Manufacturing PMI

The Markit Manufacturing PMI came in at 63.1 in May which was up on the previous month and above expectations of 62.8. This pointed to new record growth in factory activity. Output growth was the slowest in three months, though it remained close to March’s record with production again underpinned by rapid gains in new orders.

There have been increasing production disruptions in the manufacturing sector due to supply chain issues. Demand is returning quickly as new orders continue to flow in at a fast pace. Therfore, backlogs of work are increasing as supply is struggling to keep up with demand.

Services PMI

The Markit Services PMI came in at 55.2 in May which was up on the previous month and slightly above expecations at 55.1. This was strongest pace of expansion since June 2018. All countries in teh Eurozone recorded an improvement in activity since April, with Ireland and Spain leading the way, following the easing of COVID-19 restrictions. New business rose for the first time since last July, and at the fastest rate for 40 months. Looking ahead, business sentiment hit a 17-year high.

Composite

The Markit Composite PMI came in at 57.1 in May which was up from the previous month but just below expectations of 55.1. With restrictions over recent months mainly focused on services, it is no surprise that the services PMI soared from 50.5 to 55.2 in May with many countries easing restrictions and vaccination programs build momentum.

The Outlook

The combination of demand returning quickly for manufactured products in conjunction with shortages and delays in the supply chain are creating the ideal conditions for a surge in pipeline inflation. We are already seeing significatn increases in input prices and the PMIs show that manufacturing businesses are already passing these higher costs onto consumers. This makes sense as businesses can only absorb higher input costs to a certain degree before before margins get squeezed to the point where they have to pass the higher costs onto the consumer. For services, inflation is behind that of manufcturing but as reopenings continue, we could see service infation moving higher.

Overall, the economic outlook for the eurozone is looking very positive at the moment with stronger growth and inflation pressures increasing. If the re-opening and vaccination programme stay on track and build momentum, then it is highly probable that the pace of economic recovery will improve significantly in the 2nd quarter. 

In conjunction with the re-opening, we have rising consumer confidence which suggests that spending will remain strong over the next few months. However, online shopping will still dominate so the high street could still feel the pressure and a challenging recovery.
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April's surge in retail sales was significantly greater than expectations with a 9% month on month jump. This means that sales are 10% above pre pandemic levels! This is to be expected after another prolonged lockdown with lots of pent up demand. People simply weren't buying new clothes or shoes as many places were closed and events cancelled. This shows up in the data as clothing and footwear had the largest increases.

Will It Last?

The vaccination programme is steaming ahead at full speed and we can see the light at the end of the tunnel. People are feeling more confident about their safety and getting back to some degree of normality as well as more confidence in the economic recovery. The economic indicators are looking increasingly positive but there are still a few crosswinds in some of the data. 

On the High Street

Trading conditions are still a bit vulnerable on the high street as the trend to online shopping continues. The novelty of going to the shops again following the lock down may not last as people revert to online shopping. Foot fall for the High Street restailers is not as good as it could be but this may improve when the offices  reopen and people make there way back to the workplace. In addition, High Street retailers are under pressure from rent arrears and costs linked to the pandemic so cashflow is taking a hit.

Conclusion

Futher gains are on the radar for reatil sales but we might see the spending going to the online retailers rather than the High Street. 

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​The annual inflation rate in the US soared to 4.2% in April 2021 from 2.6% in March, which was significantly above market forecasts of 3.6%. Indeed, it is the highest reading since September 2008. We don't have to look too hard or far to see why this is happening. We have been in a reflationary environment with a tsunami of demand as the economy reopens. We've got soaring commodity prices with grains and energy markets heading north at a rate of knots. We've seen supply chain issues and shortages in the semiconductor market. We've also got the base effect as the April inflation numbers come a year after the pandemic lockdown when the economy was in dire straights.

The Base Effect

If we look at this just from the perspective of the base effect, you could say this is transitory inflation. The rationale being that, we move forward, away from the April 2020  measuring point, which is now known as "The Great Lockdown" and resulted in the worst economic downturn sine the Great Depression, we could see inflation cooling a little bit. However, as mentioned, this is only one factor in the melting pot. We've got other inflationary pressures creeping in to the mix.

​Supply and Demand

On the supply side, businesses are dealing with increasing cost for raw materials and fuel. Look at the price of copper and lumber in the construction business as well as the uptrend in crude oil and refined products. On the demand side, we've got consumers with more cach in their pockets from stimulus cheques and more savings. As the lockdowns ended, people wanted to spend some of that money. 

Tighter supply and increased demand equals higher prices. So the inflation numbers we are seeing may not be as transitory as the Fed would have us beleive!

Wages Increases

In addition, there is the impact of wage increases. Inflation expectations have been well anchored in recent years but comsumer inflation expectations are picking up so we could see more upside pressure on wage increases. In an environment of higher inflation, employees expect the wages to increase in line with inflation and to offset the effects of this in their own cost of living.

Companies are also under pressure to increase wages to attract new employees. The jobs reports show that getting people back into jobs in proving more challenging than expected. There are several reasons for this. Some people dpon't want to go abck to work as pandemic fears remain. Others have been constrained by working from home and home schooling. Some people don't find the wages on offer attractive enough to return to the workforce becuase of extended and uprated unemployment benefits. Other may take earlier retirement. 

Inventories and Backlogs

The Institute of Supply Management (ISM) reports are showing a backlog of orders at all time highs and inventories are at an all time low. Companies can't keep pace with demand. Look at the situation they are in with increasing costs for raw materials, delays in the supply chain, pressure to increase wages to attract new employees and demand for higher wages from exiting staff to match  current inflation levels., it is highly likely that inflation will be around for a while longer and potentially into the end of this year.

Conclusion

The Fed's purchases add up to $120 billion a month and have been saying that interest rates wll remain at current levels until 2024. However, if the economy keeps steaming ahead at it's current pace, with inflation running hot, then there is an increasing probability of the Fed bringing this forward.

So traders and investors are assessing what the Fed will do next. Will they be forced to change their story and signal to the market that they will start tapering their bond purchases sooner than they thought, ahead of the inevitable rate hikes? That is certainly one possible scenario and the probabilities for this outcome are increasing.

Who knew? Did anyone see that coming? Jobs growth of just 266,000 with big downward revisions to the March number from 916,000 to 770,000. Private payrolls rose just 218,000 with manufacturing employment actually falling 18,000 while trade and transport dropped 81,000, retail fell 15,000 and temporary help fell 111,000.

These decreases don't make a whole lot of sense given the strong performance of all these sectors, in terms of activity, over the past couple of months. Construction employment was also flat for the month and this also seems out of kilter given the booming residential construction sector that is more than offsetting weakness elsewhere.

However, we did see a boost in leisure and hospitality with an increase of 331,000 reflecting the re-opening and government employment increased 48,000. The poor jobs reports was confirmed by the rising unemployment rate to 6.1% from 6.0% (consensus 5.8%). Its worth noting that the unemployment rate is calculated from another survey (payrolls asks business, unemployment asks households). We saw worker participation rise by 430,000 – people returning to the labour market – while employment rose only 328,000. 

Does the Fed Know the Score?

The US economy has been making good progress since the economic lows of the pandemic last April. 22.4 million people lost their jobs back then. Fast forward to now, and nearly two thirds of that number have found jobs leaving a net loss of 8.2 million. This is a pretty impressive gain over the last year but the jobs reports still shows a clear slow down and the Fed really does want to see a series of strong job reports before considering a change in their policy. It's not all about jobs though as inflation is playing a critical role in this decision and the narrative around 'transitory' inflation might come back to bite them. Essentailly, inflation might be run hotter for longer than they expect and cause them to rethink there stance much sooner. The jury still out on that one.

What About Supply Issues?
Is the labout market softness more of a supply issue than a demand issue. Possibly. There are many job openings that are not being filled 59% of small businesses reported hiring or trying to hire in April, but 92% of those firms reported few or no qualified applicants. This tells us that there is a huge demand for workers but a lack of supply and this will bea drag on the labout markets for a few months. What is causing the imbalance between supply and demand? Lockdowns and schooling at home have constrained parent's ability to go out and work. In conjunction with extended and uprated unemployment benefits that will continue into September, there is a decreased incentive to go out to work.

Silver Linings

The US economy is recovering well, even if it is a bit uneven. However, getting all those jobs back will take time. Its a little bit like the stockmarket. It takes the elevator down when it crashes as it did last year at the beginning of the pandemic. Then the markets take the stairs up which  they have over the last year or so, with a steady climb to new all time highs.