The Days Ahead:

  • Earnings again up; employment costs.

This Week:

  • Metal commodities have been on a swan dive this year.
  • We look at what’s going on with Electric Vehicles (EVs).
  • Falling prices in EVs and commodities will help inflation numbers.
  • A look at bill issuance ahead of Monday’s new refunding announcement.
  • Bill issuance may ease but coupon will not.
  • The growth of the labor force and immigration.
  • How unemployment rates can climb without people losing their jobs.
  • Malaysia pulls off a magic trick.

Battery Commodities

We wrote back in May about the difficulty in mining cobalt and the long-term price implications of improving conditions in the artisanal mines in the Democratic Republic of Congo. Back then the price was around $34,490 per metric ton and today it’s, well, basically unchanged at $33,000. We weren’t expecting prices to rise in the short-term. After all, cobalt is a byproduct from copper and nickel mines in Congo and Indonesia and relatively easy to extract if safety’s not your highest priority. But we have seen a sharp fall in lithium, cobalt and nickel prices, the three basic commodities for electric vehicles (EVs).

EVs need a lot of these metals. A typical EV will have a 771 kg (1,700 lbs) battery which will use roughly 14 kg of cobalt, 30 kg of lithium and 40 kg of nickel.

None of the three are particularly scarce. The world’s nickel reserves stand at around 350 million tons and annual usage is 2 million, so a ratio of “years to use” of 175:1. It’s also 100% recyclable with no property loss. Lithium reserves are around 98 million tons and usage at 130,000 tons, so a ratio of 753:1. Cobalt is not quite so abundant with around 8.3 million tons of reserves and usage at 190,000 for a ratio of 43:1. However, there’s probably a lot more cobalt that could come on stream as the U.S. Geological Survey researchers say they haven’t looked that hard.

So, there’s enough of the three around.

What about demand? Well, the marginal demand increase all comes from EVs. China is the big player here. It produces around 30 million cars, trucks and commercial vehicles a year, which is nearly three times that of the U.S. and more than the annual output of the U.S. the EU and Japan combined. The number of private vehicles produced is around 24 million so far this year but production is very seasonal so in this chart with the green line, we’ve used a moving average.

Source: FactSet, 10/24/2023

We’ve also included Chinese exports of automobiles in the blue line. The scale and pace of China’s transformation into an auto exporter is remarkable. It’s seen vehicle export growth of 300% in two years and swung from a trade deficit of around $30 billion to a surplus of $50 billion. None of those exports go to the U.S. so the pressure on Europe and Japanese auto makers intensifies. By comparison, the U.S. runs a $270 billion trade deficit in auto vehicles and parts.

EV production in China runs at around 8,145,000 units a year with another 2,320,000 plug-in hybrids. Total global EV production 12 million units, and China is the lead producer with about 55% of global sales and 70% of production. Chinese production is up about 36% from 2022.

Sales, however, are a different story. They’ve plateaued for much of the last five months and are only up 6%, despite heavy discounts of around 15%. In fact, there’s a downright glut of EVs in China. In 2019 there were 500 EV car makers in China. Now there are around 100. Many of the cars built in the last few years were for ride-hailing companies that are now bust. They had limited range and were quickly surpassed in quality and build. Recycling costs were prohibitive so there were numerous places like this: miles of abandoned, new EVs.

Source:, Bloomberg

So, while China has fast expanded production, it also has a glut of vehicles, and consumers who don’t want to buy more new cars despite subsidies and discounts. All the hype over EVs suddenly started to look not so great.

Commodities soon reacted.

Source: FactSet, 10/24/2023

Forgive the messy chart but the quick explanation is that since January, cobalt prices fell 35%, nickel by 39% and lithium by 75%.

Part of the problem is the cyclicality of any commodity and mining business. Demand rises, production responds but with a lag, storage quickly fills up and demand drops.

Storage is an acute problem with some of these metals. Lithium reacts violently with water and humidity and can’t be held in wide spaces; narrow spaces, like silos are fine but they’re expensive.

Cobalt is highly carcinogenic in its unfinished state, and there’s only 50 tons of warehousing space in the U.S. compared to 6,600 tons of consumption.

Nickel is not hazardous but it tends to move straight to smelting. After that, it goes to end users. The high price of nickel last year also encouraged a classic “substitution.” If prices get too high for one input, producers try to get by with something else. In the case of nickel, production of nickel pig iron (NPI) came online in 2007, when the nickel price peaked at $50,000 per tonne. NPI is of lower quality, and needs higher energy intensive processing than pure nickel. But price is a big incentive to innovation and NPI is half the price of nickel.

So, EV demand is down, especially in China. Commodity prices are down because supply chains have run down stocks, manufacturers are using substitutes if they can, and the mining industry is over-producing and will probably continue to do so for a few more years. Some mining companies are trying to merge but face national and regulatory barriers. It’s all a bit of a mess. It should help EV prices for consumers because the batteries account for around 20% to 35% of the cost of the car. We should see lower prices in the next year.

Meanwhile, prices in commodities look set for only a slow recovery. It’s a reminder that despite all the technology and redesign of supply chains, large parts of the world’s economy remain very cyclical and volatile.

Why do Treasury Rate Bills Yield So Much?

Well, yes, it’s because the Fed has raised rates 10 times since March 17, 2022, over 13 meetings and remain unclear as to whether they’re done or not. But another reason is the size of bill issuance.

Warning: the next bits go into Treasury and money market plumbing and can get a bit boring. Please feel free to skip to the last paragraph for a TL;DR

Normally the Treasury issues about 24% of its debt to intra-government agencies like Social Security and various pension funds. The remainder is sold to the public and stands at around $25,730 billion. That debt is made up of:

  • Treasury Inflation Protected Securities (TIPS) of various maturities at 8% of the total.
  • Floating Rate Notes (FRNs) at 3%
  • Bills, which range from 4 weeks to 52 weeks, at 15%
  • Notes, which range from 2 years to 10 years at 58%
  • Bonds, with 20 and 30-year issues, at 16%.

The TIPS and FRNs are variable rate notes, meaning the interest paid on them isn’t known at the time of issue. What you get paid depends on inflation for the TIPS and short-term rates for the FRN. The rest are fixed rate bonds, notes and bills.

Coming into 2023, some 30% of all Treasury fixed rate issues were going to mature during the year. That meant, roughly, $6,400 billion needed refinancing in 2023, plus whatever new debt was needed to fund the deficit, which so far this year is another $1,800 billion.

Then the debt ceiling talks came round and Treasury took all sorts of special measures to avoid having to stop funding the government or defaulting on its debt. Basically, they issued a bunch of IOUs with various federal pension plans and ran down the Treasury General Account (TGA, or the government’s checking accounts) to just $71 billion from a high of $600 billion at the beginning of the year.

Congress determines the size of overall debt but the U.S. Treasury determines its composition. If the Treasury believes deficits are temporary, as with Covid-19 or the financial crisis, they will issue short-term debt. If they feel some of the liabilities are longer and can “lock in” favorable long-term rates, then they will issue more long-term notes and bonds.

When all the debt ceiling problems went away on June 1st, the Treasury announced how much debt they would have to sell to make up the maturing debt, new debt, repay the IOUs, and replenish the TGA. It turned out to be $1,439 billion in Q3 2023 from $1,275 billion in Q2. The net amount issued in bills went from $478 billion in Q2 to $829 billion in Q3 but will drop to $513 billion in Q4. They also guided that they wanted bills to reach around 20% of all debt outstanding from 16% in June.

If all that was bit too much, the basic story was the Treasury had a lot of debt rolling off in 2023, the debt ceiling prevented them from financing new debt for a while and they had to play catch up, especially in bill issuance. This is what it looks like:

Source: Department of Treasury, Cerity Partners

The Q3 issuance stands out for sure. But it may soon ease. The TGA is now at $870 billion, its highest since May 2022 and some $440 billion above the pre-Covid-19 levels. Net bill issuance month to date to  October 24 2023, was $163 billion compared to $186 billion in September. The Treasury has clearly leaned on the bill market to fund the deficit and has now pushed the bills to 20.4% of all debt outstanding.

Source: FactSet, 10/24/2023

It’s shown in the green line with the blue line being the total amount of bills outstanding at around $5,200 billion. The level has now reached the 20% Treasury spoke about in June. This should, therefore, mean bill issuance eases and, indeed, the estimate is that it will drop to around $300 billion in the current quarter.

But things are on the move again.

First, the Treasury stated that they’d be happy with a 22.4% target, which would mean another $570 billion of bill issuance on top of the scheduled $513 billion for Q4. However, they did not say when, merely stating that they are comfortable with the higher number for “some time”. So, there’s more bill issuance coming, but we don’t know exactly when.

Second, the Treasury is worried about note and bond issuance, which is expected to be around $920 billion in Q4 compared to $670 billion in Q3 and $660 billion a year ago. Recently some of the bond auctions had poor receptions, especially when the 10-year Treasury moved sharply from 4.0% to nearly 5.0% in less than two months. The Treasury asked market participants what they thought about higher bill issuance and the introduction of a new 6-week bill (they currently have a 4-week and an 8-week). We don’t know the response yet but the fact that they asked it suggests more bills are coming.

So, is that bad for rates? Probably not much because of the $5,700 billion retail money market fund (MMF) industry. They hold things called reverse repurchase operations (RRO) balances at the Fed. And they hold a lot of them. These are overnight cash balances that money market funds sell to the Fed. In return they receive a rate of 5.3%, but it’s only good for one day.

For the year up to June 2023, the RRO rate was more than the 3-month treasury bill rate and it was moving up quickly because it tracks the Fed Funds rate.

In 2022 and the first half of 2023, a money market fund manager faced the choice of buying:

  1. overnight riskless paper from the Fed yielding more than 3-month bills when they knew rates were headed up or…
  2.  3-month bills, yielding less and have their rates locked.

“A” was the only real choice and in 2022 to early 2023, and MMF managers took their RROs to $2,500 billion. But now the RRO rate is 5.3% and 3-month bills are at 5.6%. That makes the 3-month bill far more attractive. Since the debt ceiling resolution, MMFs have run down their RRO balances to $1,100 billion. They could run them down to zero which is where they were from 2017 to early 2021.

So, where does all that leave us? The Treasury is likely to continue to issue more bills but not at the same fast rate as they did in Q3. MMF managers will likely take their Fed balances down, because they can earn more in the bill market. And rates will probably stay quite attractive at the short end, at least until the Fed signals otherwise.

There’s a lot of moving parts behind the Treasury market but the last few months have seen very deft handling of the chaos that came from the debt ceiling standoff. Investors have done well out of it, even though it probably gave some Fed and Treasury officials some very sleepless nights.

People Working

The U.S. labor force has grown by around 3.3 million in the last year and the number of people employed by 2.9 million. The labor force is the sum of people employed and unemployed. The employed is just those people working. The growth in the labor force comes from more people entering the workforce either by rejoining, in which case participation rates increase, or people join and leave as they reach certain ages or by immigration. We’ve not seen much of a pickup in the participation rate in the last year and the population hasn’t changed much. So, the rebound in the labor force seems to come from immigration.

Immigration numbers aren’t particularly up to date, but we have 2022 data. Immigration averaged 1,087,000 a year from 2005 to 2019. It then fell to 707,000 for two years and rebounded to 1,018,350 in 2022. We took a look at job growth and labor force growth for the last year.

Source: FactSet, 10/25/2023

The blue line is the labor force and the green line is the number of people employed.

When the labor force grows faster than the number of people employed, unemployment rises. Since January, the labor force has grown much faster than the employed labor force and in the last two months it moved sharply ahead. The average monthly job growth for the last year is 226,000 while the average labor force growth is 275,000.

This is good. If the unemployment rate goes up without large job losses, we’ll get two good things.

One, unemployment will rise not because people have lost a job but because they’ve just entered the workforce, and probably through immigration.

Two, it reduces wage pressure. People looking for jobs because they’re recent immigrants don’t ask for pay raises. Getting a job is enough.

So, we’ll see more people enter the workforce, unemployment rise, the Fed relaxed about wage pressure, and we won’t see a lot of job losses. If that sounds all too optimistic, fine…but that’s exactly what we’ve seen in the last few months.

Could Not Pass This One Up

We’ve written before about just how leaky the sanctions are against Russia. We’ve seen massive rises in exports to out of the way places like Armenia, Georgia and Kyrgyzstan. Basically, these became entrepots for western goods headed to Russia. It seems enforcement of the U.S. and EU sanctions was sort of voluntary. Now we’ve seen this.

Source: China General Administration of Customs, as compiled by Bloomberg, L.P.

This is China’s crude oil imports. It’s not the big jump in oil imports from Russia that’s the surprise. It’s the 1,100,000 million barrels of oil coming from Malaysia every day, up from around 800,000 barrels in 2022.

So what? Well Malaysia produces around 600,000 barrels a day on a good day and recently it’s more like 567,000. How does it sell nearly 80% more than it produces? It basically takes Iranian and Russian oil and relabels it as Malaysian oil and ships it over to China. As the EIA diplomatically puts it:

“During this [2023] period, the import volume from Malaysia exceeded total production in Malaysia.”

And that’s how you beat the sanctions.

The Bottom Line

The pattern of selloff, consolidate, selloff continued this week. The 10-year Treasury breached 5% on Monday and then dropped back to 4.8% and then to 4.9%. The price action is choppy but the direction seems clear from the last two months: rates were headed up. We think this is the top of the range for the cycle but we wouldn’t want to call the time and day.

The big number for the week was the blistering GDP numbers for the quarter ended in September. The Atlanta GDP Now had predicted over 5% growth but the St. Louis Fed Nowcast had predicted 2.3% (it uses very different inputs) and the New York Fed’s version was at 2.5%. The published number was 4.9%, the highest level since Q4 2021.

Nominal GDP was up 8.5%. The U.S. economy crossed $27.6 trillion up from $25.9 trillion a year ago. That’s $1,600 billion in a year. Those are all pre-inflation numbers of course and we tend not to talk about nominal growth but it gives some idea on the strength of the economy. If nominal growth is at 8.5%, then bond yields at 5% don’t look onerous.

The upside surprise was the increase in the GDP deflator, a sort of big-macro-inflation measure followed by no-one,  which was 3.5% after 1.7% in Q2. But then the PCE inflation, which the Fed watches, came in at 2.4% compared to 3.7%.

Treasuries rallied but stocks dropped. It’s another signal that higher rates will be around for a while. But it was also a week where some big names like Google and Meta reported lower numbers than expected…. still big but less than expected. Both were down between 9% and 11% on the week. Add that to the 18% drop in Tesla’s share price this month and some of the Mag 7 magic has dimmed.

Earnings as a whole have been fine but any company that “missed” has been taken down harshly. As my colleague Jim Lebenthal put it “it’s all about the macro and higher rates right now.” That will pass but it means good earnings are not getting the immediate attention of investors.

Art: Stephanie Holman (b. 1967)

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