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Good morning. The world’s eyes are back on the war in Ukraine, after the country’s President Volodymyr Zelenskyy pushed back against comments made by Donald Trump insinuating that peace in the region would require “some swapping of territories”, ahead of a planned summit between the US president and Russian leader Vladimir Putin. European capitals joined Zelenskyy’s outrage over the weekend. What might come out of this week’s summit? Peace? Email us your predictions: unhedged@ft.com.
Which is falling, labour demand or labour supply?
After the weak July jobs report, calls for the Federal Reserve to cut interest rates have intensified. The demands make sense if the falling number of new jobs comes from falling labour demand: stimulate the economy, and more hiring should follow.
But what if the issue is supply? Dhaval Joshi at BCA Research argues that the labour force is now several million people smaller than total labour demand (which he defines as jobs, job openings, and unemployed workers on furlough). He argues that
Fewer jobs are being created because there are fewer available workers to do them. Hence, cutting rates now — as Waller and Bowman are suggesting — would boost labour demand but it would have no impact on job creation . . . Worse, cutting rates would widen the excess of labour demand over labour supply, and thereby reignite inflation . . . it would be a policy error.
Parag Thatte of Deutsche Bank points out to Unhedged that the number of total hours worked — the number of people employed, multiplied by the average work week — has been growing at a steady pace for some time now, rather than slowing or contracting as one might expect if demand were suddenly weakening:
At the same time, the fall in net immigration under the Trump administration has created a labour “supply shock,” according to Matt Klein of The Overshoot, who argues the fall in job creation “mirrors” the decline in immigrant inflows:
The Fed’s Michelle Bowman — one of two dissenters who wanted the Federal Open Market Committee to cut at the last meeting — takes the other side of the argument. She highlights the fall in the employment-to-population ratio, to 59.6 per cent from 60.4 pre cent in November 2023. HSBC economist Ryan Wang agrees that “the downward trend is a sign of slowing demand for labour.” His chart:
Bowman also notes a slowdown in gross hiring, despite an increase in the overall population and labour force. Further, she sees low firing rates not as an indicator of sustained labour demand but the result of memories of pandemic worker shortages.
It doesn’t have to be either demand or supply, of course: both could be falling, to different degrees. But it is worth trying to determine which is likely the predominant factor. Unhedged leans towards falling supply, simply because we see only scattered signs of a recent drop in demand outside of the job numbers (see next piece). But our confidence in this is only moderate.
(Kim)
More thoughts on falling profit growth
We wrote a couple of pieces last week about faltering underlying profit growth at big US companies. We looked at S&P 500 operating profits excluding the booming Mag 7 tech stocks and the energy and financial sectors (which don’t tend to track the overall corporate economy). Here are the updated numbers:
Why is this happening? Softening demand? Spiralling costs? Tariffs? Some exogenous factor we haven’t thought of? One reason to doubt that final demand is not the problem is that sales growth is holding up:
But this is not decisive. Those are nominal sales. Real sales growth, at something under 5 per cent, is not roaring. And strains on demand can show up on the cost side, too: companies might be having to spend more to bring in the same amount of revenue.
Making matters more complicated, the slowing trend is unevenly spread, as a look at second-quarter profits growth of different sectors shows. Tech is booming even without the Mag 7 (Micron, IBM, Amphenol and Lam all made chunky contributions). Materials, industrials and utilities look sluggish and consumer discretionary looks terrible.
The most basic way to answer these questions is to listen to what companies say is going on. Start with the weakest sector, consumer discretionary, where operating profits at the 40 S&P 500 companies that have reported second-quarter results are $4.3bn lower this year than in 2024. The companies creating the biggest profits drag seem to fit in three categories:
Carmakers. This is mostly a tariff story. General Motors’ vehicle deliveries were up, but profits were $1.8bn lower in the second quarter than a year before, and $1.1bn of that decline was down to tariffs. There was a $1.4bn drop at Ford, $800mn of which was from tariffs.
Big consumer doing turnarounds. Nike and Starbucks are both rebuilding after big strategic mistakes. Nike went overboard with direct sales and Starbucks fell into operational and menu sprawl. Combined operating profit at the two fell by $1.8bn in the quarter.
Homebuilders. This is a demand story, but a sector-specific one. Mortgage rates are still high and the builders are protecting margins and return on capital rather than bringing prices down. The result is weak demand. DH Horton CEO Paul Romanowski said that “new home demand continues to be impacted by ongoing affordability constraints and cautious consumer sentiment.” Between them, Horton, Pulte, Lennar and NVR saw operating profit fall $1.3bn in the second quarter. Homebuilding-adjacent companies (Pool Corp, Mohawk Industries) are sluggish too.
None of that paints a dark picture of US demand overall. But there is another discretionary category worth looking at, because it is sensitive to consumer economic vibes: restaurants. While most of the big chains are reporting rising profits, there are signs of trouble at the margins.
The one S&P 500 restaurant company that reported falling operating profit in the second quarter was former high-flyer Chipotle. The CEO said that
I think much of what we’re experiencing right now is due to macro, and the consumer — the low-income consumer is looking for value as a price point at present. You have to look no further than what’s going on with our competitors with snack occasion or $5 meals and that’s where the consumer is drifting towards value . . . because of low consumer sentiment.
The results of other restaurants don’t quite confirm this. Darden, which operates “fast casual” restaurants such as Olive Garden and is not miles away from Chipotle in terms of price, is doing quite nicely. At the same time, while McDonald’s managed to grow US same-store sales at about the rate of inflation, executives noted that poorer customers were staying home. At Yum Brands, the only US brand that is working is Taco Bell, which is very cheap.
Looking across consumer discretionary companies, the general impression is not one of a general slowdown in demand, but rather scattered patches of trouble, as poorer consumers struggle, the housing sector wobbles, and tariffs take a toll on certain subsectors. Slowing US profits is not a simple story of a weaker economy.
(Armstrong)
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