VIPs

• PPI inflation for intermediate goods has exceeded the same metric for finished goods by a double-digit margin for the last six months; only the seven-month stretch from July 1974 to January 1975 compares historically, as pipeline pressures risk bleeding into consumer prices
• ISM Manufacturing New Orders, though still above the 50-breakeven, has fallen below 60 after a 15-month streak north of that threshold; further declines could continue to push down Small Business Expectations, already at near record pessimism due to elevated uncertainty
• In the NFIB October survey, a record 51% of small business owners said they plan to raise prices in order to combat higher material, transport, and labor costs; with core PCE printing at 4.4% vs. the 2% target, the latest CFO Survey also validates the rising input cost dilemma

If you harbor an obsession with the Banzai Pipeline Hawaii, known worldwide for its perfect barreling waves, head to Ehukai Beach Park on Oahu’s North Shore. Surfing pipeline is a unique experience like no other and ranks high on hardcore surfers’ bucket lists. The location’s name combines the surf break (Pipeline) with the name of the beach fronting it — Banzai. The spot is also rich in history. In December 1961, legendary surfing producer Bruce Brown was driving up to the North Shore with Californians Phil Edwards and Mike Diffenderfer. He stopped at the then-unnamed site to film Phil catching several waves. Coincidentally, on adjacent Kamehameha Highway, there was a construction project for an underground pipeline underway, prompting Mike to suggest the break be named “Pipeline.” The reference was first used in Bruce Brown’s movie Surfing Hollow Days and went on to be the name of a 1963 hit by surf music rockers The Chantays.

Those who dabble in the science of the dry know there’s a lower-case ‘pipeline,’ as in the production pipeline. Each month, the producer price index (PPI) report dives deep under the waves to unearth pipeline price pressures. With “supply chain” trending and inflation trades all the rage, a more delicate dissection of the PPI should be on the to-do list of true bond vigilantes…or those with a fundamental hankering for going into the weeds, like QI’s Dr. Gates.

Gates’s old-school perspective requires PPI metrics be referenced by their stage of processing — ‘crude,’ ‘intermediate’ and ‘finished.’ When pipeline pressures would build in past cycles, the Street would monitor sets of waves in crude, intermediate and finished goods PPI inflation to gauge whether pass-through from the supply chain would generate upward movement in consumer prices. Then globalization happened (read: China entering the World Trade Organization in 2001). Being a pipeline watcher was relegated to the Mesozoic Era. The trade war and, more forcibly, the pandemic’s effect on the supply chain reasserted the idea of waves into the price setting mechanism.

Watching pipeline costs entails more than assessing inflation risks; they also matter for the growth outlook. Take the pipeline cost spread (purple line), defined as the spread between intermediate and finished goods PPI inflation. Over the last 50 years, many waves are visible through business cycle expansions. The current episode, however, echoes 1970s-style inflation risks. Yesterday’s PPI report revealed that intermediate PPI inflation has exceeded that of finished goods by a double-digit margin for six consecutive months ended October. In the last half century, with respect to duration, only the seven-month stretch from July 1974 to January 1975 compares.

History doesn’t repeat itself, but it sometimes rhymes. Not surprisingly, 1974’s persistent cost pressures coincided with a decline in the ‘it-girl’ – the ISM Manufacturing New Orders index. The upstream cost bulge in 2021 has seen this metric fall out of the right tail distribution, ending a 15-month winning streak north of the lofty 60 mark (green line). Is there more to come?

Because of its stalwart postwar track record, U.S. ISM Manufacturing New Orders provides a signal for firms of all sizes, including those on Main Street. The 1974 experience saw a sharp decline in small business economic expectations. In 2021, the path has similarly led to near record pessimism (orange line). QI friend and mentor National Federation of Independent Business (NFIB) Chief Economist Bill Dunkelberg put it this way: “Not knowing the course of federal economic policies (e.g., taxes) makes it harder to make the investment expenditures that will be needed to raise worker productivity. Add to that the unclear course of the virus and associated government policies and owners face an economy filled with uncertainty that must be resolved to figure out the likely course of the economy.”

Moreover, small business owners capitulated on their future view of the economy view by flagging a further deterioration in earnings (red line) and a stalling in expectations for real sales volume over the next six months (light blue line). With profits challenged and revenues expected to stall, what’s a proprietor to do in this higher material, transport and labor cost environment? In October, a record 51% said they planned to raise prices to combat this testy triumvirate (yellow line).

The latest CFO Survey validated: “Most CFOs also indicate in the third-quarter survey that their firms are experiencing supply chain disruptions that are expected to last well into 2022 [and]…Small firms note less ‘room to maneuver’ and are more likely to report waiting for supply chain issues to resolve themselves.”

Federal Reserve Vice Chair Richard Clarida would concur. In (very) prepared remarks, the Fed official who wrote the book on inflation expectations dictating monetary policy, dryly noted that he, “would not consider a repeat performance next year a policy success.” Though he towed the party line, noting that the 4.4% increase in the PCE — which the Fed traditionally hid behind to keep Quantitative Easing humming, was a “moderate overshoot” (or more than double) the Fed’s 2% target, it must have been painful to be conciliatory when inflation expectations have gone haywire.

Perhaps Clarida is trying to ride the wave until January 31st, when his term ends, and vacate the Eccles Building before the inevitable wipeout hits. With pipeline cost pressures persisting, the risk of inflation psychology becomes ingrained into Main Street business decision-making. Adjusting to such an environment may not be smooth surfing.

VIPs

• The S&P 500 Basic EPS Hotels was never negative until 2020, and has stayed in contraction for the last seven quarters; despite their historically tight correlation, hotel occupancy has recovered to pre-pandemic levels while hotel profits lag on account of higher input costs
• Since bottoming out in April 2020, hotel workers have seen their aggregate hours worked recover 111%; meanwhile, linen/uniform supply workers have only risen 38%, diverging from the former as services previously contracted out are brought in-house to cut costs
• Per Cirium, airlines are increasing flights between the UK and U.S. by 21% MoM as U.S. borders are re-opened to vaccinated travelers; inflows from nonresident travelers should drive service consumption, though this will manifest in GDP accounting as export services

We go together
Like rama lama lama ka dinga da dinga dong
Remembered forever
As shoo-bop sha wadda wadda yippity boom de boom
Chang chang changitty chang sha-bop
That’s the way it should be
Wah-oooh, yeah!

The tongue-twisting opening lines to the final song of the 1978 musical romantic comedy Grease can’t help but bring a smile to your face. Many (ill-sighted) critics saw the film as mediocre, condescendingly describing it as “a pleasing, energetic musical with infectiously catchy songs and an ode to young love that never gets old.” The timeless classic featuring greaser Danny Zuko and Australian transfer student Sandy Olsson found its place in the archives in 2020 when the film was selected for preservation in the National Film Registry by the Library of Congress as being culturally, historically and aesthetically significant. What took them so long?

Going together in economics has a different connotation than “Summer Lovin,’” “Hopelessly Devoted to You,” and “You’re the One That I Want.” Eyeballing what Danielle calls a “huggy-bear” relationship between two distinct gauges gains credence when the correlation (better known as the ‘r’) rises to noteworthy heights, which you see on the left. Over time, the seasonal movement in U.S. hotel occupancy (orange line) has been a key driver of operating earnings per share (EPS) in the S&P 500’s hotel sector (purple line). We know we’re not breaking new ground in deducing that demand for hotel stays, whether for business or leisure, drives revenue per available room — the industry metric for top-line activity.

However, in the post-COVID-19 world, a disconnect has emerged. Hotel EPS has had a record run in negative territory, while hotel occupancy has fully recovered to pre-pandemic levels. Never before 2020 had the S&P 500 hotel sector recorded contracting EPS. Seven quarters later, it appears permanent damage has been inflicted.

As for the light at the end of the tunnel, with profits lagging occupancy, major lodging operators have gotten creative to save on the cost side of the ledger. Even at what we once considered “posh digs,” services are limited. The norm these days is your room is serviced every third day, meaning never for most staying 2-3 nights. That duration is standard fare for the leisure traveler who’s largely replaced the once lucrative business traveler. The front desk is most cordial about explaining the effective inflation — you are paying more for less — as “You understand, with the COVID restrictions and all…” Savvy travelers have learned a few tricks — ask for towels to be replenished, fresh toiletries delivered and then they make their own damn beds if they need to return to a room that’s tidied up.

This has played out in a diverging recovery between hotel workers and those whose services are contracted out, such as those in the linen and uniform supply industries that also includes industrial laundries. In an industry like accommodation, workers’ input is essentially the equivalent of the businesses’ output. Aggregate hours worked, a measure of the number of payroll jobs times the average workweek, is the conventional way to judge guidance.

As you see on the right, both hours worked series for hotel workers and linen/uniform supply workers were indexed to the COVID low point of April 2020. Normalizing as such determines if both groups would recover in concert. It’s clear that they have not. By June 2020, hours worked for hotel workers began to outperform that of the linen/uniform supply group – and they never looked back. To date, through September 2021, the former rose 111% off the bottom, while the latter only advanced 38%.

For the most part, the recovery in hotel activity has been limited to domestic travelers. That’s about to change. As announced Sunday, after 20 months of travel restrictions, U.S. land and air borders are reopening to foreign visitors. The new rules allow air travel from previously restricted countries if the entrant has proof of vaccination and a negative COVID-19 test. Land travel from Mexico and Canada will require proof of vaccination, but no test. Airlines are expecting more travelers from Europe and elsewhere. Data from travel and analytics firm Cirium show airlines are increasing flights between the United Kingdom and the U.S. by 21% this month over October.

How this encouraging news could play out in gross domestic product (GDP) math is another story. U.S. net foreign travel services — the difference between what U.S. residents spend in foreign countries and what foreigners spend in the U.S. — is about to roll off its peak September print. The pent-up demand of inflows of nonresident tourists should be the more influential factor driving service consumption. For what it’s worth, in the three months ended September, net foreign travel had accounted for nearly one-third of all real consumer spending on services. The wind is about to shift on consumer spending. That said, it will manifest as export services in the trade gap, so all is not lost. Any growth from the influx of foreign travels should be a net-plus for the trade gap.

The way GDP accounting works suggests reopening borders will be a wash as activity moves from consumption to exports. The math for the hotel industry is much more straightforward – any incremental travel demand will support a return to profitability. In the interim, expect cost-saving initiatives to become a more permanent staple for hotel operators, all in the name of productivity and profits first.

VIPs

• At 28.3%, those who have been unemployed for fewer than five weeks are now at a post-pandemic high; meanwhile, 31.6% of the unemployed have been out of work for more than 27 weeks, a 13-month low but still well above the 19.3% registered in February 2020
• After hitting a high of 41.7, the manufacturing worker workweek has fallen to 41.3, the lowest since December 2020; in leisure and hospitality, the workweek peaked at 25.3 hours in April with the last round of stimulus checks, before falling slipping back to 25.0
• Per Burning Glass, job openings in manufacturing are at -9.5% in the week ended October 29 vs. January 2020, the first negative read since last November; at -10.5%, leisure & hospitality openings have contracted for the last two weeks to their worst showing since January

“Mommy’s alright, Daddy’s alright
They just seem a little weird
Surrender, surrender
But don’t give yourself away”

Gotta love a true contrarian. Pushing back against the conventional wisdom and profiting is as good as it gets. Who knew this applied to musicians? In 1976, Cheap Trick first played “Surrender” on tour. The ‘70s anthem was subsequently recorded in studio and released in 1978. Isn’t the band supposed to first record and release the potential hit and then have its popularity carry over into lucrative concert tours? As if there isn’t enough irony in what you’ve just read, the first song featured on their third studio album, “Heaven Tonight,” tells a contrarian story of a teen’s realization that his parents weren’t uncool after all, despite the generational divide. Though the “teen” singing the song says his parents were “a little weird,” he then stumbled into their “rolling on the couch” listening to KISS records. To get into the right frame of mind to pen the lyrics, songwriter and lead guitarist Rick Nielson said he had to, “go back and put myself in the head of a 14-year-old.”

Economists and investors alike had to surrender to the reality of what appears to be full employment with wage inflation nowhere near retreat and signs that it’s pinching margins in the current quarter through which we’re nearly halfway through. On Friday, Factset’s John Butters noted that, “For Q4 2021, 41 S&P 500 companies have issued negative EPS guidance and 26 S&P 500 companies have issued positive EPS guidance.” While in line with the 5-year average, it’s still the mirror image of where we were three months ago when 29 firms were guiding negatively and 42 were telling investors to expect upside.

The bravado gainfully employed workers are brandishing was evident in those who’ve been unemployed for five weeks or less (light blue line). At 28.3%, these effective job hoppers as a percentage of the unemployed are at a post-pandemic high. If you’ll indulge some anecdata, here in Dallas, a colleague who runs the third-party logistics arm for a Fortune 100 had a new hire quit after two days in protest of being made to wear the same orange safety vest required of all warehouse workers.

At the opposite end of the spectrum are the long-term (LT) unemployed. You know that we’ve been increasingly concerned about the element of scarring that’s becoming increasingly apparent, as in structural damage to the labor force. While the 31.6% of the pool of unemployed who’ve been out of the workforce for 27 weeks or more (orange line) is at a 13-month low, it’s still the highest since January 2015. The journey from that month’s 31.3% ended in February 2020, when it hit 19.3% before COVID-19 started wreaking havoc on the data. That datapoint marked “full employment” as defined by Federal Reserve officials.

Given the abrupt nature of the economic slowdown and the dim prospects for fresh rounds of nationwide stimulus checks, the risk is we may be approaching the current cycle’s lows in the percentage of LT unemployed.

What’s exceedingly rare is the percentage of LT unemployed being higher than that of the very short-term (VST) unemployed (purple line), a manifestation only seen in the past two cycles. The word “structural” once again rises to the fore.

The most cyclical parts of unemployment occupy the tails – LT and VST. These series gauge the bad vs. the good in the unemployment distribution. In the postwar period, VST trended above LT, which is intuitive in “the land of opportunity.” VST are seizing opportunities because they can easily secure a bigger paycheck. The last two cycles’ persistently high LT unemployment speaks to the permanent dislocation that’s made it more difficult for workers to become re-employed.

And here’s the linchpin via QI’s Dr. Gates: “This spread line shows that this IS NOT a theme unearthed because of COVID. It also happened after the Great Financial Crisis (GFC). Throw in that productivity was downshifting before the GFC and seemed structurally lower over that entire episode. As a result, certain sectors may not have been able to carry the same labor share and jettisoned workers leaving a permanent scar on LT unemployed.”

One final note – this phenomenon is a novelty of the post-Quantitative Easing era. Can we be surprised that incentivizing the monopolization of the economy via the conduit of passive investing institutionalized by the Fed Put has permanently shrunken the labor force participation rate?

Today’s right chart certainly seems to concur with that conclusion. After reaching a high of 41.7, the manufacturing worker workweek (blue line) has slumped to 41.3, the lowest since last December. As for the media-hyped over-stretched Leisure & Hospitality (L&H) sector (yellow line), the workweek peaked at 25.3 in April 2021, the month those stimulus checks hit (which is surely a coincidence) and has since drifted to 25.0.

Employers not having to stretch their workers so thin should show up in reduced demand for fresh hires. Per Burning Glass Technologies real-time weekly data, at -9.5% in the week ended October 29 and vis-à-vis a January 2020 baseline, job openings for manufacturing positions (red line) are negative for the first time since last November. As for L&H openings at -10.5% (green line), they’ve been contracting for the last two weeks and are at their worst showing since this past January. To what are employers surrendering if not reduced demand?

VIPs

• Unit Labor Costs saw a spike to 8.3% in the third quarter, beating out the 7.4% consensus and soaring above Q2’s 1.1% rate; while labor costs grew at their fastest pace since 2014’s first quarter, productivity moved in the other direction with a 5% drop, its worst since 1981
• The white LFPR has recovered to 65.7% from February 2020’s 68% vs. the black LFPR falling from 63.1% to 61.3% and the Hispanic LFPR from 63.2% to 61.5%; 2.8 million Black and Hispanic workers still remain out of work due to COVID and rising childcare costs
• The White unemployment rate is 1.1% above its February 2020 levels vs. 2.0% and 1.9% higher for Blacks and Hispanics, respectively; with minority groups seeing higher permanent job losses as well, recovery is far from the inclusiveness Powell aspires to achieve

You’d have thought that along with baseball and apple pie, fireworks would have been invented in the United States. But, baseball is the one and only real deal, having been started in 1845 when the rules were written by the New York Knickerbocker Club. As for the case of that iconic dessert, the first apple pie recipe was published in England in the 14th century. Fireworks date back even further and conjure images of naughty teenage boys tossing things into fires to see how they will react, which is sometimes with a bang. In the second century B.C. in ancient Liuyang, China, it was bamboo stalks that were being thrown into fires. The explosion that followed resulted from overheating the hollow air pockets unique to bamboo, which is a grass, not a tree. The Chinese believed that nature’s “firecrackers” warded off evil spirits. Roughly 2,700 years later, a Chinese alchemist mixed potassium, nitrate, sulfur and charcoal which became a black, flaky powder and was the world’s first gunpowder. Combine the old with the new by pouring this innovative powder into bamboo and voilà — the first man made fireworks.

Over the past week, fireworks have been going off aplenty on Wall Street. It started last Friday with the release of the third quarter Employment Cost Index. The economics community saw a rise coming – they’d penciled in an acceleration to 0.9% from the prior quarter’s 0.7% pace. Instead, the 1.3% print marked the fastest pace in the series’ 39-year history. The hits kept coming yesterday, with the spike in third quarter Unit Labor Costs to 8.3%. Once again, economists anticipated a massive pop of 7.4% from the second quarter’s 1.1% rate. If you net out the violent moves induced by the pandemic, labor costs grew at the fastest pace since 2014’s first quarter. The mirror image – productivity – collapsed at a 5% rate, its worst showing since 1981. We know there are massive disruptions that continue to plague the bean counters’ best efforts; there is no doubt an element of distortion that suggests you fade the magnitude of these moves. But we are talking quarterly series in all three cases, which cannot and will not be ignored inside the microcosm of PhDs at the Federal Reserve.

Whatever will Jay Powell do if wage inflation persists for several more quarters? We hate to use the term “conundrum,” but that’s what he’s facing. In Wednesday’s painful post-FOMC presser, in defiance of Merriam-Webster, he bumbled about trying to convince himself that “transitory” was measured subjectively. Powell is desperate to buy time with such nonsense. And we would argue that he a leg to stand on as it pertains to the most pernicious form of rising costs – wage inflation.

Achieving “maximum inclusive employment” by June 30th would be a miracle and Powell knows it. That’s why he’s deluding himself that he won’t have to quicken the pace of the taper much less hike rates come July. Viewers of the press conference may have noted the most confrontational interaction with reporters we’ve seen since Pedro da Costa asked Janet Yellen about the Medley scandal. The highest inflation many have experienced in their lifetimes is undeniably a regressive tax, harming lower-income earners appreciably more than their high-income-earner counterparts.

That’s what brings us to the above referenced leg Powell has to stand on and defines the dilemma he faces as tightening into a slowing economy never ends well. This point may not resonate with those on the receiving end of soaring wages. But it sure does with the lowest income earners who’ve slashed their budgets to accommodate the higher costs of essentials, from housing to groceries to gasoline. And that’s the case for those with incomes. As you see in today’s left graph inset, the labor force participation rate (LFPR) among Whites (yellow bars) has recovered to 65.7% from February’s 68.0%. We’ve seen appreciably less of a bounce back in the LFPR of Blacks (red bars), which has moved down from 63.1% to 61.3%; Hispanics (blue bars) have fared about the same, with their rate at 61.5% vs. that which preceded the pandemic of 63.2%.

The blue-shaded area of today’s right chart fills in another blank. If you tally the number of Black and Hispanics who are unable to or not looking for work due to COVID-19, you see an enormous improvement from May 2020’s peak of 22.7 million. But the 2.8 million who remain is still a materially high figure. Think about how skyrocketing childcare costs factor in disproportionately for those who earn the least. Moreover, these same workers are also the least likely to have jobs that can be performed remotely.

We present the data on LFPR and those who’ve been yanked out of the workforce to contextualize the unemployment rates, which can’t properly reflect these elements. Even so, the unemployment rate recoveries are still nowhere near the “inclusivity” Powell aims to achieve. Since February 2020, the unemployment rate for Whites is 1.1% higher (blue line) while those of Blacks (red line) and Hispanics (blue line) remain 2.0% and 1.9% higher, respectively. As for permanent job losses, in the case of White workers (green line) they number 160,000 more than they did in February 2020 vis-à-vis Blacks (orange line) at 174,500 and Hispanics (purple line) at 214,500. Even against the backdrop of clear labor market scarring, the fireworks promise to continue in coming months.