Economic Outlook – 7 May 2023

Nonfarm payrolls rose 253K in April, a lot more than the median economist forecast calling for a +185K print. However, this positive surprise was offset by a -143K cumulative revision to the previous months’ data. Average hourly earnings rose 4.4% YoY in April, up from 4.3% the prior month and two ticks above consensus expectations. Month on month, earnings progressed 0.5%, again two ticks above consensus expectations and the steepest monthly gain recorded in more than a year. It would be hard to describe April’s report as disappointing. Indeed, job creation continued to be driven by the private sector, where headcounts expanded at the fastest pace in three months. Solid gains in cyclical industries such as manufacturing and construction was another positive since these sectors are generally the first to be affected by a drop in demand or an increase in interest rates. But once again, client-facing industries in the services sector were the real driver of employment gains in April, with health/social assistance and leisure/accommodation registering healthy increases. Elsewhere, gains were much more modest, with the 6-month diffusion index even dropping to its lowest level since the early days of the pandemic  The FOMC voted to raise the target range for the federal funds rate 25 basis points to 5.00% to 5.25%. This marks the tenth straight rate increase of this 500-bp tightening cycle that began in March 2022. Meanwhile, the Fed will continue to reduce its holdings of Treasuries and MBS pursuant to a preexisting program and subject to monthly caps for both Treasuries ($60 billion/month) and agency MBS ($35 billion/month). The interest rate on reserve balances increased an equivalent 25 bps to 5.15%. There were no dissenters in the decision Regarding ongoing stresses in the U.S. banking sector, the statement repeated March’s assessment that the “U.S. banking system is sound and resilient”. However, tighter conditions (presumably a result of banking stresses) “are likely to weigh on economic activity, hiring, and inflation”, though to what extent remains uncertain. On the broader economy, activity “expanded at a modest pace in [Q1]” and job gains have been “robust”. For the second straight decision, only three words were spent on assessing inflation: “inflation remains elevated”. As for the future rate path, policymakers dropped March’s guidance: “some additional policy firming may be appropriate”. Instead, they stated: “In determining the extent to which additional policy firming may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” Nonetheless, the FOMC “remain[ed] highly attentive to inflation risks” Fed Chair Powell noted that upcoming policy rate decisions would ultimately be data-dependent, mentioning the usual suspects (i.e., inflation and labor market metrics), while also putting a focus on credit conditions. Tighter credit conditions ultimately serve a similar purpose to rate hikes when it comes to cooling economic growth and inflation. This is something that the Fed considers in setting monetary policy, especially in light of the recent banking stress, with this week marking the failure of another regional bank. Powell had access to the Senior Loan Officer Opinion Survey (SLOOS), due to be released publicly on Monday, and noted that it would show a tightening in credit conditions among small and medium sized banks. The ISM non-manufacturing PMI remained in expansion territory in April and even grew more vigorous (from 51.2 to 51.9). Growth in business activity decelerated (from 55.4 to 52.0) while new orders gained momentum (from 52.2 to 56.1). New export orders, for their part, recorded a massive increase, jumping 17 points to 60.9 after diving 18 points the previous month. Amid this increased demand, the orders backlog contracted at a slower pace (from 48.5 to 49.7), as did supplier delivery times (from 45.8 to 48.6). On the other hand, the employment sub-index expanded at a slower pace (from 51.3 to 50.8). All this translated into relative stability in the prices-paid sub-index, which remained well in expansion territory (from 59.5 to 59.6 The trade deficit shrank from $70.6 billion in February to $64.2 billion in March. The goods trade deficit, for its part, narrowed from $93.0 billion to $86.6 billion. The contraction was due to a 3.1% increase in exports (to $174.3 billion) while imports essentially held steady (-0.5% to $260.9 billion). On the exports side, the main contributors to the increase included industrial supplies/materials (+$3.9 billion), automotive vehicles/parts (+$0.7 billion), and consumer goods (+$0.3 billion). The decline in goods imports was led by capital goods (-$1.9 billion) and industrial supplies (-$1.4 billion) while consumer goods were up (+$2.4 billion) Construction spending was up 0.3% in March after slipping 0.3% in February. Consensus expectations were for a 0.1% gain in the month. The increase stemmed from both private (+0.3%) and public (+0.2%) construction spending. In the public sector, the bulk of the increase came from the residential segment, which grew 0.8%. The non-residential sector grew as well, but to a lesser extent (+0.2%). In the private sector, residential outlays slipped 0.2% while non-residential spending increased 1.0%. After outperforming during the pandemic, residential construction seems to be running out of steam, as it has now declined for ten consecutive months. This is not surprising given the significant rise in mortgage rates and the marked slowdown in the home resale market According to the Job Openings and Labor Turnover Survey (JOLTS), the number of positions waiting to be filled fell from 9,974K in February to 9,590K in March. This was this indicator’s third consecutive monthly decrease. The decline was steeper than expected by consensus, which called for a 9,736K print. As a result, the ratio of job offers to unemployed person dipped from 1.68 to 1.64, its lowest level since October 2021 but still well above early 2020 levels. The monthly decline was led by transportation/warehousing (-144K), professional/business services (-135K), and health services (-71K). Alternatively, job postings increased in accommodation and food services (+75K) US regulators had hoped the seizure of First Republic Bank, the resolution of its failure, and its subsequent sale to J. P. Morgan would draw a line under the crisis in confidence in US regional banks, but those hopes were quickly dashed this week as a series of regional lenders came under further selling pressure. Early in the week, the US Federal Deposit Insurance Corporation outlined three potential avenues of deposit insurance reform meant to stem the deposit flight from vulnerable institutions, but those reforms would require congressional approval, which would come slowly, if at all. Banks with solid deposit flows and fundamentals have come under attack, but the pressure on the sector eased late in the week. Much of the recent price action in banking has been seen as speculative and not driven by a further deterioration in fundamentals US Secretary of the Treasury Janet Yellen told congressional leaders this week that the US government could run out of money by the beginning of June, a much earlier date than policymakers and markets had anticipated. With just weeks to go before a potential default, talks between congressional leadership and the White House are scheduled for Tuesday, 9 May. House Republicans are looking to cap spending at fiscal year 2022 levels in exchange for raising the debt limit for a year while the administration of President Joe Biden prefers a two-track solution in which the debt ceiling is raised without conditions in return for negotiations over fiscal restraint. Office of Management and Budget Director Shalanda Young said Thursday that Biden and congressional leaders may discuss a short-term debt cap extension but that prioritizing government payments would only be default by another name. It’s worth noting that debt ceiling brinksmanship is nothing new in Washington. A 1987 New York Times column said “the fight to raise the debt ceiling is a periodic ritual on Capitol Hill, and every battle is surrounded by predictions of fiscal ruin.” The US Securities and Exchange Commission approved a rule stipulating that beginning in Q4 companies will have to provide more disclosure when buying back stock. The SEC also adopted a rule that hedge funds must inform regulators of extraordinary losses and margin events within three days Despite a rally on Friday, the S&P 500 Index ended the week lower on comments from Federal Reserve Chair Jerome Powell that suggested a pivot to cutting rates might not occur as quickly as the market had hoped. Uneasiness surrounding the need to raise the U.S. debt ceiling may also have weighed on sentiment, as U.S. Treasury Secretary Janet Yellen notified congressional leaders in a letter that the agency might not be able to meet its debt obligations “potentially as early as June 1.” Within the S&P 500, the information technology sector fared the best and ended higher. Energy shares pulled back in sympathy with the price of West Texas Intermediate crude oil The NFIB Small Business Optimism index is out on Tuesday. The index’s outlooks appear to be worsening alongside mounting recession fears. The small business optimism index slipped 0.8 points to 90.1 in March, the 15th straight month that the index has measured below its long-term average of 98. Despite easing price pressures, only 2% of firms on net believed it is a good time to expand, the lowest reading since the Great Recession (March 2009). In the same vein, only 15% of small businesses on net planned on expanding payrolls over the next three months, the lowest level since May 2020 The CPI print is out on Wednesday. Consumer price inflation has improved notably since peaking at 9.1% in May 2022. The headline index in March posted its smallest monthly gain in nearly a year (0.1%), amounting to a 5.0% annual increase. Core inflation remains much stickier. A pickup in goods inflation, largely attributable to a rebound in new vehicle prices, caused the annual growth in core CPI to increase to 5.6% in March from 5.5% in February. Yet, the March CPI print also gave the first glimpse into the long-anticipated slowdown in CPI’s rent measure, which fell from a 0.8% monthly increase in February to 0.5% in March. Decelerations in both rent and owners’ equivalent rent, on top of outright declines in medical care prices, led core services prices to post their smallest increase in eight months.   

Mortgage approvals for March registered at 52,000, a significant jump from February’s figure of 44,100 and exceeding market expectations of 46,000. While approvals are stronger than expected, it is important to note that levels remain below the average for 2022 of 62,700. This data comes on the back of recent data showing prices in the housing market being more robust than expected Households withdrew, on net, GBP 4.8bn from banks and building societies in March, compared with net deposits of GBP 2.6bn in February. When you include NS&I accounts in net flow of deposits, March registered at GBP -1.3bn versus GBP 4.6bn of deposits in February. UK non-financial businesses withdrew, on net, GBP 1.3bn of deposits from banks and building societies, although this was down from GBP 4.8bn in February. Consumer borrowing remained fairly consistent with the previous month’s reading: individuals borrowed an additional GBP 1.6bn in consumer credit in March, on net, compared to GBP 1.5bn in February. 

The Governing Council (GC) decided to raise its policy rates by 25bp stating that the inflation outlook continues to be too high for too long. The GC meeting press releases signals that future decisions will ensure that the policy rates will be brought to levels sufficiently restrictive to achieve a timely return of inflation to the 2% medium-term target and will be kept at those levels for as long as necessary. The April bank lending survey (BLS) had an impact on the Governing Council’s interest rate decision. The BLS showed that loan demand weakened and credit conditions tightened in the first quarter. For the ECB, the BLS shows that the policy rate hikes are having an impact on loan demand and economic activity in the eurozone. The ECB expects to discontinue the reinvestments under the APP as of July 2023. Currently, the APP holdings are being reduced at a pace of EUR 15bn per month as they are not fully reinvested and this process will continue until the end of June Lagarde did not provide clear forward guidance on the future policy rate path in the press conference. She reiterated that the ECB is not pausing and they still have more ground to cover. “This is a journey and we have not arrived.” Also the press release indicated that “the Governing Council’s future decisions will ensure that the policy rates will be brought to levels sufficiently restrictive to achieve a timely return of inflation to the 2% medium-term target and will be kept at those levels for as long as necessary.” Eurozone inflation in April was slightly above expectations at 7.0 percent YoY, compared to 6.9 percent the month before.  Food, alcohol & tobacco is expected to have the highest annual rate in April (13.6 percent, compared with 15.5 percent in March), followed by non-energy industrial goods (6.2 percent, compared with 6.6 percent), services (5.2 percent, compared with 5.1 percent) and energy (2.5 percent, compared with -0.9 percent). Meanwhile, core inflation was in line with expectations at 5.6 percent compared to 5.7 percent the month before.  The HICP releases in April (March) for major eurozone countries were as follows: France 6.9 percent (6.7), Germany 7.6 percent (7.8), Italy 8.8 percent (8.1) and Spain 3.8 percent (3.1). High core inflation would suggest a 50bp policy rate hike by the ECB on Thursday. However, the April 2023 Bank lending Survey (BLS) indicated that euro area banks have substantially tightened their credit standards for loans or credit lines to enterprises in the first quarter of 2023. In the second quarter of 2023, euro area banks expect a further, though more moderate, tightening of loans to companies.  The tightening of credit standards would call for a smaller policy rate hike In local currency terms, the pan-European STOXX Europe 600 Index ended 0.28% lower over the five trading days ended May 5, as recession fears and banking tremors continued to weigh on sentiment. Major stock indexes were mixed. Germany’s DAX ticked up 0.24%, while France’s CAC 40 Index weakened by 0.78%.  

China’s official manufacturing purchasing managers’ index (PMI) fell to 49.2 in April from March’s 51.9, marking a return to contraction for the first time since December after Beijing abandoned its zero-COVID policy. The nonmanufacturing PMI also softened in April but remained above 50, the level separating growth from contraction. Separately, the private Caixin/S&P Global survey of manufacturing activity eased to 49.5 in April from 50.0 in March amid softening global demand. The Caixin/S&P Global survey of services activity also weakened but remained in expansion territory for a fourth consecutive month. The downturn in factory activity in both surveys raised concerns that China’s post-COVID recovery is losing momentum Domestic tourism during the five-day holiday rebounded to pre-pandemic levels. Approximately 274 million trips were taken from Saturday through Wednesday, marking a roughly 71% increase from a year earlier, according to the Ministry of Culture and Tourism. Spending activity over the break surged about 129% over the year-earlier period. The latest figures fueled optimism that a sustained recovery in the services sector could help offset manufacturing sector weakness and a fragile property market recovery Chinese equities ended mixed after a holiday-shortened week as surprisingly weak manufacturing data tempered sentiment. The Shanghai Stock Exchange Index gained 0.34% while the blue chip CSI 300 fell 0.3% in local currency terms. Financial markets in mainland China were closed Monday through Wednesday for the Labor Day holiday.
Sources: T. Rowe Price, MFS Investments, Wells Fargo, Handelsbanken Capital Markets, National Bank of Canada, TD Economics, M. Cassar Derjavets.