Dow surged on hypes of an early Fed pivot after Powell’ speech

·         Stimulus-addicted Wall Street surged after a roller coaster move as Powell signaled an imminent rate cut in his Jackson Hole speech

·         But Powell didn’t commit to a Sep’24 rate cut; the Fed will be data dependent; i.e. will evaluate the August employment situation and core inflation report for any policy action

·         Latest jobless claims data indicate that the US unemployment rate may fall back to 4.0% or even 3.9% in August/coming months (just ahead of the Nov’24 election)

·         The US manufacturing recession and job loss is a legacy and structural issue that can’t be resolved by mere Fed rate cuts

·         The US service sector labor market is still tight and robust

On early Thursday, Wall Street Futures were almost flat on lingering suspense about an early Fed pivot and Gaza war ceasefire. Latest FOMC minutes and Fed talks indicate that the Fed is ready to start cutting rates from Serp’24 provided economic data in totality supports the Fed’s much-needed confidence and for that Fed may watch August employment and core inflation data closely before taking any rate cut action. If August job/employment data comes as ‘terrible’ / mixed as July, while core inflation eased by another 0.10/0.20% in August, then the Fed may launch the 11-QTR rate cuts cycle from Sep’24 QTR; otherwise, it may want to observe more data (at least Sep-Oct-Nov’24) before launching the same from Dec’24 QTR.

Overall, most of the FOMC/Fed policymakers are arguing for wait & watch and not in a hurry to cut rates from Sep’24 unless there is a material deterioration in the labor/job market as the Fed is looking for more disinflation pace or time to be more confidence about sustainable inflation target of +2.0%.

On Thursday, some focus was also on U.S. jobless claims (seasonally adjusted), which serves as a proxy for the unemployment trend/overall labor market conditions. The U.S DOL flash data shows the number of Americans filing initial claims for unemployment benefits (UI-under insurance) rose to +232K in the week ending 17th August from 228K in the previous week, and higher than the market expectations of 230K. In the U.S., Initial jobless claims refer to the number of people who have filed for unemployment benefits with their state's unemployment agency for the first time during a specific reporting period, typically every week.

The 4-week moving average of initial jobless claims, a better indicator to measure underlying data, as it removes week-to-week volatility, also eased to 236.00K on the week ended 17th August from 236.75K in the previous week.

The continuing jobless claims in the U.S. rose to 1863K in the week ending 10th August, from 1859K in the previous week, and lower than the market expectations of 1870K. The 4-week moving average was 1865.500K, from the previous week's average of 1860.750K and the highest since late Nov’21 (around 1928K). The advance seasonally adjusted insured unemployment rate for the related week was unchanged at 1.2%. The advance number of seasonally adjusted insured unemployment during the related week was around 1863K against 1859K for the previous week and the highest since late Nov’21 (around 1878K).

The continuing jobless claims number is a proxy for the advance numbers of seasonally adjusted insured unemployed persons for the week. The continuing jobless claims in the U.S. measure unemployed people who have been receiving unemployment benefits for a while/ more than a week or filed for unemployment benefits at least two weeks ago (under UI),

Overall, as per seasonally unadjusted continuing jobless claims under all categories (UI) of around 1935K (4-week rolling average) and assuming average uninsured employees (not getting any UI benefit) of around 4837K (usually 2.5 times of 4WMA seasonally unadjusted continuing jobless claims), estimated unemployed persons was around 6771K in Aug’24 against 7163K sequentially.

Assuming the muted addition of the labor force in Aug’24 (after an unusual addition of +420 K in July due to some exceptional factors against average R/R +200K), the headline unemployment rate should come below 4.0% in August against 4.3% in the prior month.

On Thursday, the S&P Global flash PMI tumbled to 48.0 in August from 49.6 sequentially, way below market expectations of 49.5 to mark the 2nd consecutive contraction in the US private factory (manufacturing) activity, at the sharpest pace this year. This was mostly driven by a second successive decline in inflows of new work for manufacturers, which also fell at the sharpest pace since December, to underscore the higher impact of restrictive interest rates in factory activity. In the meantime, employment levels nearly stalled in the period to record the smallest gain since January. In the meantime, the drop in demand from factories eased capacity pressures for the deliveries of raw materials and reduced suppliers' delivery times. On the price front, input costs accelerated the most since May, but producers were not able to fully pass the pressures to consumers.

On Thursday, the S&P Global flash data shows US Service PMI edged up to 55.2 in August, from 55.0 sequentially, higher than the market expectation of 54.0. The latest reading pointed to a slight improvement in the US private service sector activity compared to the previous month, which was also solid overall. New business inflows saw the second-largest increase in the past 14 months, despite a slight dip in exports. However, payroll numbers declined again after two months of job gains, reflecting ongoing hiring challenges. In terms of prices, average costs rose at an unchanged rate in August, matching July’s four-month high. Selling price inflation meanwhile cooled in the service sector to the second-lowest since May 2020 to a level only marginally above the pre-pandemic average. Finally, optimism about output in the year ahead lifted from July's eight-month low, but remained below the survey’s long-run average.

Finally, the S&P Global flash data shows 54.1 in August, a four-month low, eased from 54.3 sequentially and above market expectations of 53.2. This indicates that US private business activity continues to grow, marking 19th consecutive months of expansion. Despite the slower pace, the growth remains strong, particularly in the service sector, which saw solid and increased expansion. In contrast, manufacturing output declined at its fastest rate in 14 months, contributing to employment challenges, as hiring nearly stalled in manufacturing and slowed in the service sector due to difficulties in finding workers. Inflation showed some positive signs, with prices for goods and services rising at their slowest pace since June 2020, although input costs remain high by historical standards.

The S&P Global comments about the US Composite PMI in Aug’24:

“The solid growth picture in August points to robust GDP growth in excess of 2% annualized in the third quarter, which should help allay near-term recession fears. Similarly, the fall in selling price inflation to a level close to the pre-pandemic average signals a ‘normalization’ of inflation and adds to the case for lower interest rates. This ‘soft-landing’ scenario looks less convincing, however, when you scratch beneath the surface of the headline numbers. Growth has become increasingly dependent on the service sector as manufacturing, which often leads the economic cycle, has fallen into decline. The manufacturing sector’s forward-looking orders-to-inventory ratio has fallen to one of the lowest levels since the global financial crisis.

At the same time, service sector growth is constrained by hiring difficulties, which continue to push up pay rates and means overall input cost inflation remains elevated by historical standards. The policy picture is therefore complicated, and hence it’s easy to see why policymakers are taking a cautious approach to cutting interest rates. However, on balance, the key takeaways from the survey are that inflation is continuing to slowly return to normal levels and that the economy is at risk of slowing amid imbalances.”

Overall, the S&P Global survey indicates a lingering US manufacturing recession, moderate disinflation, and mixed labor market/employment situation as the US service sector continues to face hiring difficulties. But as there is no real concern of a hard landing amid a still strong US labor market, the Fed may afford to continue a further wait-and-watch stance to gather more confidence about sustainable price stability target. Thus Fed may not start cutting rates from Sep’24 QTR until Aug’24 employment data becomes ‘terrible’ again like in July. Also, the Fed will watch the disinflation pace in August; if it stalls, then the Fed may not go for rate cuts in Sep’24, just ahead of the Nov’24 US Presidential election; Fed may like to launch an 11-QTR rate cut cycle spanning over next three years from Dec’24 to till Dec’27 in an orderly way to reduce restrictive real positive rate slowly.

The US is mainly a service sector economy (almost 80%), while manufacturing contributes only around 10% of real GDP. The US economy has been suffering from a recession-like situation for a long, even before COVID due to various structural factors; US manufacturing PMI averaged between 55-50 most of the time in pre-COVID periods and after COVID, not sustaining over 50.0 booms/bust redline due to trade war with China. A PMI below 50.0 signifies a shrinking manufacturing sector, with many industries reporting declining new orders and growing inventories, signaling subdued manufacturing activities.

Also, the US abandoned manufacturing activities to a large extent in the mid-1980s in China (after the later included in the WTO) to contain inflation as Chinese imports were much cheaper due to currency leverage, huge infra/transport support, much lower labor cost and China’s massive scale of manufacturing (global factory/powerhouse). If the US stops importing cheaper Chinese or SE/SA goods completely, US inflation/overall cost of living will soar. In short, China is now the king of ‘hardware’, while the US remains the king of ‘software’ and complements each other.

The current recession in the U.S. manufacturing sector can be attributed to several interrelated factors that have collectively hindered growth and led to a significant contraction in output. The U.S. manufacturing sector has experienced periods of recession due to various interconnected factors, including:

·         Global Competition and Offshoring: The U.S. companies have outsourced production to countries with lower labor costs, such as China and Mexico. This has led to factory closures and job losses domestically

·         Rapid Automation and AI Technology: Advances in robotics and automation have reduced the need for human labor in manufacturing. While this boosts productivity, it can also shrink the number of jobs available in the sector

·         Strong USD: A strong U.S. dollar makes American-made goods more expensive on the global market, reducing export competitiveness and leading to reduced demand for U.S. manufacturing

·         Trade Policies: Trade disputes, such as the U.S.-China trade war, have resulted in tariffs and disrupted supply chains. This uncertainty can cause manufacturers to reduce production or delay investments

·         Weak Domestic Demand: Periods of economic downturn/recession and also higher borrowing costs intermittently cause stagnation in consumer demand and lead to reduced demand for manufactured goods, which affects production levels

·         Supply Chain Disruptions: Events like the COVID-19 pandemic and subsequent geopolitics with China  caused global supply chain issues, making it difficult for U.S. manufacturers to get raw materials and components, slowing down production; the same is partially true after the Russia-Ukraine war and subsequent sanction on Russia

·         Volatile Energy Prices: Volatile energy prices can increase manufacturing costs, especially for energy-intensive industries, leading to cutbacks in production when prices rise

·         Shift to Service Economy: The U.S. economy has been transitioning towards a service-oriented structure, which often de-emphasizes traditional manufacturing in favor of hi-tech and finance

·         Weak Consumer Demand: Since early 2022, U.S. manufacturing output has stagnated, driven by a shift in consumer spending patterns. As the economy reopened post-pandemic, consumers redirected their expenditures from physical goods to services, such as travel and leisure activities. This shift has resulted in a notable decrease in demand for manufactured goods, contributing to a contraction in the sector

·         High Interest Rates/borrowing costs/tighter credit: The Fed’s aggressive monetary policy, characterized by rapid interest rate hikes to combat inflation, has significantly increased borrowing costs. This has led to tighter financing conditions for both consumers and businesses, reducing demand for durable goods, which are often financed through loans. Higher interest rates have also depressed housing/mortgage transactions, which directly impacts demand for household goods and appliances and other interest-sensitive sectors including credit cards, auto/personal loans, and business loan

·         Inventory Management Issues: Many manufacturers are facing bloated inventories due to reduced customer orders. This situation has prompted companies to cut back on production, leading to further job losses and a slowdown in manufacturing activity. The need to manage excess inventory effectively has become a pressing concern for many businesses in the sector

·         Sector-Specific Challenges: Certain industries within the manufacturing sector, such as apparel, machinery, and transportation equipment, have been particularly hard hit. The recent United Auto Workers strike and other sector-specific issues have exacerbated the overall decline in manufacturing activity. Recently GM fired almost 1000 tech & service employees as the US automobile/EV sector is not able to compete with China despite almost 100% tariffs; average lower/middle range EV costs around $10K in China against $30K in the US; Tesla starts from around $40K

Conclusion:

The combination of weakened consumer demand, high borrowing costs, persistent supply chain issues, Chinese/SE/SA competition, and sector-specific challenges has collectively pushed the U.S. manufacturing sector into recession. Moreover, the lack of adequate fresh infra stimulus in the US as a result of political & policy paralysis is also responsible for the US manufacturing recession despite the US being the leading global player in aerospace & defense equipment, semiconductors/AI-Chips, and electronics, pharmaceuticals and medical equipment, energy equipment & machinery, foods & beverages, and chemical products.

The U.S. did not intentionally abandon its manufacturing sector to China in the mid-1970-80s. The decline of U.S. manufacturing was a gradual process that began much earlier and accelerated due to various factors:

Shift from Vertically Integrated to Outsourced Manufacturing

In the 1980s, financial markets put pressure on large U.S. companies to break up their vertically integrated manufacturing models and outsource or offshore non-core competencies. This led to the hollowing out of the U.S. factory as companies like Texas Instruments, Alcoa, and DuPont subcontracted or offshored parts of their operations.

Lack of Focus on Manufacturing in the Innovation System

Coming out of World War II; the U.S. innovation system focused on early-stage R&D rather than manufacturing. Meanwhile, post-war Germany and Japan rapidly rebuilt their industrial bases, with their innovation systems focused on manufacturing. This imbalance explains why the U.S. has been innovating new technologies that get built elsewhere, starting with Japan in the 1970s-80s and then China.

Gradual Decline in Manufacturing Employment

The US Manufacturing employment trended upward after WW-II, peaking at over 19 million in 1979. From 1979 to 1989, the sector shed 1.4 million jobs, or 7.4% of its base, with losses concentrated in primary metals and textiles. Employment was relatively stable in the 1990s, declining by about 4% from 1989-2000, which can be explained by outsourcing of tasks previously done in-house.

Acceleration of Decline of Manufacturing Jobs in the 2000s

The U.S. lost over a quarter of its manufacturing jobs since 2000, a decline of over 4.7 million. Increased competition from China led to an estimated 985,000 American manufacturing jobs being lost between 1991 and 2011. Automation has not significantly contributed to the last 20 years of manufacturing job losses. In summary, while the U.S. manufacturing sector has declined significantly since the 1980s, this was not due to an intentional abandonment of China. The roots of the decline stretch back much earlier, and the acceleration in the 2000s was driven by increased global competition and outsourcing rather than a deliberate policy choice.

Early 2000s:

In the early 2000s, the U.S. manufacturing sector faced significant declines, particularly after China joined the World Trade Organization (WTO) in 2001. Many manufacturing jobs were offshored to countries with lower labor costs. According to data from the US BLS, the sector lost over 3 million jobs between 2000 and 2007, with manufacturing employment declining from roughly 17 million to 14 million.

Great Recession (2007-2009): GFC (Global Financial Crisis)

The Great Recession/GFC hit the manufacturing sector hard, causing a steep drop in employment. During this period, more than 2 million additional manufacturing jobs were lost, bringing employment in the sector to a low of about 11.5 million by 2010.

2010s Recovery:

Following the GFC/ recession, there was some recovery in manufacturing jobs, though not to pre-2000 levels. From 2010 to 2019, the sector regained approximately 1 million jobs, supported by economic growth, government policies favoring domestic production, and demand for American-made goods in specific industries such as automotive and aerospace.

COVID-19 Pandemic (2020): Another global recession

The pandemic dealt another blow to manufacturing jobs due to disruptions in supply chains, factory shutdowns, and reduced demand in certain sectors. However, after the initial shock, there was some rebound in 2021 and 2022 as the economy reopened.

Automation and Technological Change: AI

One of the main contributors to job losses over the past two decades has been automation and the increased use of advanced technologies, such as robotics and artificial intelligence (AI), in manufacturing processes. While this improved productivity, it reduced the need for manual labor in certain areas of manufacturing.

Over the last 20 years, the U.S. manufacturing sector has experienced significant job losses due to various factors, including automation, globalization, trade policies, and shifts in the economy. Overall, the U.S. manufacturing sector has seen a decline in employment from about 17 million jobs in 2000 to around 12.5 million jobs in 2023. However, in terms of output, the sector remains strong, as productivity per worker has increased dramatically.

Bottom line:

The US manufacturing recession and job losses are a legacy and structural issue that can’t be resolved by mere Fed rate cuts; it requires fiscal side/government intervention with monumental policy reform. But present political & policy paralysis and lack of bipartisan political consensus are unable to resolve this issue. The increasing geo-political fragmentation under the Biden admin (Democrat policies) right from China/COVID and the Russia-Ukraine war is negative for US supply chain restoration in full.

Also, after COVID, the US is now experiencing huge pressure on immigrants from various developing countries (legal/illegal), resulting in more demand for basic services like housing, healthcare, education, and food apart from various services. Higher population, higher demand, higher GDP growths, and higher inflation are natural for any economy if supply capacity is limited; but due to higher productivity of around 4% and also almost equivalent wage growths, US inflation is almost under control; when wage growths significantly beats productivity levels, then it will create a cycle of wage inflation.

The Fed is also aware of this fact and thus is interested in producing more slack in the economy (without hurting the labor market too much) so that the constrained supply capacity of the economy can match with demand and bring price stability. Fed is of the view that increased disinflation in H21CY23 was a result of supply chain restoration to some extent and a higher supply of immigrant workers, helping to cool the labor market. But those benefits may not be there in 2024 and thus Fed is cautious about disinflation, while the US labor market is still strong/robust. Latest jobless claims data indicate that the US unemployment rate may fall back to 4.0% or even 3.9% in August/coming months (just ahead of the Nov’24 election).

Market wrap:

On early Thursday, Wall Street Futures were almost flat on lingering suspense about an early Fed pivot and Gaza war ceasefire but eventually closed lower on the concern of lingering US manufacturing recession (legacy issue), but a robust service sector, which may keep Fed on the sideline in Sep’24. But on Friday, Wall Street Futures surged after a roller coaster move as Fed Chair Powell signaled an imminent rate cut in his much-awaited Jackson Hole speech, although Powell didn’t commit to a Sep’24 rate cut. Fed will be data dependent; i.e. will evaluate the August employment situation and core inflation report for any policy action.

Weekly-Technical trading levels: DJ-30, NQ-100, SPX-500, and Gold

Whatever the narrative, technically Dow Future (39300) has to sustain over 39900 for any further rally to 40100/40500-41050/41450* and 41675*/41950-42100*/42700 in the coming days; otherwise sustaining below 39800/39550, DJ-30 may again fall to 39200 and 39000/38800-38600/38300-38000 in the coming days.

Similarly, NQ-100 Future (18300) has to sustain over 18800-19000 for any further recovery to 19300/19600-19750/19950 and 20150*/20600-20800/21050* and further to 21300/21700-21900/22050 and even 23000 levels in the coming days; otherwise, sustaining below 18700/18500-18200/18000 it may further fall to 17700 and 17600/17500-17300/17150 in the coming days.

Technically, SPX-500 (5300), now has to sustain over 5450 for any further recovery to 5475/5525-5605/5675 and rally further to 5725/5750*-5850/5800-6000/6050 and 6100/6150 in the coming days; otherwise, sustaining below 5425/5400-5350/5300 may further fall to 5250/5200-5175/5100* and further 5000/4900*-4850/4825 and 4745/4670-4595/4400* in the coming days.

Also, technically Gold (XAU/USD: 2400) has to sustain over 2425-2440 for a further rally to 2455*/2490-2500*/2525-2535/2540* and 2560*/2575-2600/2650 in the coming days; otherwise sustaining below 2420-2410, may fall to 2395/2385-2370/2360 and 2350*/2340-2320/2300-2290/2275* and 2235/2210-2160/2110 in the coming days (depending upon Fed stance, Gaza/Ukraine war trajectory and US election outcome).