Will AI, millennials and productivity save the day?
Let's hope so because massive and growing deficits are spooking markets.
Travels this week took me to Chattanooga. Although its Terminal Station with its famous “Track 29” was significant during the train area, little was known about the first Chattanooga Choo Choo until Glenn Miller’s orchestra’s catchy song of the same name in the 1940s. Today, Chattanooga sits in the center of “Freight Alley,” spanning Tennessee, South Carolina, North Carolina, Georgia and Alabama. For years a manufacturing powerhouse and major distribution/logistics region—one study ranks it No. 1 of all metro areas in freight movement—it’s also known as “Gig City.” It was the first in the Western Hemisphere to offer 1 gigabit-per-second fiber internet service to all residents and businesses. I spoke there about a different kind of “gig,” a job. A job guarantee is the cornerstone of MMT (which arguably is now policy), and my presentation on the subject stirred debate and shaking heads among the amiable group of bankers. No doubt the run-up in debt is scary. The Congressional Budget Office projects deficits will eat up 6.1% of GDP annually over the next 10 years, doubling interest on the debt to above 20% of the federal budget. Ongoing Covid relief ($130+ billion so far this year with $100 billion more to go) and Bidenomics are keeping Treasury issuance high even as buying is softening. This (and the Bank of Japan’s easing of yield control) is elevating yields despite moderating inflation. Indeed, the 2/10-year Treasury curve spread is back above its 200-day moving average for the first time since spring, only this time due to a rare bear steepener, with long rates rising faster than short rates.
Could it be that yields are simply normalizing after an abnormally low stretch from the global financial through the Covid crises? That’s what Yardeni Group thinks. It notes the spread between 10-year nominal and TIPS yields mostly hovered around 2.00% in the three years before the GFC—4.50% on the 10-year and 2.5% expected inflation. The economy performed just fine then. So did stocks. Whatever the reasons, with the 10-year breaching resistance at 4.25%, yield anxiety is unsettling markets. Where does it stop? 4.50%? 5.00%? How will stocks respond? While Evercore ISI views stocks as oversold and on the tail end of a seasonal pullback in a powerful uptrend, it thinks 4,200 on the S&P 500 may be tested before a buying opportunity emerges. The market rarely bottoms until more than half of industries trade below their 200-day moving averages; right now, slightly more than half are above those averages. In bond land, the U.S. Agg index is about to mark 37 months without a new all-time high, an historic run. The good news: the 10+-year Treasury index historically has averaged a 14.5% return in the 12 months after the last Fed hike. The bad news: not sure the Fed’s done yet.
The economy’s strength is challenging for Powell et al. He suggested as much at Jackson Hole where as expected he hewed to the Fed’s 2% goal. The Atlanta Fed is tracking Q3 GDP at 5.9% annualized! And credit spreads keep tightening, a sign the corporate end of the bond market may be starting to price a soft landing. While credit delinquency warnings from Macy’s shook markets Tuesday, a broader set of Fed data shows delinquencies simply normalizing to 2.6%, in line with the 2011-2019 average and well below the 4.4% average from 1991 to 2007. Revolving credit is setting new highs but relative to disposal income, still averages just 6.3% vs. the 6.6% average from 2012-2019. The broader household debt service ratio has ticked lower and remains below the 2011-2019 average of 10%. With households and nonfinancial corporations having termed out debt at historically low levels, they’ve largely been immunized from tighter monetary policy (home buyers aside, more below). But what’s going to save us from big trouble, i.e., massive and growing deficits? AI and productivity, perhaps? This week’s blowout Nvidia earnings suggest the AI revolution is just getting started. It’s helping drive capex as an estimated $200 billion of computer, electronic and electrical industries facilities are underway or breaking ground. Another catalyst, Jefferies says, is the wave of younger workers replacing retiring boomers. As this massive generation gains experience, productivity growth should follow, just as it did in the ’80s and ’90s as boomers aged into their prime working years. Q2 may have offered a glimpse, with productivity posting its biggest increase in 3 years. AI, millennials and productivity—a combo that just may save the day!
Positives
- The consumer reigns supreme Back-to-school shopping appears to be going strong, with payment card transactions excluding non-store retail up 13.9% through Aug. 15. It’s not just excess savings behind the spend. Minimal layoffs (initial claims fell 10,000 to a 3-week low) and rising real wages (the Atlanta Fed says wage growth is tracking at around 6% (!) y/y) are factors, too.
- New homes continue to pick up … Despite spiking mortgage rates, July new home sales increased a better-than-expected 4.4% m/m to a 16-month high, putting them up 32% (!) y/y. The report follows housing starts, which also surprised to the upside on a big increase in single-family homes. A key factor is supply, which at 7.3 months doubles that of existing homes (see below). It helps that new home sales prices also continue to moderate off last year’s record high.
- Global trade bottoming? To the extent that Taiwanese export orders are a bellwether for global trade, July hints at an inflection point, with the pace of decline slowing sharply thanks to a 33.7% y/y jump in orders from Southeast Asian economies. Particularly noteworthy is that electronic products, which account for the lion’s share of Taiwanese export orders, saw their contraction effectively evaporate from June’s 22% y/y decline to just -0.39% y/y. Swedish economic data (including a rising new orders-to-inventories ratio) also suggests the global manufacturing cycle is turning the corner.
Negatives
- Not looking good across the pond EU flash PMIs for August disappointed, with the composite reading falling to 47, a 33-month low consistent with zero GDP growth. Manufacturing improved but remained deep in contraction while services buckled below a breakeven 50. Germany was at the heart of the weakness. In the U.K., the flash PMI plunged, led by manufacturing. Services also dipped below 50. By comparison, the flash U.S. composite remained above 50, despite further manufacturing deterioration.
- … Existing home sales continue to struggle They fell 2.2% in July, with the y/y decline at 16.9%. Three big headwinds are to blame: slim pickings (existing home inventories are running at 3-months’ supply, roughly half normal); mortgage rates (the average 30-year is its highest since 2000); and prices (the y/y median sales price rose in July to $407k, only the fourth time ever that it’s eclipsed $400k!).
- Better than the headline July durable goods orders slid 5.2%, but solely on a 14.3% plunge in volatile transportation orders (civilian aircraft). Ex-transportation, new orders rose a third straight month, with machinery orders up 1.1%, their biggest one-month increase since October. Core orders—non-defense capital goods ex-aircraft—also increased for the third time in the last four months.
What else
On the bright side, maybe they won’t come live with us after college Big high-profile wage settlements risk keeping broad pay gains elevated—American Airlines’ new labor deal calls for 46% in cumulative pay raises over four years, Delta’s raises are 34% and UPS drivers could see their pay averaging $170k. New data from the NY Fed shows the average “lowest wage” respondents would be willing to accept for a new job at $79k, vs. $69K two years ago. Employees with college degrees now anticipate $98.6k to start!
A post-Jackson Hole bump? Fundstrat puts odds of such at 80% next week, based on past equity market behavior. Of seven instances over the last 20 years when the S&P was down two weeks prior to the annual confab (as it was this year), equities rallied six times in the subsequent week, with gains ranging from +0.5% to +5%. The one exception? 2022, when Powell’s comments were uber hawkish.
We all know what “shrink” means Because of rising retail theft, many stores now lock up merchandise in clear containers (from ice cream to cosmetics), only to be retrieved by pressing a button alerting a store associate for assistance (who sometimes don’t show up). Just another reason why shoppers increasingly are opting for one-click checkout and next day delivery to your doorstep.