Weekly Update 6/2/2023: U.S. Consumer Confidence Remains High as Debt Ceiling Issue is Resolved and Employment Remains Healthy

• Domestic Economic News
• Interest Rate Insight and the Fed
• Impactful International News

Domestic Economic News

The US labor market sent conflicting signals in May as payrolls surged along with joblessness, giving Federal Reserve officials more reason to pause interest-rate hikes. This was welcome news in early Friday trading as equities rallied and fixed income securities declined. Nonfarm payrolls increased 339,000 last month after an upwardly revised 294,000 advance in April, a Bureau of Labor Statistics report showed Friday. The unemployment rate rose to 3.7%, while wage growth slowed. Frankly, that was a great combination! It shows that there continues to be strong hiring while at the same time more people are entering the workforce. The rise in the actual unemployment rate helps contain the demand by workers for wage hikes, so that in turn should over time put downward pressure on wage inflation which is an area Chair Powell has mentioned in each of his press conferences. So here are the numbers relative to expectations: Nonfarm payrolls were +339k vs the expectation for +195k; Unemployment rate was 3.7% vs the expectation for 3.5%; Average hourly earnings (MoM) were +0.3% vs the expectation for +0.3% while the year-over-year increase in wages was lower than expected as noted.

The advance in jobs was broad-based, reflecting gains in professional and business services, government and health care. Traders upped their bets of the Fed hiking rates by the end of July. Bets on a June hike also rose, though investors still leaned toward expecting a pause. For the Fed, however, policymakers will also be looking at the surge in the unemployment rate, which was the biggest one-month increase since April 2020. There were 440,000 more people out of a job in May, also the largest monthly rise since the onset of the pandemic. Even though labor demand has remained resilient, it’s unclear how long that will last. With a credit crunch threatening to halt the expansion and more companies planning to let workers go, hiring and pay gains may slow substantially in the coming months. The mixed nature of the report may validate Fed Chair Jerome Powell’s approach to pausing interest-rate hikes to assess the impact of five-percentage points of hiking so far. Other officials have also voiced support for holding rates steady at this month’s meeting, while leaving the door open to resume tightening in July, as price pressures remain robust and the threat of a US debt default has been avoided. The jobs report is one of the last major releases policymakers will see before they convene on June 13 for a two-day meeting. That morning, they’ll also see the consumer price index for May.

The Senate passed legislation to suspend the US debt ceiling and impose restraints on government spending through the 2024 election, ending the drama – finally! We have noted to clients that we have experience with this situation in the past where it came right down to the wire. That was in 2011, and we held steady through that period just as we did during this period. Clients were rewarded then and we are confident they will be this time as well. There were other issues back in 2011 that applied pressure to equity markets at that time. Europe was going through a sovereign debt crisis post 2008 financial crisis and as a result of the debt ceiling issue being as protracted as it was back then, Standard & Poor’s – one of the two most prominent credit rating agencies – downgraded the U.S. debt from AAA to AA+. Many analysts and traders criticized that decision at the time as it ended up creating more turmoil in markets. With the debt ceiling issue basically resolved at the time of writing this email, Moody’s – the other prominent credit rating agency – affirmed their view that US debt is worthy of their AAA rating. In the lead up to this whole issue we had been following the lead analyst for Moody’s that actually rates US debt and he had been indicating there was a very low probability of a downgrade occurring. That proved to be the case. The measure now goes to President Joe Biden, who forged the deal with House Speaker Kevin McCarthy and plans to sign it at some point on Friday. The 63-36 vote in the Senate on the bill was carried by moderates in both parties. Traders have largely judged the risk of a US default as resolved.

As noted in our headline, US consumer confidence beat expectations in May although it did decline slightly month-over-month on more pessimistic views about the current state of the labor market. The Conference Board’s index was a relatively robust 102.3 from a upwardly revised 103.7 a month earlier, data out Tuesday showed. The median forecast in a Bloomberg survey of economists called for a reading of 99. The group’s gauge of current conditions decreased to 148.6. A measure of expectations — which reflects consumers’ six-month outlook — edged down. Results of the survey preceded the deal reached by White House and Republican negotiators to raise the debt ceiling.

Home prices rose for a second straight month as buyers returning to the market competed over few homes for sale. A measure of prices nationally increased 0.4% in March from a month earlier, according to seasonally adjusted data from S&P CoreLogic Case-Shiller. Demand is picking back up in parts of the US as buyers start to adjust to much higher borrowing costs that shot up starting last year. But transactions remain relatively slow as homeowners are often reluctant to sell and give up lower rates, keeping inventory for previously owned homes tight. “Two months of increasing prices do not a definitive recovery make, but March’s results suggest that the decline in home prices that began in June 2022 may have come to an end,” Craig Lazzara, managing director at S&P Dow Jones Indices, said in a statement. On a yearly basis, prices rose 0.7% in March, slower than the 2.1% gain in February. Miami and Tampa, Florida, posted the biggest year-over-year increases in a measure of some of the largest metro areas. Buyers are still confronting high borrowing costs compared to a year ago. Mortgage rates have climbed recently as markets react to deliberations on the US debt ceiling. The average rate on a 30-year loan hit 6.57% last week, up from 3.22% in early January 2022, according to data from Freddie Mac. “The challenges posed by current mortgage rates and the continuing possibility of economic weakness are likely to remain a headwind for housing prices for at least the next several months,” Lazzara said.

US factory activity shrank for a seventh month in May as orders contracted at a faster pace, while a measure of materials costs fell by the most in nearly a year. The Institute for Supply Management’s manufacturing gauge slipped to 46.9 from 47.1 a month earlier, according to data released Thursday. The current stretch of readings below 50, which indicates shrinking activity, is the longest since 2009. The figures are consistent with a sluggish manufacturing sector as consumers concentrate their spending on services and companies focus on getting inventories more in line with sales while also limiting capital expenditures. Fourteen industries reported shrinking activity in May, led by wood products, primary metals and apparel. An index of orders placed with US producers dropped more than 3 points last month to 42.6, the second-weakest reading in three years. “New order rates contracted further, as panelists remain concerned about when manufacturing growth will resume,” Timothy Fiore, chair of the ISM Manufacturing Business Survey Committee, said in a statement. “Panelists’ comments again registered a 1-to-1 ratio regarding optimism for future growth and continuing near-term demand declines.”

Here was the good news in the report – and we here at SGK took a good look at this component. As bond traders parsed through the report themselves, we would attribute at least part of the decline in Treasury yields across the curve and a rally in equities to this aspect of the report in Thursday trading. The purchasing managers group’s index of prices paid for materials slumped 9 points, the most since July. At 44.2, the gauge has collapsed since peaking two years ago. It’s also consistent with the recent slide in energy, metals and crop prices tied to tepid global demand. One comment from one of the survey recipients sums it up nicely, “pricing seems to be becoming the primary focus of supply and sourcing teams, as customers and consumers are beginning to push back. While inflation is easing on some discretionary goods, high food costs persist across most categories.” We noted this on our commentary on Walmart in the summary below under Company Events.

Interest Rate Insight and the Fed

Vacancies at US employers unexpectedly surged in April to the highest in three months, giving the Federal Reserve more reason to consider hiking interest rates again soon. The number of available positions increased to 10.1 million from an upwardly revised 9.75 million in March, the Labor Department’s Job Openings and Labor Turnover Survey, or JOLTS, showed Wednesday. The figure beat all estimates in a Bloomberg survey of economists, which called for 9.4 million openings. Market expectations for a rate hike in June recovered to price in a more than 70% probability following the report, after earlier taking a slight knock following a worse-than-forecast Chicago PMI reading. The yield on the two-year Treasury initially spiked and the S&P 500 fell further. The advance was led by retail trade, health care and transportation and warehousing. Openings fell in accommodation and food services, business services and manufacturing. At the same time, hiring edged up. Demand for labor has remained largely resilient even though tighter financial conditions have forced some employers to hit the brakes on hiring. While job cuts that began in white-collar sectors including technology and banking are starting to spread to other industries, some companies are still struggling to find workers. The figures show demand for workers continues to outstrip supply, and the Fed has stressed it’s key to get the two back into balance to cool wage growth. The data, combined with inflation that’s still running well above target, may tilt officials to press on with another interest-rate hike when they meet in two weeks. On the other hand, some officials are leaning toward a pause given stress in the banking sector and the debt-ceiling drama. Here is the take on the report from Bloomberg Economics economist Stuart Paul: “We expect the jump in job openings to prove temporary, as other indicators show the labor market slowly cooling. That said, the April job-openings data mean the Fed likely will continue leaning against the labor market to sustainably achieve its 2% long-run average inflation target.” As we have indicated, the U.S. economy remains resilient despite the best efforts by the Fed to counter that trend.

Federal Reserve Governor Philip Jefferson signaled the central bank is inclined to keep interest rates steady at its next meeting in June to give policymakers more time to assess the economic outlook, but such a decision wouldn’t mean hikes are finished. “A decision to hold our policy rate constant at a coming meeting should not be interpreted to mean that we have reached the peak rate for this cycle,” Jefferson, recently nominated to be Fed vice chair, said Wednesday in an online presentation on financial stability and the economy. “Indeed, skipping a rate hike at a coming meeting would allow the Committee to see more data before making decisions about the extent of additional policy firming.” Jefferson’s speech pushes back against growing expectations by investors that the central bank would raise rates in June, with markets pricing in 69% odds of a hike at the June 13-14 meeting. The Federal Open Market Committee has raised rates by 5 percentage points in the past 14 months to curb inflation running more than double their 2% target. With their benchmark rate now in a 5% to 5.25% target range following a quarter-point increase earlier this month, Fed Chair Jerome Powell has said that policymakers could afford to watch the data and the evolving outlook. While US banks have stabilized since a series of failures in early March, the strains are likely to lead to a further tightening in credit that will weigh on economic activity, Jefferson said. “I expect spending and economic growth to remain quite slow over the rest of 2023, due to tight financial conditions, low consumer sentiment, heightened uncertainty, and a decline in household savings that had built up after the onset of the pandemic,” he said. “Inflation has come down substantially since last summer, but it is still too high, and by some measures progress has been decelerating recently, particularly in the core services sector,” Jefferson added. Jefferson said it was difficult to forecast the US outlook in part because the amount of tightening of credit by banks and its effect on the US economy is not yet clear. It is healthy to hear a Fed governor adding a dose of common sense to the debate. We do believe it makes sense to skip a hike in June to let the rate hikes they have already implemented sink in, pay attention to forward economic indicators as opposed to constantly looking in the rear view mirror, and continue to monitor incoming data.

Further stabilizing markets this week – and a nice change from listening to Loretta Mester of the Federal Reserve of Cleveland saying at least two times every week they need to keep raising rates until we are at 2% level of inflation - Federal Reserve Bank of Philadelphia President Patrick Harker said the US central bank is close to the point where it can stop raising interest rates and turn to holding them steady in an effort to further bring down inflation. “I do believe that we are close to the point where we can hold rates in place and let monetary policy do its work to bring inflation back to the target in a timely manner,” Harker said in remarks prepared for a virtual event with the National Association for Business Economics. He emphasized that the economic outlook is uncertain and that he’ll assess incoming data to determine whether additional tightening is needed. Mester does not vote on policy this year so why she gets so much media attention we have no idea given she basically sounds like a broken record and rarely demonstrates much in the way of intellectual analysis or grasp of economic data when she makes comments. Harker, who votes on policy this year, said inflation is still “way above” the Fed’s 2% target. Though down from a peak of 7% reached a year ago, the Fed’s preferred gauge of price changes edged up in April, to 4.4% from 4.2%, Commerce Department data showed last week. “Disinflation is under way, but it is doing so at a disappointingly slow pace,” Harker said. The Fed has raised rates by 5 percentage points in the past 14 months as it tries to cool inflation. The rapid clip of that tightening has prompted policymakers to say that they may take a pause at their June 13-14 meeting to give the economy time to digest the rate increases. Some of the central bank’s more hawkish members have said more hikes may be necessary at future meetings to fully bring down prices. Harker said the labor market is effectively at full employment, but that tighter credit conditions, especially following the collapse of four banks this spring, may slow hiring. Thank you Patrick Harker!

On that note, the US economy showed signs of cooling in recent weeks as hiring and inflation eased slightly, the Federal Reserve said in its Beige Book survey of regional business contacts. “Employment increased in most districts, though at a slower pace than in previous reports.” the Fed said Wednesday in the report, published two weeks before each meeting of the policy-setting Federal Open Market Committee. “Prices rose moderately over the reporting period, though the rate of increase slowed in many districts.” The survey showed economic activity was little changed overall in April and early May. “High inflation and the end of Covid-19 benefits continued to stress the budgets of low- and moderate-income households, driving increased demand for social services, including food and housing,” the Fed said in the survey. The report, put together by the Chicago Fed, draws from anecdotal information collected by the institution’s 12 regional banks through May 22. Policymakers are carefully assessing how their tightening campaign over the past 14 months, which brought interest rates to a range of 5% to 5.25% from near zero, is affecting the economy. They have shifted to making decisions on a meeting-by-meeting basis, letting the evolution of data guide policy. Some officials, as we noted above, have indicated it may be appropriate to pause hikes at their next meeting in June. Others, wary of persistent inflation, say the central bank may need to do more, even if it comes after they skip hiking at that meeting. The US economy has proven resilient, even amid 500 basis points of rate increases from the Fed over the past year. The Beige Book is a forward looking indicator and in our view the FOMC needs to pay more attention to these types of releases.

Impactful International News

On a positive overseas note, Spanish inflation slowed by more than anticipated, supporting the European Central Bank officials who say the continent’s historic price spike is fading and interest-rate increases can soon end. May’s reading moderated to 2.9% — the least since July 2021 — as fuel costs fell and the growth in food prices eased. The result follows April’s uptick to 3.8% and is well below the 3.3% median estimate in a Bloomberg survey of economists. There was more good news, too, on underlying inflation as the gauge that excludes the costs of energy and some food items fell for a third straight month, though it remained elevated at 6.1%. Government bonds rallied and the euro extended losses after the data, weakening 0.3% to a two-month low of $1.0673. Traders trimmed bets on future rate hikes but are still more than fully pricing another half-point of increases this year. While Spain has of late boasted by far the slowest inflation among the euro zone’s largest economies, it’s demonstrating the same trend: a faster retreat in headline price gains than in the core measure. With ECB officials primarily watching the latter as a guide to when to conclude their unprecedented monetary-tightening campaign, economists and investors expect at least two more quarter-point rate increases to come. Some policymakers reckon hikes could stretch into September, potentially pushing the deposit rate to 4% from 3.25% now to get inflation back to the 2% goal.

Germany joined its major euro-zone peers in reporting a steep slowdown in inflation — underscoring arguments by some European Central Bank officials that interest-rate increases are coming to an end. Consumer prices in the region’s largest economy rose 6.3% from a year ago in May, the Federal Statistics Office said Wednesday. That’s down from 7.6% in April and below the 6.7% median estimate in a Bloomberg survey. The retreat came as fuel and heating-oil costs tumbled, and a cheap, nationwide public-transport ticket was introduced. In a tweet, German Finance Minister Christian Lindner said that there’s “no reason to give the all-clear,” but that the latest figures represent “a positive intermediate step.” Fiscal policy must continue to work “hand in hand” with the ECB to ensure the downward shift in price gains isn’t undermined, he said. The inflation data are a key input into the ECB’s next policy decision in two weeks, when another quarter-point increase in the deposit rate, to 3.5%, is likely amid what’s already an unprecedented barrage of monetary tightening since last July. More interesting will be the signals as to what happens beyond that. Many officials have embraced market bets for borrowing costs to peak after another move of the same size in July. Some, however, argue that hikes may need to continue to the following meeting, in September, to return inflation sustainably to the 2% goal.

In other positive overseas news on the world’s second largest economy, two surveys suggest China’s manufacturing sector improved or at least stabilized in May compared with the previous month, providing some respite following signs of a slowdown in the economy’s recovery. China Beige Book, a US-based data provider, said its surveys show manufacturing output increased “notably” in May from April, as did domestic and foreign orders. Separately, Goldman Sachs Group Inc. cited a pick up in the emerging industries purchasing managers’ index. “It’s still too early to put a nail in the coffin of the post-Covid Zero recovery,” China Beige Book said in a statement. “Manufacturing activity defied rumors of demise, though soft demand from Western economies remains a major headwind.” Revenue and profit margins for Chinese manufacturers as well as the service and retail sectors also increased in May from the previous month, it said. China Beige Book’s data was based on a survey of about 1,000 Chinese firms conducted between May 18-25.

Economists are closely scrutinizing Chinese economic releases after April’s data widely missed forecasts, causing several investment banks to downgrade their projections for GDP growth this year closer to the government’s official target of about 5%. Investors have turned more bearish on Chinese stocks, with the Hang Seng China Enterprises Index dropping about 20% from its Jan. 27 peak. Robin Xing, chief China economist at Morgan Stanley, remained optimistic about China’s growth trajectory for the year despite the softer data last month. “I would see recent April data weakness as a hiccup,” he said in an interview with Bloomberg TV, adding that the strength in services spending limits any need for additional stimulus. “As we have witnessed in other Asian economies who didn’t use paychecks or fiscal transfers to jump start the recovery, the recovery takes time because you need the service sector to recreate jobs,” he said. China’s emerging industries PMI, which measures month-on-month changes in activity in sectors such as renewable energy, advanced manufacturing and biotech, showed an uptick in May compared to the previous month after seasonal adjustment, Goldman Sachs’s China economist Hui Shan said in a note. The EPMI is widely seen as a leading indicator of China’s official manufacturing PMI, and the figures suggest “a tentative sign that manufacturing activity may begin to stabilize,” Hui added.

We hope all of our clients are safe and well. Our planning and client service team has been engaging in a client outreach program to check to see how all our clients are doing – so please do not be surprised when you receive an email and/or phone call from a member of our outstanding team.As always, stay tuned!

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