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Monthly Macro & Markets February 2023: Markets fret over higher MoM inflation, but the US is still in a disinflationary phase
Monthly Macro & Markets February 2023: Welcome!
Welcome to the first installment of Monthly Macro & Markets (MMM), where I break down the key economic data & market events that took place during the last month — I hope you enjoy this latest addition to Economics Uncovered!
This month in macro
M2 continues to decline — now down 1.8% YoY
With the Fed continuing to tighten, the M2 money supply continues to fall. M2 has now recorded MoM declines in 8 of the past 12 months. The 0.7% decline in January takes its YoY growth rate to negative 1.8%.
In the 60+ years that the Fed provides monthly M2 data, it had NEVER recorded a YoY fall. This shouldn’t be surprising, as an inflationary debt driven monetary system requires additional credit and money growth in order avoid painful deflationary debt deleveraging.
Using annual average data allows us to go back further — it provides an ominous warning. When was the last time that the Fed hiked rates while M2 was falling? The Great Depression. Remember, a system built on leverage does not like money being artificially pulled from the system.
Just as a rapidly rising money supply saw a surge in economic activity, aggressive tightening that sees it decline will lead to the opposite occurring, as the change in M2 filters through the economy.
Look beyond the headline: underlying economic growth continues to weaken
While GDP rebounded in 2H22 from two consecutive quarters of headline declines in 1H22, looking beyond the headline number reveals a much weaker picture.
The “rebound” in growth during 2H22 was significantly driven by changes in the volatile private inventories components, as well as a significant decline in imports, which actually suggests a weak economy.
In order to get a better picture of the underlying economy, we can look at the movement in real final sales to domestic purchasers — this metric excludes changes in inventories and net exports. On this basis, economic growth remains weak, and was revised down to just 0.7% in Q4 2022. This compares to the average QoQ annualised growth rate of 2.2% since 2000, and is BELOW the 0.9% growth that was recorded at the beginning of the 2001 recession.
Emphasising the weak underlying economic growth is the aforementioned decline in imports. While lower imports act to boost headline GDP, one needs to remember that much of the US’ demand for goods is satisfied by imports. Given that the US hasn’t suddenly onshored an enormous amount of goods manufacturing, the significant decline in imports that has occurred over the past two quarters suggests weakening demand, and is yet another indicator that is flashing recession.
CPI sees a high MoM reading, but the disinflationary thesis remains intact
While economic growth continues to show a weakening trend, monthly inflation moved in the other direction in January, with the CPI’s MoM growth rate rising to 0.8% (non-seasonally adjusted). The CPI also increased by 0.8% MoM on an ex-shelter basis.
Does this represent a return to accelerating inflation after a significant deceleration was seen in 2H22? I don’t think so. Remember the first point raised at the beginning of this report: YoY M2 is falling. The key condition that would allow for another wave of inflation, like occurred in the 1970s/80s, is thus not present.
Instead of surging inflation, the disinflationary cycle continues. Durables prices have decelerated. Nondurables prices are decelerating. Services prices are the most lagging and are yet to decelerate — though given falling M2, they will in time.
Given that much of the large disinflationary offset from lower durables/nondurables price growth has already occurred, MoM price changes over the next few months will not only be bumpy on account of volatile energy prices, but likely also somewhat higher than in 2H22, as we await a final peak in YoY services price growth.
Seasonality is also a driver of higher MoM CPI readings from January to May, further suggesting that MoM price growth is likely to be higher than what was seen in 2H22. Rather than indicating a resurgence in prices, much of it will thus also be a result of seasonal patterns.
While the MoM growth rate in January was above its historical average, this is to be expected now that durables have largely decelerated and that services prices are yet to turn lower — more time is needed for the latter happen.
Another month of “strong” jobs data — but is it really?
Amidst a weakening trend in underlying economic growth and a falling M2 money supply, the monthly jobs report posted a blowout number: 517,000 nonfarm payroll jobs were estimated to have been added in January.
Indeed, it’s such a large blowout that it raises suspicion.
A deeper look at the employment situation reveals several important factors that suggest nonfarm payrolls could be being significantly overstated.
Allow me to try and briefly explain the situation.
The first thing to understand is that the monthly nonfarm payroll numbers are calculated from the Current Employment Statistics (CES) report. This report is based on data that covers ~6% of employers. The BLS also produces a more comprehensive QCEW (Quarterly Census of Employment and Wages) report that covers data from more than 95% of employers. The latter is thus the more reliable indicator of changes in employment.
Great — so let’s just look at the more comprehensive data and problem solved, right? Well, there’s one big problem.
The more comprehensive QCEW data is provided MUCH less frequently - the BLS releases the report ~5 months after the end of a quarter (meaning that it takes up to 8 months for insights into employment from the BEGINNING of a quarter), whereas the monthly CES report is released within weeks of the prior month ending.
In order to gain a more prompt picture of employment, policymakers, economists and analysts thus focus their attention on the CES report, assuming it to be relatively accurate.
The problem is, that from time to time, the more comprehensive QCEW data can conflict with the monthly CES data — which is exactly what happened in Q2 2022.
The Philadelphia Fed produces the Early Benchmark Revisions of State Payroll Employment report, which is based on the more comprehensive QCEW employment data. Its report for Q2 2022, shows that just 10,500 jobs were added. This compares to the revised 988,000 jobs that the BLS’ monthly nonfarm payrolls survey says were added.
The BLS’ own Business Employment Dynamics (BED) report, which analyses private sector employment based on QCEW data, says there were 287,000 job LOSSES in Q2 2022.
The monthly sample thus saw SIGNIFICANTLY more job growth in Q2 2022 than the comprehensive report. Why could that be? One reason could be the benchmarking process.
In order to ensure its accuracy, the monthly nonfarm payrolls report is benchmarked against the more comprehensive QCEW data — but this benchmark is only done once a year, in February. Not only is the benchmark only done annually, but its benchmarked against QCEW data from the March quarter of the PRIOR year. The recently completed benchmark was thus done to QCEW data up to March 2022.
Again, the BIG lag, is the key issue. QCEW data up until the March quarter hadn’t shown a major slowdown. Instead, the slowdown began in the June quarter, to which the monthly CES survey won’t be benchmarked against until February 2024!
The household survey, which doesn’t have this benchmarking problem, has also significantly deviated to the downside of nonfarm payrolls. When did this deviation begin? Q2 2022.
We thus have a situation whereby both the comprehensive employment data and the household survey, suggest that nonfarm payrolls could be being significantly overstated.
It’s important to note that comprehensive data from one quarter doesn’t make a trend, so it’s important to see what the data for Q3 2022 says. Fortunately, we now don’t have long to wait, with the Philly Fed set to release its Early Benchmark Revisions of State Payroll Employment report for Q3 QCEW data, on 14 March.
Retail sales jump in January, but beyond the monthly noise, a weakening trend remains evident
While many saw January’s 2.3% rise in retail sales as evidence that economic weakness is behind us, it’s important to remember that there’s lots of seasonal noise in January. It’s also important to remember that a single monthly report doesn’t make a trend.
Looking at non-seasonally adjusted data, shows that on a 3-month moving average basis, YoY retail sales growth continues to decelerate.
Real PCEs surge in January … but the same thing happened last year
In-line with the higher MoM retail sales print in January, real personal consumption expenditures (PCEs) rose briskly in January, rising 1.1% MoM. Alongside higher MoM inflation data, it’s led many to conclude that the Fed somehow hasn’t done enough tightening (despite deploying its most aggressive tightening in over 40 years, and there being YoY declines in the M2 money supply).
Though again, one must remember that SEASONALITY is a big issue in January. Look at the chart below of MoM changes in real, SEASONALLY ADJUSTED PCEs. Notice any months in particular that stick out? Clearly, there’s a huge issue with seasonal adjustments in January.
Note also that January’s high growth in both 2022 and 2023, comes after weak growth in November and December. Further still, note that the weaker growth in November and December was preceded by strong durable goods spending growth in October of both year’s. It certainly appears that the BEA is struggling to accurately depict seasonality in its measurements.
As is the case with retail sales data from the U.S. Census Bureau, one should NOT be making wholesale changes to their outlook from one month of heavily seasonally adjusted data. Before calling a big flip in economic activity (no less one that goes heavily against the grain of Fed tightening and a falling M2 money supply), one should wait for a broader trend of data to emerge in support of that view.
In order to gain a clearer picture of the current trend in PCEs, we can analyse the 3-month moving average change. On that basis, YoY PCEs did increase slightly, from 1.8% in December to 2.0% in January, but this is hardly indicative of an economy that is running “too hot” and requires aggressive further tightening.
Fed manufacturing surveys show ongoing weakness
Highlighting the need for caution in interpreting heavily seasonally adjusted data that suggests a rebound in growth, is the various Fed branch surveys of manufacturing activity.
The long-running Philadelphia Fed Manufacturing survey PLUNGED to -24.3 in January, the lowest reading seen since the depths of the COVID panic and the GFC.
Taking the average of the results across the Fed district surveys, we can see that new orders remain deeply negative. The next leg in the chain, being hours worked, has now also turned firmly negative. Once hours have been reduced, the last resort for businesses is to reduce employment. Given the difficulty many firms have had in hiring staff on account of an artificially driven surge in demand, making cuts to employment is set to be a particularly lagging indicator during the current cycle. Nevertheless, the employment indicator is now right on the verge of turning negative across the Fed branch manufacturing surveys.
Fed services surveys turn the other way, but a downtrend remains
Working in the other direction, was the average of the Fed district services surveys, where there was a slightly uptick across the sales, hours worked, and full-time employment measures in February. Despite the February uptick, the broader trend continues to point downward.
In another sign that January’s “jump” in retail sales activity may be short-lived, the Dallas Fed’s retail services sector subcomponent slumped to its lowest level since July 2020 in February.
Housing market continues to broadly show weakness — what happens now that rates are rising again?
While still WAY up on the prior year, there was some mortgage rate relief in January, where monthly average 30-year fixed mortgage rates were 9.1% below their October peak.
Despite lower rates in January, it was not enough to drive an increase in existing home sales, which declined further in January and are now down 36.9% vs the prior year.
Underpinning the drop in home sales is a decline in mortgage purchase applications, which have fallen to their lowest levels since 1995!
Though moving in the other direction was pending home sales, which are a leading indicator of existing home sales. Pending home sales rose 8.1% in January, reducing their YoY decline from 33.9% in December 2022 to 24.1%.
Though now that US mortgage rates have begun to rise again, the recent MoM increases in pending home sales may once again reverse.
The other factor to consider is prices. According to the S&P/Case-Shiller US National Home Price Index, prices continue to record MoM declines. While prices are still up 5.8% YoY, the 3-month annualised price change is -3.4%, while the 6-month annualised price change is -5.4%.
We are now in a situation where volumes have sunk, as people don’t want to sell their home and lose their very low fixed rate mortgage, while others are holding out in the hope that prices will return to their COVID boom peaks. Buyers meanwhile, don’t see value and/or face affordability issues as prices remain 39.0% higher than where they began 2020, despite far higher mortgage rates today.
In order for the housing market to normalise, rates and/or prices must fall. With the broad macro environment suggesting a recession ahead, and the Fed remaining hawkish, I anticipate that sellers will soon become more “motivated” and that prices will begin to do more work to balance the housing market. A return to rising mortgage rates may also cause some to bring forward their selling intentions, for fear of higher rates still and lower prices ahead.
Weak housing sales, falling prices & higher rates spark a decline in new housing starts
Given the signal from weak housing sales data, housing starts also continue to also fall, where on a rolling 3-month moving average basis, housing starts have declined 19.3% YoY. This is the largest YoY fall since December 2009.
Summary: key indicators continue to suggest a slowing economy & the risk of a recession
In summary, the holistic read of the economic data continues to paint a picture of a weakening economy.
Real GDP excluding changes in private inventories & net exports fell to just 0.7% in Q4 2022.
Imports are falling, suggesting weak demand.
While real PCEs jumped higher in January, it appears readily apparent that much of this is due to incorrectly applied seasonal adjustments. The 3-month moving average change in retail sales data continues to move lower, while real PCEs only saw a modest rise, from 1.8% to 2.0%.
New orders in Fed district manufacturing surveys continue to be at recessionary levels. This has now moved into the hours worked component, which too has firmly turned negative. The most lagging component, being employment, is now on the verge of doing the same.
Inflation rose MoM in January, and may remain higher than 2H22 levels for several months on account of 1) seasonality and 2) much of the disinflation already having occurred, with the final piece of the puzzle, being services prices, yet to peak as they are the most lagging component.
With the Fed tightening at the most aggressive pace in over 40 years, and the M2 money supply now seeing YoY DECLINES, broadly negative economic data should be expected. This is what Fed tightening is designed to do — slow the economy. More often than not, it causes a recession. The most aggressive tighteining in over 40 years, risks a severe recession.
A low unemployment rate isn’t a reason to think that this time could be different — instead, it’s another warning sign that that the end of the current economic cycle is near.
This month in markets
2023 off to a positive start, but higher MoM CPI gives it the wobbles
While equities got off to a strong start for 2023, much of their gains evaporated in February. Indeed as at the end of February, the Dow Jones is now down 1.5% YTD. The S&P 500 and Nasdaq have trimmed their YTD gains to 3.4% and 9.4% respectively.
The decline in equities began in earnest following a hotter MoM inflation reading.
Equities were also impacted by Q4 earnings results, where with 465 companies having reported, Refinitiv expects Q4 S&P 500 earnings to ulitmately be down 3.2% YoY. Excluding energy companies, the decline is expected to be 7.4%.
Market moves to price in significantly higher rates - now above the Fed’s outlook
The decline in equities during February came alongside market expectations for Fed interest rate hikes increasing after a strong jobs report and a hotter MoM CPI report.
At the end of February, markets ascribed a 23.3% chance of a 50bp hike in March, versus a ZERO percent chance at the beginning of February.
At the end of February, the market gave the greatest probability to rates ending 2023 at 525-550bps, up a full percentage point from 1 February!
Earlier this year I briefly outlined the manner in which future events could play out, we are now on the second step. The big question, now, is how long it takes for unemployment to begin rising, and the third step to begin. Remember that Fed branch manufacturing surveys suggest that a turn in employment could be imminent.
Higher rate expectations reflected in bond yields
As a result of the market increasing their interest rate expectations, bond yields rose significantly in February. Unlike equities, which only saw a material decline after the CPI report, bond prices began to fall after January’s jobs report was released.
The yield curve continues to remain deeply inverted with the 2Y-10Y spread closing February at -89.7bps.
Is this the big blow off period?
With markets delivering a MAJOR repricing of future hikes off the back of a single month of economic data, is this the big blow off period for rate hike expectations, which could now turn lower over the months ahead? I believe that very well could be the case.
As articulated above, there’s data that indicates that the jobs markets isn’t as strong as nonfarm payroll reports suggest. The CPI report is seasonally hotter during the first few months of the year, and January also saw an increase in gasoline prices. Higher MoM CPI rates are to be expected for the next several months, as we wait for lagging services prices to follow the disinflation that’s been seen in durables and nondurables prices. Though the key overarching point, is that with M2 declining, the US remains in a disinflationary cycle.
With the strength seen in many other economic data points likely overstated in January due to seasonal adjustments, other indicators like Fed manufacturing surveys continue to point to a downturn.
With the M2 money supply getting increasingly negative, I continue to believe that not only lower inflation lies ahead, but a recession.
I thus continue to expect further weakness in equities, but a reversal in US bond yields, which I expect to fall as both lower inflation and a recession become more readily apparent over 2023.
What I’ll be watching most in March
The usual suspects will be important to watch in March, being the monthly CPI and jobs reports.
Again, the potential exists for another hotter MoM CPI print on account of seasonality, another month of increases in gasoline prices, and lagging shelter prices. It will be important to look for any signs of lagging services prices beginning to disinflate.
Employment data will be of particular importance this month, with the Philly Fed’s analysis of comprehensive employment data due out on 14 March. This has the potential to provide further light on just how strong (or weak), the employment market currently is, after comprehensive employment data from Q2 2022 indicated a significant slowdown.
More broadly, it will also be important to see whether the “strength” in some economic data that was seen during January, transfers through to February, or whether much of “strength” turns out to be seasonal noise.
Something that caught my attention
A data point that should likely be getting significantly more attention than it is, is federal government receipts. On a 3-month moving average basis, they turned negative in December, and turned increasingly negative in January, to be down 6.4% YoY.
This sure doesn’t indicate an economy that is running “too hot” and is experiencing a renewed wave of higher inflation.
Have your say!
In case you missed it …
During February I published four research reports. In case you missed one, or would like to review any report again, here’s a summary of what I published:
Thank you for reading!
I hope you enjoyed reading the first installment of Monthly Macro & Markets (MMM), let me know what you think in the comments below — as well as your view on the current macro & market situation.
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