Andrew Cates

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The incoming economic data over the past few days have – on the whole - painted a bright picture of the world economy. May's purchasing managers surveys for the US and Europe, published last week, suggested a broadly based improvement in economic activity among a number of countries and sectors has been unfolding. Last Friday's US employment report validated that message by exhibiting a decent pick up in labour market activity in May, notwithstanding some disappointment in the aggregate payroll figures. Multi-year highs for South Korea's export growth in May added further resonance to the idea that the world economy is picking up a good head of steam.

Less conventional high frequency data reinforce this message. In figure 1 below we have plotted daily data from mid-February 2020 to end-May 2021 for a newly calculated global growth indicator. This comprises three component series concerning trends in population mobility, job postings and restaurant dining activity. Great care needs to be taken in interpreting this indicator as the baselines for each series differ and the numbers are not seasonally adjusted. Still, that our indicator has climbed to its highest level since March last year, and is now not too far shy of its pre-COVID peak, endorses the idea that the world economy has been healing quite rapidly.


Figure 1: Global growth indicator – from alternative data
<a href="/comment/210607z1.png" name="modal"><img class="small" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/210607z1.png"></a>
Source: Google, Indeed, Open Table, Haver Analytics. This indicator is an unweighted normalised average of three component series concerning trends in mobility, job postings and restaurant dining. Global mobility trends are calculated from unweighted normalised averages of Google's retail and recreation data for the US, Japan, Germany, France, the UK, Canada and India. Global job postings data are calculated from unweighted normalised averages of Indeed's labour market data for the US, Canada, France, Germany and the UK. Global dining data is calculated from Open Table's global aggregation of restaurant dining trends, in turn derived from data for the US, Canada, Germany, the UK, Australia, Mexico, and Ireland. Care needs to be taken in interpretation as baselines differ across component series.


Nevertheless, while all these data are yielding upbeat aggregate signals about global economic performance if we dig a little deeper there are some trends that are more troubling. Three trends in particular stand out.

Firstly, the global recovery is somewhat uneven outside of the US and Europe. While last week's Purchasing Managers' surveys offered upbeat signals for those areas, the messaging was less promising for others, including Japan and China (see figure 2 below).


Figure 2: Manufacturing PMIs in the Euro Area, Japan and China
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One reason for this uneven performance appears to be rooted in vaccination rollouts. Those countries that have delivered vaccines at a relatively rapid clip in recent months, such as the US and UK, have chalked up impressive gains in PMI indicators. On the other side of that equation, however, countries that have been slower to rollout a vaccination programme, such as Brazil, India and Japan, have chalked up less impressive gains or even outright declines (see figure 3 below).


Figure 3: Economic success may be linked at present to vaccination success
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Source: University of Oxford/Haver Analytics


The second troubling trend relates to supply side bottlenecks and inflation. The underlying details of most countries' Purchasing Managers surveys revealed lengthening delivery times, higher numbers of order backlogs and firmer output prices (see figure 4 below). An even bigger dig into the details reveals that the rate at which delivery times worsened was much faster than the rate at which output has growing.


Figure 4: Global manufacturing PMI: Output prices versus suppliers' delivery times
<a href="/comment/210607z4.png" name="modal"><img class="small" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/210607z4.png"></a>


The third troubling trend concerns the wheels of credit in China. For these are slowing down (see figure 5 below) probably in response to a more intense effort from the Central Bank to curtail lending growth. Excess leverage in the property sector and the heightened use of business loans to buy property in particular have concerned the PBOC and driven its policy guidance and liquidity management toward less monetary accommodation. Insofar as this has reverberations for financial conditions, capital flows and trade, this could have been a factor in driving the broader Asian region onto a slightly softer growth path in recent weeks.


Figure 5: Fading credit momentum in China
<a href="/comment/210607z5.png" name="modal"><img class="small" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/210607z5.png"></a>


There are several implications from this analysis:

•	Firstly, further positive progress on the global growth front is heavily contingent on the pace and efficacy of vaccination programmes. Policymakers in the meantime still need to be mindful of COVID mutations on the one hand and policy responses toward lockdowns on the other.

•	Secondly, prospective inflation pressures are now heavily contingent on the pace at which capacity can be expanded – along with the productivity ramifications - relative to further positive progress on global growth.

•	Finally, policymakers may need to be additionally mindful of any potential ramifications of a further monetary policy tightening in China, not least given its linkages with global commodity price trends and global growth and inflation outcomes more generally.

The broad policy conclusions from this seem clear. Policymakers should retain a heavy focus on the pace and efficacy of vaccination programmes with a keen eye on the global distribution. On the macroeconomic front in the meantime they should ensure companies are incentivised to make the necessary investments in labour and capital that, in turn, fosters firmer productivity growth and holds unit cost and price pressures at bay.

On that last point there are couple of factors that speak positively to the outlook from here. Firstly, capital spending is picking up strongly at present in a number of major economies. Annual growth rates of capital goods orders in the US and Germany, for example, are running at multi-year highs. And as we saw above, manufacturing sentiment gauges – usually a good leading indicator of capex trends – are also at multi-year highs in the US and a number of European countries. These capex positives incidentally are one reason why South Korea (and other Asian economies) have been posting double digit export growth in recent months (see figure 6 below).


Figure 6: US capital goods orders versus South Korean export growth
<a href="/comment/210607z6.png" name="modal"><img class="small" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/210607z6.png"></a>


The second factor relates to the links between supply chain bottlenecks, capex and productivity growth that have held sway in the past. As figure 7 below attests, whenever manufacturers' delivery times have lengthened in earnest in the past, businesses have typically responded by adding capacity and marshalling an improvement in productivity.

There are no guarantees of these productivity echoes this time round of course not least because the pandemic is posing additional challenges. In the global recovery race, however, this is a reminder that there are several competing forces. Vaccines are competing with the virus (and mutations). And growth is competing with capacity and inflation. Navigating these crosscurrents will remain challenging and require policymakers to be both nimble and global. Straight line forecasts for, say, firmer growth and higher inflation, in the meantime, are arguably unwise.


Figure 7: US ISM: Supplier delivery times versus US productivity growth
<a href="/comment/210607z7.png" name="modal"><img class="small" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/210607z7.png"></a>

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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The incoming economic data over the past few days have – on the whole - painted a bright picture of the world economy. May's purchasing managers surveys for the US and Europe, published last week, suggested a broadly based improvement [...]

Vaccines, Capex and China Now Hold the Key

Joseph G. Carson

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In May, the Institute of Supply Management (ISM) reported that lead time for production materials jumped to 85 days, up from 79 in April. The May reading is an entire work-day month (21 days) above the level from one year ago and the highest reading since 1979, or when ISM has been using the current methodology to track lead times.

Leadtimes are a valuable indicator of current and future demand. When backlogs rise and get stretched out, firms protect their production schedules by building safety stocks and placing long-dated orders for materials and supplies to meet expected future demand.

The current generation of policymakers probably does not follow lead times, but the old generation did. (Read the 1994 transcripts of the Federal Open Market Committee meetings). Former Federal Reserve Chairman Alan Greenspan religiously tracked lead times, order backlogs, and delayed deliveries (i.e., vendor performance or nowadays called supplier delivery index) as signs of future inflation and inventory building. The latter is an essential part of demand-driven fast growth and inflation cycles since it adds a layer of demand, putting more pressure on prices.

In May, a record low 28% reading for the customer inventories index and a relatively high price index reading of 88% accompanied the record high reading for lead times. The old generation of policymakers would see these data points as evidence of a more general emergence of inflation pressures.

It would be prudent for the current generation of policymakers to scrap their "transitory" price playbook and take out the policy playbook of 1994.

In 1994, with a set of lead time, suppliers index, and price paid data that is not as scary as today, the old generation of policymakers saw the need for substantial monetary restraint to break the inflation cycle and limit the cyclical rise in general inflation. When the monetary tightening cycle was over 12 months later, the old generation raised the nominal and real federal funds rate 300 basis points. Years later, Mr. Greenspan praised his team's decisions as it successfully cut short the inflation cycle.

The current generation is not even thinking about lifting official rates, and even if they decided to so tomorrow, there is a gradual progression of effects on the economy. So if policymakers decided to raise the official rates to pre-pandemic levels of 1.5% over several quarters, the full impact would not be felt for a year or more. Even that would not impose much monetary restraint as it would still leave real interest rates negative.

As such, the current generation of policymakers is running with a policy approach--doing nothing--- that has never even been used to break an inflation cycle. In the past, delays in enacting monetary restraint triggered bad outcomes, so the odds of a successful outcome from a doing nothing policy approach seem very low, probably as low as the federal funds rate (0.06%).


Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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In May, the Institute of Supply Management (ISM) reported that lead time for production materials jumped to 85 days, up from 79 in April. The May reading is an entire work-day month (21 days) above the level from one year ago and the [...]

Record Lead-Times For Materials Signal Firms Are Expecting Persistent Inflation

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In Q1 2021, the US economy registered double-digit annualized growth in nominal GDP, a rare occurrence. Yet, an even more rare event is that corporate operating profits did not increase in the quarter when GDP growth increased double-digits.

How can companies' operating earnings be flat when nominal growth is booming? How does the GDP measure of operating square with S&P 500 firms reporting substantial gains in Q1, far exceeding analysts' estimates?

GDP Growth &amp; Operating Profits 

The Bureau of Economic Analysis (BEA) reported that nominal GDP increased at an annual rate of 11% in Q1 2021. Since the Reagan boom of the early 1980s, the US only registered double-digit annualized quarterly growth eight times, not including Q1. Five of those occurred during the 1983-84 period of massive federal tax cuts and defense spending boom.

Rapid gains in GDP generate equally substantial increases in gross domestic income (GDI). GDI has two main components; personal income and corporate profits. BEA reported that Q1 gross domestic income (GDI) jumped 11.4% annualized in Q1, with personal income jumping 59% annualized (helped by record federal stimulus payments) while operating profits showed no gain.

A decline in operating margins helps explain the weak profit performance against a backdrop of rapid nominal growth. Factors that squeezed Q1 margins include private-sector wage and salary cost increasing faster than GDP prices (4.6% versus 4.3%) and a 20% jump in costs for intermediate materials and supplies.

Declines in profits margins are more late-cycle events, so drop the Q1 margins, which comes on the heels of a drop in Q4 2020 as well, bears watching, especially with equity markets trading at record highs with elevated price-to-earnings ratios.

Yet, equity investors are responding to reported earnings for S&P 500 companies. GDP profits and S&P earnings reflect different accounting frameworks. GDP operating profits are extrapolated from tax-return-based accounting, whereas S&P 500 companies report their earnings based on financial accounting.

The financial accounting framework allows companies to include non-operating profits and losses. The most significant non-operating items include capital gain income and losses resulting from trading activities or a revaluation of an asset. GDP profits exclude capital gain income and losses and revaluations of assets (higher or lower). Also, financial accounting allows firms not to record employees' stock options as an expense, but firms can use the appreciation of securities for specific purposes to boost reported earnings.

Past studies by the Bureau of Economic Analysis (BEA) have found that capital gain income and losses and the mark-to-market of securities holdings can explain much of the difference in the operating profit measures.

At the moment, there seems to be a circular flow going on between equity market gains and reported profits. Equity prices rise based on the expectations of higher reported profits, and it's the increase in the share prices that enables companies to report strong financial results when profits from operational units are underperforming.

Yet, its core earnings, not capital gain income, that matter the most, something that equity investors, analysts, and strategists are ignoring for the moment.

At the outset of an economic upturn, profit margins expand, and the expansion in margins can run for several years. But operating margins are not expanding today.

Several factors are at work. Labor shortages are forcing wages up much more so than is typical at the early stage of recovery. Also, delayed deliveries because of supply-chain bottlenecks result in higher transportation and logistics costs, and strong demand is lifting material and supplies input costs.

Wage and cost pressures are not dissipating anytime soon. Surveys of manufacturing and services firms for May continue to show relatively high prices paid indexes. Also, with the customer inventories index in the manufacturing surveys at record low levels, it will take several months, if not quarters, before a better balance exists between supply and demand. And a rising percentage of small and big firms have already or are planning to raise wages to attract more labor.

One has to ask why so early in the economic upturn are there general costs and price pressures. The history of business cycles shows a cycle in prices, but many of these cost and price pressures have been missing in recent business cycles and never show up early in the upturn. It is wrong and short-sighted to argue that it is transitory or a blip, especially with the current policy backdrop. Should more inflation be a surprise when fiscal policy runs record deficits to support growth, and monetary policy is the most accommodative on record?

Firms need to raise prices to cover rising costs from all sides and stabilize, if not reverse, shrinking margins. And they are. As this process continues to play out, the inflation cycle runs longer, bringing the Fed into play with the need to raise interest rates at some point. Higher interest rates will not immediately impact the operating results of non-financial firms, but they will pressure the valuations of equity prices.

Shrinking profit margins are never a harbinger of good news for equity investors, nor is the prospect of monetary restraint to dampen rising price pressures.


Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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In Q1 2021, the US economy registered double-digit annualized growth in nominal GDP, a rare occurrence. Yet, an even more rare event is that corporate operating profits did not increase in the quarter when GDP growth increased double- [...]

A Margin Story: Fast Economic Growth Without Profits

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Fiscal-policy aided factory building in the U.S. provided an unusually large boost to growth last year

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Blue Chip forecasters expect significant monetary easing this year except in Japan

Euro area economy stagnating while US grows above trend

Chinese and Japanese equity markets are diverging markedly

Chinese population declines in 2023 for second consecutive year

Outlook for US GDP growth on the rise; declining in euro area, Japan and China

There are still 1.4 job openings for every unemployed person in the US

US PCE inflation over the past six months has slowed to the Fed's 2% target

FOMC think rate hikes are done and looks for 75bps of decline in 2024

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Ken Matheny

**The US economy is stronger than suggested by the “soft” 1.6% increase in GDP in the first quarter, while a sharp upturn of inflation puts Fed rate cuts on hold for at least several months.**

**Look to final sales to private domestic purchasers, not GDP, for a better indication of the economy’s underlying strength.**
The initial (“advance”) report of the national accounts for the first quarter of 2024 should be interpreted carefully.  Looking beyond the headline figures, the economy’s underlying growth momentum was notably stronger than the disappointing figure of 1.6% quarterly GDP growth in the first quarter.  GDP growth was held down by declines in components that tend to be more volatile  --- inventories and net exports --- in contrast to solid growth in other components, including consumer spending and private investment.  Personal consumption expenditures (PCE) posted solid growth (of 2.9%).  Business fixed investment also rose 2.9%, while residential investment jumped 13.9%, continuing a recovery that began in the second half of 2024.

A more telling indicator of the US economy’s underlying strength is final sales to private domestic purchasers, which rose at a solid 3.1% annual rate in the first quarter, virtually identical to increases in the third and fourth quarters of 2023 of 3.0% and 3.3%, respectively.  This is a clear if preliminary indication that the economy retains solid momentum for growth.

Together, declines in inventory investment and net exports subtracted 1.2 percentage points from GDP growth in the first quarter, but those components are not likely to continue to subtract large amounts from GDP growth on an ongoing basis, even though quarterly swings could be significant (in either direction) from time to time.  The level of inventory investment ($35 billion in the first quarter) is broadly sustainable, suggesting that repeated large declines are not the most likely outcome.  Net exports have been in a sideways waffle since the second half of 2022.  Future large declines are possible if foreign demand were to collapse or the dollar were to appreciate sharply, but neither of those outcomes appear to be highly likely at this juncture.  In short, the 3.1% growth in final sales to domestic purchasers is a better indicator of underlying strength in demand than the smaller 1.6% increase in GDP in the first quarter.

Of course, GDP and other estimates are subject to revision, so the picture of first-quarter growth could be altered in coming months.

**Inflation surged in the first quarter, nearly eliminating any prospect for a Fed rate cut prior to this fall.**
Another major component in today’s report on the national accounts was a disturbing increase in consumer inflation.  The price index for personal consumption expenditures (PCE) rose at a 3.4% annual rate in the first quarter, the largest increase since the first quarter of 2023.  Meanwhile, the core PCE price index rose at an even higher 3.7% annual rate in the first quarter, far above the increase of 2.0% in the final two quarters of last year.  This is a direct challenge to any hope that the Federal Reserve will begin to lower interest rates in coming months.  As of the first quarter, the annual (four-quarter) increase in the core PCE price index was 2.9%.  It is likely that tomorrow’s report on monthly PCE will show annual (12-month) inflation at or slightly above February’s 2.8% reading.

The Federal Open Market Committee (FOMC) will almost certainly not begin to seriously contemplate rate cuts without clear indications that inflation is easing and well on track to fall to 2% over time.  The latest inflation figures suggest that progress on bringing inflation down has stalled.  It will take more than one or two “good” monthly inflation reports to convince policymakers that it is appropriate to begin cutting interest rates.  This makes any rate cut prior to this fall a low probability outcome and adds to the risk that there might not be any Fed rate cut in 2024.

240425KM.jpg

First-Quarter 2024 National Accounts

Charles Steindel

The Federal Reserve Bank of Philadelphia’s state coincident indexes in March showed some moderate variance. Four states were down slightly from February. The largest increase was Arizona’s .8 percent; three other states (Iowa, Delaware, and Vermont) had gains of at least .5 percent. Over the three months since December, Massachusetts was up 1.9 percent, while 8 other states (scattered across the nation) rose more than 1 percent. Over the last 12 months, Massachusetts again led, with an increase of 4.9 percent, while New York’s 3.6 percent was a fairly distant second. 5 states were down over the period, with Montana’s slump continuing, with a loss of 3 percent.

The independently estimated national figures of growth over the last 3 months (.75 percent) may be a touch higher than the state estimates would have suggested, but the 12-month figure (2.9) percent) looks to be roughly in line with the state numbers.

State Coincident Indexes in March 2024

State labor markets were little-changed in March, but on the whole the report looked better than February’s. Only five states had statistically significant gains in payrolls (Arkansas, Georgia, Kansas, Kentucky, and Virginia), with two having .5 percent increases (Arkansas and Virginia).  The other states, and DC, had insignificant changes, though numbers had point increases comparable to those that were deemed significant. For instance, California had an increase of about 30,000, though that was less than .2 percent, and New Jersey was up around .3 percent.

Six states had statistically significant declines  in their unemployment rates in January, while one had a significant increase. The only move larger than .1 percentage point was a decline of .3 percentage point in Arizona.  The highest unemployment rates were in California  (5.3%), DC (5.2%) and Nevada (5.1%). States with unemployment rates of 4.8% (one point above the national rate)were Illinois, New Jersey, and Washington.   Maryland, Minnesota, Nebraska, New Hampshire, North Dakota, South Dakota, Utah, Vermont, and Wyoming  had rates of 2.8% or lower, with North Dakota at 2.0%.

Puerto Rico’s unemployment rate moved up to 5.8 percent, while the island’s job count moved up by 2,200.

State Labor Markets in March 2024

Viewpoints: June 2021

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Vaccines, Capex and China Now Hold the Key

Record Lead-Times For Materials Signal Firms Are Expecting Persistent Inflation

A Margin Story: Fast Economic Growth Without Profits