁃ U6 unemployment includes not only traditionally unemployed people (unemployed and actively seeking work) but also people that want a job but have given up looking, and those that are employed on a part time basis and are looking for full time work (underemployed).
• US Job Openings and Labor Turnover Survey for October was released and showed a significantly larger than expected decline in job openings. Job openings came in at 8.733 million (Exp. 9.3M, Prev. 9.35M), lowest since March 2021. The report recorded -236K jobs in health and social care, -168K in finance and insurance, -49K in real estate and rental. The report suggests job openings continue to fall in the US while we are yet to see a dramatic spike in layoffs or unemployment. So far, Powell’s claims that the labor market can loosen without a large uptick in unemployment is playing out. Whether this remains the case is another question.
⁃ Quits rate 2.3% (Prev. 2.3%), has been stagnant for 4 months now. Quits is the number of people who are leaving their job voluntarily. Decreasing quits suggest that people may be finding it harder to find jobs as people tend to leave of their own accord when they have a better offer/another job lined up.
⁃ Hires rate 3.7% (Prev. 3.8%). This is the percentage of new hires relative to current respondent workforce. Companies continue to hire less people.
⁃ The response rate of the JOLTS data has declined and thus the power of the data has been called in to question of late, with response rates as low as 30% this year.
• ADP employment change, which tracks employment only in the US private sector, came in lower than expected at 103K (Exp. 130K, Prev. 106K) in November. Hiring has softened markedly from the YTD high in June of 455K. The increase in jobs was driven overwhelmingly by the services sector:
⁃ Services sector +117K, leisure and hospitality -7K, professional/businesses services -5K, construction -4K.
• US initial jobless claims came in around consensus at 220K (Exp. 222K, Prev. 219K). However, continuing jobless claims surprised to the downside and fell, coming in at 1861K (Exp. 1910K, Prev. 1925K). This data was from Thanksgiving week. Of late, the trend in continued claims has been increasing, as US citizens find it more challenging to find work once unemployed.
⁃ The jobless claims report is a very timely proxy report of US unemployment, reported on a weekly basis by each state for compilation and seasonal adjustment by the US Department of Labor.
⁃ Continuing claims are the number of people who are filing for unemployment benefits in the US for their 2nd or more time. It is reflective of how difficult US citizens are finding it to get work after they have lost their job. Initial claims is the number of people filing for unemployment benefits for the first time. It is reflective of current layoffs in the US.
4. US MBA mortgage applications increased by 2.8% on the week, marking the 5th weak in a row of improvement in the US. This coincides with loosening financial conditions and mortgage rates falling from 8% to closer to 7%. The increase was driven by a 13.9% increase in refinancing applications; new mortgage applications actually fell 0.3% on the week.
• US mortgage applications both for purchase and refinancing remain at very suppressed levels amidst high interest rates, lower turnover of houses and suppressed inventory of existing homes.
5. US Factory Orders fell more than expected coming in at -3.6% month over month (Exp. -2.8%, Prev. -2.3%), suggesting that trouble for US manufacturers is not over. This is the biggest decline since April 2020. The data refers to the month of October, so is backwards looking. However, more timely manufacturing PMIs continue to report contraction.
Factory orders excluding transport declined -1.2% (Prev. +0.4%). This metric gives a better look at underlying demand as headline factory orders can be heavily skewed by demand for transportation like aircraft that fluctuates heavily e.g. non-defence aircraft and parts declined 49.6% in October, transport was down 14.7% overall.
6. Deflation continued for the second consecutive month in China as headline CPI printed in at -0.5% (Exp. -0.1%, Prev. -0.2%), the biggest decline since November 2020, driven largely by food (pork in particular) prices. Core inflation, which excludes the most volatile components of CPI (food and energy), rose 0.6%.
• Further suggesting deflationary readings may continue in the coming months, producer price index (PPI) came in at -3% YoY (Exp. -2.7%, Prev. 2. 6%), the 14th consecutive deflationary reading. PPI reflects price changes higher up the supply chain than the CPI and thus can act as a leading indicator of consumer prices as prices are passed down to consumers.
• The worsening of headline deflation will likely prompt the People’s Bank of China and the Chinese government to continue and intensify their attempts to stimulate the economy as demand remains sluggish in the midst of the ongoing downturn in the Chinese real estate market. In a statement released this week, the Chinese government hinted at increasing fiscal stimulus in 2024 in order to try and increase demand.
• Deflation terrifies economies around the globe for a number of reasons:
It can exert downward pressure on consumer spending. If goods are persistently falling in value and something is going to cost less in a year then this may encourage consumers to save money and buy later. Thus, saving is highly incentivised and consumer spending suppressed.
Furthermore, debt becomes more difficult to pay off and the underlying assets fall in price. If I take out a loan for $10,000 and deflation takes place then even if the nominal interest on the loan is 0% the real value of the $10,000 has increased and thus I am having to pay back a loan that costs more in real terms, as the money is worth more than when it was initially borrowed.
Central banks also fear deflation due to worries over the possible lack of effectiveness of monetary policy in combatting it once it has taken hold; even if governments/central banks start handing out lots of stimulus, this money may not actually make its way into the financial system as people are still incentivised to save while prices are declining. The worst-case scenario envisaged by central banks is that of a deflationary spiral in which business revenues drop due to falling prices, unemployment rises due to lower revenues, consumer spending falls due to the unemployment rise, this leads to further revenue decline, price declines and so on and so forth.
It should also be noted that not all deflation leads to awful repercussions.
7. Ongoing weak domestic demand in China was further evidenced in the country’s trade balance. Exports increased 0.5% YoY in November, the first increase in exports since April. However, imports dropped by 0.6% YoY (Exp. +3.9%), a huge miss, and when taken in to account that it is compared to last November, when China was still pursuing their zero COVID policy with widespread lockdowns, it speaks volumes about how weak the Chinese consumer is at the moment.
8. European Construction PMIs were released, generally showing contractionary readings. Eurozone contraction eased slightly, France’s more so. Italian construction expanded at a faster pace, while the UK remained in contraction. However, Germany’s construction industry continues to deteriorate, seeing an increase in the rate of contraction from an already rapid pace of decline:
Eurozone 43.4 (Prev. 42.7)
France 44.6 (Prev. 41)
Germany 36.2 (Prev. 38.3)
Italy 52.9 (Prev. 51.8)
UK 45.5 (Prev. 45.6)
• In the German report the first line reads ‘Germany's construction sector remained deep in recession midway through the final quarter of the year’, another quote reads ‘The building sector in Germany is experiencing a perilous plunge’.
• There was rapid decline in German housing projects, a steep decline in demand and further fall in employment. New orders (a reflection of current demand) remained firmly in contraction. German housing is being hit the hardest according to the report seeing some of the worst readings since 1999.
• Germany is the largest economy in the Eurozone, providing almost 30% of GDP for the economic area.
9. German factory orders fell 3.7% in October alone and is now down 7.3% YoY, well below expectations of +0.2% and September's +0.7% revised reading. There was decline of 13.5% in machinery and equipment orders. Furthermore, capital goods (-6%) and intermediate goods (-1.4%) orders fell. However, consumer goods (+2.8%) new orders did increase and domestic (from within Germany) orders grew 2.4%, indicating an uptick in demand in the country. On the other hand, foreign demand fell markedly and more than offset this with orders from Europe -7.6% and Everywhere else -7.4%.
• The index tracks the volume of orders for in the manufacturing sector in Germany. Sample size of around 6000 manufacturers.
10. Japanese final GDP came in weaker than expected at a rate of -2.9% on an annualized basis (Exp. -2.0%, Revised from -2.1%) and -0.7% QoQ (Exp. -0.5%)
• Consumer spending, the largest driver of GDP in the 3rd largest economy on the planet, fell 0.2% (Revised down from 0.2%)
• This may act as a softener on the view that was rip-roaring this week that the Bank of Japan is set to increase interest rates at their December meeting. BOJ governor Ueda stated this week that monetary policy would become more difficult from year end, fuelling speculation in markets that the BOJ are set to end their reign of negative rates. Japanese Government Bond (JGB) yields rose and the Yen strengthened against the dollar as markets began to price in an increased likelihood of a pivot away from the Bank of Japan’s ultra loose monetary policy and a step towards normalisation.
• The BOJ has implemented negative interest rates and yield curve control since around 2016; the ultra-loose monetary policy was introduced by the previous governor, Kuroda, to stimulate the Japanese economy and combat deflation in the country.
11. The Bank of Canada decided to hold interest rates at 5%, as expected
12. The Reserve Bank of Australia left interest rates at 4.35%, as expected
-
Domestic demand continues to be weak in China with falling imports and deflationary CPI persisting. The PBoC and Chinese government are likely to step up measures intended to stimulate the economy in the New Year.
Japanese GDP being worse than expected may have pushed back some of the expectation that the Bank of Japan will end negative interest rates at their December meeting. While the Bank of Japan are likely to take steps towards policy normalisation in the near future, it does remain unclear exactly when it will happen.
European construction PMIs continued to paint a weak picture with Germany continuing to stick out like a sore thumb as the worst affected, with collapsing construction activity and weaker than expected factory orders.
Meanwhile, in the US, employment data released this week continues to suggest a similar narrative of an ongoing tight labor market with some signs of loosening, but no marked surge in unemployment or layoffs as of yet. Whether this remains the case remains to be seen.
US consumers seemed pretty happy, erasing 4 months of consumer sentiment declines and predicting better outcomes for both the economy and inflation, something the Fed will be delighted to see.
Going into next week we have a central bank triple header with the Bank of England, European Central Bank and Federal Reserve all set to make their next decision on interest rates. It is likely that all three will hold rates where they are. The meetings are going to be all down to narrative, as markets try and decipher when we might see rate cuts.
Plus, we'll get an updated Summary of Economic Projections from the Fed, which is always fun.
Markets are currently pricing in a 98.4% chance of a Federal Reserve pause, with the first rate cut priced in for May 2024.
