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Hello. We all have our little dignities. Ours is the refusal to write on Elon and Twitter. But there was a lot going on in the less absurd corners of the market, including a job openings report that encouraged stocks, already primed to rise, to rise even faster. Is this gathering a repeat of the false dawn of August? Let us know what you think: [email protected] and [email protected].
Chill in the labor market
Remember Fed Governor Christopher Waller’s soft landing theory?
Here is a reminder. Waller argues that the pandemic has changed the job market. Specifically, job vacancies – a measure of labor demand – have been much higher relative to unemployment. This creates the possibility that a tighter policy could reduce job vacancies – ie the demand for labor – without increasing unemployment. Wage growth, and therefore inflation, would also fall.
The chart below from Waller (which we’ve shown you before) plots the vacancy rate against unemployment, where each dot represents a month. The change he envisions would follow the green arrow below, returning to the pre-pandemic regime:
We were skeptical of Waller’s theory. It is difficult for us to see why tighter monetary policy – which works by hitting demand indiscriminately – would narrowly reduce job vacancies without also increasing unemployment. Moreover, as Employment America’s Skanda Amarnath has Noted, job posting data may not be as reliable. It is, after all, cheaper and easier than ever to post a job offer online.
Yesterday brought data that made Waller look prescient. Vacancies in the latest Jolts survey fell sharply, with 10% fewer openings in August than in July. Add to that anecdotes of hiring freezes and layoffs in certain sectors, and some are already seeing a cooling in the labor market. Paul Krugman of the New York Times tweeted this updated version of Waller’s job vacancies versus unemployment chart (called the Beveridge curve), with the latest data reported:
Krugman writes:
Two more months like this (unlikely, but still) would restore the old [relationship between vacancies to unemployment]. This suggests that labor market disruptions may be on the mend.
Yes, a month’s data, don’t count your chickens etc. But it was the best economic news I’ve seen in a long time.
This could impact Fed decision-making. Ian Shepherdson of Pantheon Macro called him a “potential game changer for the Fed”, saying:
The frequency with which Mr. Powell refers to this figure indicates that it is taken very seriously within the Fed. . . two other Jolts reports will be published before December [Fed meeting]and if they look like August, the Fed won’t hike 50 basis points or more at the last meeting of the year.
Maybe. We would have read the opening numbers more cautiously. Consider the big picture. Inflation is the real target here. It’s down slightly but still hot, and the Fed has set the bar high (“clear and convincing evidence”) for abandoning rate hikes. And even just looking at labor market indicators, normalization is still a long way off. The quit rate, a more reliable measure of strain than job vacancies, is still well above pre-pandemic levels. At the rate quits have fallen from their December 2021 peak, it would take 11 months to normalize:
From wage growth to hours worked, nearly every labor market chart looks like the one above: off their peaks, but far from normal. Financial markets primarily care about change at the margin, but the Fed has made it clear that it will wait until the trend is evident. There is still a lot to do. (Ethan Wu)
Housing crisis in China, global disengagement and return to low inflation
Everyone should read the great read on the Chinese real estate crisis by our colleagues James Kynge, Sun Yu and Thomas Hale. Here is the basic argument:
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China’s introduction of “three red lines” debt limits in 2020 has left developers without capital to complete pre-sold housing projects. These “suspended” projects caused a rout in the bubbling real estate market.
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Broke or almost broke real estate developers, no longer able to consider new projects, have bought much less land from local authorities.
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This has left local government finance vehicles (LGFVs) short of funds and at risk of default. LGFVs are the main source of financing for infrastructure projects, from roads to power plants, and the stock of LGFV debt is equivalent to half of China’s annual GDP. Yeah.
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The underlying problem? Falling returns from private and public debt-financed projects. Killer quote from an American investor: “LGFVs are about 6% leveraged and are getting returns on equity of maybe 1%. . . Most of them depend on subsidies from local governments. But now that local government revenues from land sales are down, many of the grants are stopping.
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The government has the means to prevent this “crisis in slow motion” from accelerating. But the debt-based growth model of the past decades seems outdated.
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This has global implications: “Between 2013 and 2018, according to an IMF study, China contributed about 28% of global GDP growth, more than double the share of the United States. A contribution close to this level seems unlikely in the future.
This last point is part of a debate that we have broadcast several times in space (most recently last week). Is the current economic moment an outlier incident in the low inflation regime of past decades, or an inflection point and a taste of a more inflationary world to come? If China’s growth phase is over, this supports the top position. A slow-growing China should be deflationary.
One point that seems crucial to Unhedged is that the change imposed on China by the real estate crisis is reinforced by deliberate shifts in Chinese policy – by the plan to create what Kynge called “Fortress China.”
In this context, it is worth reading the latest position paper of the European Chamber of Commerce in China. It opens as follows: “Although Europe and China are already at opposite ends of a shared continent, they seem to be moving further and further apart.” A litany of complaints ensues: foreign form regulations are becoming stricter and less predictable; barriers to new entrants into the Chinese market are increasing; efforts to reform China’s state-owned entities, which dominate key industries, have stalled.
The chamber report does not name specific companies. But this summer, for example, the boss of automaker Stellantis (the product of the Fiat Chrysler/Peugeot merger) warned “there is growing political interference in the way we do business as a Western company in China. “, after Stellantis dissolved a manufacturing joint venture with a Chinese partner.
Beijing’s zero Covid policies make all of this worse, but the chamber sees these policies as an extension, rather than an aberration, of trade policy in general. Ideology takes precedence over economics. The reforms and opening up of the 1990s are a thing of the past. As a result, according to the chamber, European companies that were once bent on expanding into the country are increasingly focusing on the challenges facing their existing Chinese operations. European investment in China is declining and is now dominated by only a few large companies. Companies are actively exploring diversification of supply chains outside of China.
The picture painted by the chamber report is important for the trajectory of global growth. This suggests that not only will China struggle to grow rapidly as it moves away from the borrow-and-build model, but that growth is no longer a top priority for Chinese policymakers — at least not the growth of the outward-looking type that the rest of the world has grown accustomed to.
A good read
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