input costs

US bank stress test results – 28/06 –  these stress tests couldn't be timelier given the meltdown in the US regional banking sector in March. In February the US central bank released its criteria which included a severe recession with stress in commercial and residential real estate markets, as well as corporate debt. One of the main criticisms of these tests was a lack of a scenario that factored in a sharp rise in interest rates which brought down Silicon Valley Bank as well as First Republic. Furthermore, US regional banks were not covered under the stress test scenario as they were considered too small and not systemically important enough. As recent experience in Europe has taught us and particularly in Spain where a large cohort of Spanish Cajas nearly brought the economy to its knees and resulted in a banking bailout, just because a bank is small doesn't mean it won't cause a financial meltdown if its troubles spread. The problems in US regional banks were well known at the time, however, there appears to have been a serial underestimation of the risks that a sharp rise in rates would have on some of the smaller parts of the US banking sector, none of which are covered by this week's stress test results.           Associated British Foods Q3 23 – 26/06 –  the recovery in the Associated British Foods share price since the 10-year lows posted back in October appears to have ground to a halt after hitting 15-month highs back in April, just before the release of its H1 results. H1 group revenues rose by 21% to £9.56bn, while adjusted profit before tax came in at £667m. sales across all ABF businesses were higher from the previous year, partly due to higher prices, while its Primark business which has seen an expansion in the US performing particularly well. The company is also hoping to expand its new UK click and collect scheme. On the various businesses Primark sales rose 19% to £4.23bn while margins came in at 8.3%. The various food businesses saw revenues rise to £5.33bn, a rise of 23%, with the ingredients business posting strong profit growth. On the outlook management warned that input costs are a priority, even as some have started to reduce, saying they expect adjusted operating profit in the food business to be ahead of last year. With respect to the Primark business management expressed concern about consumer spending holding up in the face of rising interest rates, and the higher cost of living. H2 margin is still expected to in line with H1 at 8.3%, while adjusted operating profit for the year is expected to be in line with last year.   Carnival Cruise Lines Q2 23 – 26/06 –  the travel and leisure sector has been one of the hardest hit from the Covid shutdowns, and the journey back for the cruise ship sector has taken longer than most, with the industry still struggling to turn a profit even as revenues start to return to pre-Covid levels. For Carnival the journey has been a long one given that in the first year of lockdowns annual revenues fell from $20.8bn in 2019 to a mere $1.9bn in 2021, with the industry undergoing a near death experience. Last year the company managed to turnover $12.17bn in revenue with management optimistic that the new fiscal year would see a return to normal for the first time in 4 years. In Q1 the company said that revenues came in at $4.43bn as losses narrowed to $690m, against a forecast of -$759.7m. On the outlook management said that cruises are well booked for the remainder of the year at higher prices, however, the higher cost of fuel and other costs is acting as a headwind. On annual EBITDA Carnival says it expects to see a figure of around $4bn, which includes a $500m impact from higher fuel prices. For Q2 revenues are expected to come in at $4.75bn while losses are expected to come in at -$0.35c a share. Annual revenues are expected to exceed pre-Covid levels this year. On the downside while total operating expenses are only forecast to rise modestly from $12.9bn to $13.8bn, interest expenses have surged from $206m in 2019 to over $2bn.        Walgreens Boots Alliance Q3 23 – 27/06 –  Walgreens share price has performed poorly year to date, the shares down over 10%. When the company reported in Q2 revenues slid by 3% to $34.9bn, although profits came in above expectations at $1.16c a share. In Q1 the company also posted profits of $1.16c a share, however this was wiped out by a $5.2bn provision in relation to litigation the company was required to pay for opioid related litigation after several US states alleged the retailer mishandled prescriptions by overprescribing. Walgreens has found that its business has suffered through a decline in footfall since the pandemic a situation that it has struggled to adapt to. It has invested into the provision of primary health care, paying $3.5bn towards the acquisition of Summit Health, by VillageMD, putting it near the top of the pack in primary care provision. Walgreens reaffirmed its full year earnings forecast of mid $4.55c a share. Q3 profits are expected to come in at $1.08c a share on revenues of $34.15bn.        Nike Q4 23 – 29/06 –  back in February Nike shares hit their highest levels in 10 months, but have slipped back since then, despite a significant pick-up in their Greater China business. When they reported in Q3, revenues came in at $12.39bn well above forecasts, however a bigger than expected build up in inventory served to drag on its margins which fell more than forecast to 43.3%. Inventory levels were 16% above the levels they were last year at $8.9bn, while their forecasts for Q4 were also relatively conservative, with an expectation of flat to low single digit revenue growth. Given the lacklustre nature of recent Chinese consumer spending even these forecasts could miss expectations, while Nike sales may have also taken a hit due to recent publicity over its new brand ambassador Dylan Mulvaney, and the company's recent advertising campaign. Q4 revenues are expected to come in at $12.57bn pushing annual revenues to a record $50.9bn, with direct to consumer expected to rise to $21bn. Annual gross margins are expected to slip back to 43.5%. Q4 profits are expected to come in at $0.66c a share.   

Eurozone PMI suggests worsening economic conditions The eurozone PMI suggests contracting economic activity at the start of the third quarter. Overall, this fits a trend of weakening survey indicators over recent months and increases the recession risk for the bloc. The survey continues to suggest moderating price pressures, but the impact of wages on services will remain a concern for ECB hawks. Survey data became progressively bleaker during the second quarter and the July PMI continues that trend. The June composite PMI stood at 49.9, broadly signalling stagnation, but in July the PMI dropped to 48.9, indicating contraction. Demand in the eurozone is falling for both goods and services according to the survey, with services new orders dropping for the first time in seven months while the decline in new orders for manufacturing steepened further. France and Germany look particularly bleak with output PMIs signalling contraction, which is offset slightly by the rest of the eurozone. We don’t have more details yet, but this could be due to more tourism-dependent economies profiting from a somewhat stronger summer period. Still, the positive tourism effect doesn't seem strong enough to counter weakening in the economy elsewhere. We have previously argued that the eurozone economy has been in a stagnation-type environment, and the recent two quarters of minimal negative GDP growth should not be taken as a broad recession given the strength of the labour market. The July PMI suggests that recession risk has increased though. With expectations of output weakening further, the outlook for the coming months is sluggish at best. The inflation picture coming from the survey is very similar to recent months. Price pressures are cooling, but more so for goods manufacturers than services providers. Rising wages continue to keep price pressures elevated for services, resulting in a slower downward trend. Dropping input costs are helping to bring inflation expectations down much faster for goods at the moment. This confirms our view of a materially lower inflation rate towards the end of the year but keeps hawkish concerns about the effect of wages on inflation alive.

Polish PMI dips in July on falling new orders Poland's manufacturing PMI fell to 43.5pts in July, down from 45.1pts in June, the lowest level since mid-2022, when the domestic economy struggled with the effects of rising energy prices, among other factors. The assessment of current production, orders, employment and purchases all worsened in July from the previous month.   The most significant thing to note from this data release is the deteriorating assessment of the acquisition of new orders (the worst ratings in eight months), especially for exports (the weakest performance since May 2020). This was followed by a decline in current production, the fastest since November 2022 and the fifteenth consecutive month of decline. We are most likely seeing the effects of economic weakness in the eurozone, especially in Germany (the industrial PMI there is below 40pts). Around 50% of Polish industry products go to foreign markets, and Germany is Poland's main trading partner. Planned employment decreased for the fourteenth month in a row. This can be seen in the CSO's employment data, where manufacturing accounts for much of the decline. In June, for example, the business sector lost about 5,000 full-time jobs, of which 3,000 were in manufacturing. Companies also reduced purchasing activity and sought to reduce inventories. In our view, this will translate into relatively weak imports. In addition to energy commodity prices, this should sustain Poland's trade surplus despite the weak export outlook.   Manufacturing PMI in Poland and Germany External demand affects the Polish industry   The bright spot is rapidly decreasing price pressure. The lack of demand has again pushed prices down. Input costs have fallen at the strongest rate since the survey began more than 25 years ago. This was helped by declines in raw material prices and/or the strengthening of the zloty. Selling prices also fell at the fastest pace ever. More than 27% of respondents reduced their prices during the month. While there are signs of stabilisation in domestic industrial production data, recent PMI reports suggest a cautious approach to expectations of a marked improvement in the sector's condition in the second half of the year. Manufacturing is seeing a marginal rebound in the US, Asia, and sluggishly in China, but not in Europe. We think the PMIs for Poland (and elsewhere) are much more pessimistic than real trends in activity (see graph), but other anecdotal evidence we collect has not provided positive signals so far.

Food inflation finally cools in Europe after a long hot summer Food price rises are finally subsiding in Europe. We saw the first Month-on-Month decline in almost two years in July. Many branded food manufacturers, however, are reporting lower sales as shoppers turn to more affordable goods. And a combination of high food prices and sluggish growth means those volumes won't be returning anytime soon.   Extraordinary rally in consumer food prices comes to an end Food inflation rates have been cooling for the past couple of months, and July’s inflation figures even showed a small Month-on-Month decrease in the European Union. That said, food prices remain at high levels. A typical EU consumer currently pays almost 30% more for groceries compared to the start of 2021, with some considerable differences across the continent. In Hungary, prices have gone up by more than 60% since January 2021, while food prices in Ireland went up by ‘only’ 19%. Across Europe, consumers reacted by buying less, shopping more at discount supermarkets and favouring private label products over brands. The trend in the US looks fairly similar. The main difference is that 'cooling down' set in a little earlier, and the relative increase was lower compared to Europe. That's partly explained by the fact that US food makers are less exposed to the energy price shock compared to their peers in Europe. American food prices started to move sideways in the first quarter of this year; a typical American consumer currently pays 20% more for groceries compared to the start of 2021.   Food inflation reaches a plateau in the EU and the US Consumer price index for food, 2020 = 100   Is Germany really leading the way on prices? Within the eurozone, Germany has been the only country seeing consumer food prices drop for several months in a row. According to Eurostat data, prices of food and non-alcoholic beverages in Germany were 1.4% lower in July compared to their peak in March this year. This is largely the result of lower prices for dairy products, fresh vegetables, margarine and sunflower oil.   What distinguishes the German food retail market from most other European countries is that discounters have a relatively large market share. Schwarz Group (Lidl) and Aldi have a combined market share of around 30%, and other major retailers such as Edeka and Rewe also own discount subsidiaries. Given the large and competitive German market, food retailers seem to have negotiated more strongly with suppliers than their counterparts in other European countries, even at the risk of losing those suppliers. As a result, retail food prices started to drop earlier. Also, the highly competitive market delivered special sales offers for consumers since the spring. For now, German consumers are benefiting from a reversal of the price trend, and consumers in other European countries might experience a similar trend in the months ahead. However, we believe that consumers shouldn’t get their hopes up too high given that some inflationary trends in the cost base of food manufacturers and retailers are still present. That’s also why we deem it too early to forecast a prolonged period of decreasing food prices.   Modest drop in German consumer prices due to lower dairy, vegetables and margarine prices Consumer price index, 2020 = 100   Underlying costs for food manufacturers show a mixed picture Throughout 2022, almost all of the costs for food manufacturers moved in one direction, and that was up. That picture has changed when we look at some important types of costs.   Input costs are by far the most important cost category, and agricultural commodities are a major part of these inputs. Prices for agricultural inputs are moving in different directions. World market prices for wheat, corn, meat, dairy and a range of vegetable oils are down year on year, which is partly on the back of reduced uncertainty around the war in Ukraine. However, prices for commodities such as sugar and cocoa rallied considerably in 2023. The prospects of the El Niño weather effect potentially upsetting the production of commodities like coffee and palm oil in Southeast Asia alongside India’s partial export ban on rice have given rise to new concerns.We estimate that energy costs make up about 3 to 5% of the costs of food manufacturing, but this will also depend on the subsector and the type of energy contracts. Current energy prices in Europe are much lower compared to their peak in 2022, but they are still much higher compared to their pre-Covid levels. Volatility continues to linger, in part because more exposure to global LNG (Liquified National Gas) markets makes European gas markets more susceptible to price fluctuations. Uncertainty about where energy costs will be headed over winter can make food manufacturers more reluctant to reduce prices.Continuing services price inflation means companies along the food supply chain will face higher fees for the services they contract, such as accounting services and corporate travel.     Wages account for a bit more than 10% of the costs of a typical food manufacturer in the EU (excluding social security costs). Both the spike in inflation in 2022 and 2023 and the continued tightness in labour markets are leading to a series of wage increases in food manufacturing and food retail. In our view, wages will be an important driver for the production costs of food and for consumer prices over the next 18 months, given that wages go up in subsequent steps. Examples of wage increases in the food industry In the German confectionery industry, 60,000 employees get an inflation compensation of €500 in 2023 and 2024 on top of a 10-15% increase in regular wages. We see similar patterns for wage agreements at individual companies, such as for the German branch of Coca-Cola Europacific Partners. In the Dutch dairy industry, wages will increase by 8% in 2023 and another 2.65% in 2024, while the collective labour agreement in the Dutch meat industry contains a three-tiered increase of 12.25% in total between March 2023 and 2024. In France, it's expected that average wages in the commercial sector will rise by 5.5% in 2023 and 4.2% in 2024. This also gives an indication for wage development in industries such as food manufacturing.   Wages make up 13% of German food manufacturers' costs with some variation between subsectors Wage costs as a percentage of total costs, 2020     Adverse weather pushes up prices for potatoes and olive oil Following the warmest July on record, it’s evident that people are wondering to what extent weather will push up food inflation in the months ahead. The most recent monthly crop bulletin from the European Commission notes that weather conditions were on balance negative for the yield outlook of many crops and thus supportive for prices. Although the picture can be different from crop to crop and from region to region, there are certain food products where inflation is accelerating due to weather. One of the biggest victims of unfavourable weather in Europe this year is olive oil. The continued drought in Spain, and particularly a lack of rain during spring, leads to estimates that olive oil production will be down by 40% this marketing year. It will be quite difficult to find enough alternative supplies outside the bloc, given that the EU is the top exporter of olive oil. This is also the case for potatoes and potato products. Here, a wet start of the year in northwestern Europe followed by dry weather in May and June and abundant rain in July means conditions have been very unfavourable for potato yields and quality.   Food prices are likely to hover around their current levels for a while The developments in underlying costs for food producers lead us to the view that consumer food prices will likely hover around their summer levels for a while. When there are decreases in general prices, those will be the result of trends in specific categories, such as dairy, rather than being widely supported across all categories. This view is also supported by business surveys which show that sales price expectations of food manufacturers are now clearly past their peak, as you can see in the chart below.  Multiple major food companies, including Danone, Heineken and Lotus Bakeries, have signalled in their second-quarter earnings calls that there will be less pricing action in the second half of this year. However, some companies are indicating that they’re not yet done with pricing through their input cost inflation. Unilever, for example, reported that we should expect moderate inflation in ice cream in the second half of the year, for instance. In any case, we do see a likely increase in promotional activity as brands step up their efforts to re-attract consumers and boost volume growth. But given the elevated price levels and the muted macro-economic outlook, it’s likely to take a while before volumes fully recover.   European food manufacturers expect fewer price increases in the months ahead Sales price expectations for the months ahead, balance of responses       Price negotiations remain tense Food manufacturers have fought an uphill battle to get their higher sales prices accepted by their customers, such as food retailers. Negotiations in the current phase won’t be easy either because food and beverage makers will be heavily pushed by major retailers to reduce prices. Retailers that lost market share will be especially looking to secure better prices in a bid to re-attract consumers. Whether there is room for price reductions will vary from manufacturer to manufacturer depending on the agricultural commodities they rely on, the energy contracts they have and cross-country differences in wage developments. As such, explaining why prices still need to go up, cannot go down (yet) or can only go down by so much will be a significant task for food manufacturers in the coming months.

Strong Tokyo CPI will likely put pressure on the Bank of Japan The Bank of Japan should be concerned about whether 'higher for longer' inflation could hurt the economic recovery.   Headline inflation in Tokyo topped 3% again in three month Tokyo inflation climbed up to 3.3% YoY in October (vs 2.8% in September, market consensus). Upside surprises came from: Higher than expected pick up in utilities with a reduction of government subsidies and A solid rise in entertainment prices. More importantly, the BoJ's preferred measures of inflation, core CPI excluding fresh food (2.7% vs 2.5% in September & market consensus) and core-core CPI excluding fresh food and energy (3.8% vs revised 3.9% in September, 3.7% market consensus) came out higher than market consensus. Since Tokyo inflation is a leading indicator for nationwide inflation, today's readings showed that inflation has been clearly overshooting the BoJ's projections.  On a monthly comparison, CPI soared 0.9% MoM, seasonally adjusted, in October, with both goods and services prices rising by 1.6% and 0.4% each   Tokyo's inflation reaccelerated in October   Utilities and fresh food prices rose the most, but prices of all other major items gained. In particular, the weak JPY has accumulated pressure on the imported goods prices, and this prolonged pressure pushed up prices of household goods, apparel, and transportation. The rise in entertainment is mostly driven by strong demand from foreign and domestic tourists. Going forward, we expect that base effects will kick in and suppress the headline inflation again by the end of the year, but we will likely witness a stickier than expected inflation trend throughout next year.   Overheated inflation is a risk for the recovery Today’s hotter-than-expected Tokyo CPI reading will likely be a warning to the Bank of Japan. It may still rule out a policy change at its October meeting, but at least we expect the BoJ to change its view on inflation. It is clearer that companies are shifting the pressure of rising input costs to consumers, and the weak JPY is partially contributing to the added pressure on input costs. Also, demand-led price hikes continued on the back of a solid recovery in service activity despite a fall in real wage growth. But, if the yen weakens further and brings about overly heated inflation for longer, it will eventually hamper private consumption even before the BoJ's long-awaited goal of sustainable inflation is accomplished, which is the biggest risk for the BoJ. We are sticking to our call that the BoJ will deliver a policy tweak and revise the inflation outlook meaningfully for FY 23 and 24. And today's outcome has slightly increased our confidence in our non-consensus view. There are more details about the BoJ's next moves in our article earlier this week;  Source: CEIC

Eurozone is likely in a shallow technical recession The November PMI does not provide much evidence that eurozone GDP growth will turn positive in the fourth quarter, but the good news is that the downturn is not deepening. We’re currently likely in a very shallow technical recession. The eurozone composite PMI ticked up from 46.5 to 47.1 in November, which still indicates a contraction in business activity. New orders continue to fall as backlogs of work are being depleted. This is more so the case for manufacturing, where the downturn is deeper than for services. Still, new orders fell slightly less in November than in October. This confirms the view that the downturn is not worsening at the moment, but there is little evidence of recovery either. Overall, it looks like this is a shallow technical recession. The employment outlook continues to deteriorate. Services job growth had kept overall employment growing up till now but the survey suggests that employment in this sector is now growing at a snail’s pace. With manufacturing shedding jobs, this is resulting in a marginal downturn. To us, this fits into the bigger picture of a labour market weakening on the back of a few quarters of negative growth. Inflation is on a solid downward trend, but the PMI indicates that input cost pressures remain and that selling price inflation ticked up in November compared to last month. This is mainly coming from services as prices in manufacturing continue to fall. This serves as a warning that inflation pressures are not over yet, even though inflation does continue to move in the right direction with demand having weakened materially.

Eurozone PMIs show very tentative signs of bottoming out The eurozone economy continues to trend around 0% growth and there are no signs of any imminent recovery. Price pressures are still increasing for the service sector, which provides another argument for the ECB not to hike before June. How you read today’s PMI release for the eurozone reveals whether you’re an optimist or a pessimist. The increase from 47.6 to 47.9 in the composite PMI for January cautiously shows signs of bottoming out but also still indicates contraction. We also note that France and Germany saw declining PMIs, making the increase dependent on the smaller markets. Manufacturing price pressures remain moderate despite the Red Sea disruptions, but the service sector indicates another acceleration in input costs. To us, this shows that the eurozone economy remains in broad stagnation and that risks to inflation are not small enough to expect an ECB rate cut before June. The eurozone continues to be plagued by falling demand for goods and services, although new orders did fall at a slower pace than in recent months. Current production and activity were weaker than in recent months, though, suggesting that January started with contracting output still. The slowing pace of contracting orders does suggest that there is a bottoming out happening though. Whether this is enough to show positive GDP growth in the first quareter depends on February and March. In any case, GDP growth is so close to zero that we still qualify the current environment as broad stagnation anyway. The PMI continues to show some concern around inflation. Even though demand remains lacklustre, services cost pressures are on the rise again due to higher wage costs which are being transferred to consumers. Cost pressures on the goods side remain low despite Red Sea disruptions as energy prices trend lower and demand overall remains weak. This also means that goods inflation continues to trend down according to the survey. So, despite Red Sea problems prominently featuring in the news, inflation concerns currently stem more from services than goods, interestingly. For the ECB, enough worries about inflation not trending down to 2% quickly still remain. We think that makes a first cut before June unlikely.