Economic Outlook – 1 July 2018

US

• New home sales jumped 6.7% in May, to a 689,000-unit pace. However, April sales were revised lower and now reflect a 3.7% drop. Sales in the South were up 17.9% in May, to a new cycle high, and accounted for all of the national increase. More than half of new home sales occur in the South, so fluctuations in this region have a large impact on the total. There is almost certainly a lack of inventories restricting sales in the markets for new and existing homes. Despite this, new home construction looks to be picking up, especially in the South where land is more readily available for development. Building activity looks to be back on track in the region after disruptions from hurricanes Harvey and Irma.
• The S&P Core Logic Case-Shiller National Home Price Index increased 0.3% in April, a 6.4% gain year-on-year. Price increases are widespread, with 17 markets in the 20-city index showing higher prices in April. Average prices for new homes fell in May, but this reflected compositional changes (more entry-level sales and more sales in the South where homes are less expensive) rather than underlying weakening.
• US consumer confidence dropped 2.4 points in June to 126.4, but remains at a high level. The largest portion of the dip in confidence came from consumer expectations, which were likely dampened by ongoing trade disputes and higher gasoline prices. Nevertheless, more than twice as many consumers expect business conditions to improve over the next six months than expect them to worsen. Optimism about the labor market eased somewhat, but remained consistent with continued gains in non-farm payrolls. Some slowing in job growth may occur as open positions become harder to fill in a tighter labor market, but for the upward trajectory in non-farm payrolls to remain intact.
• First-quarter US GDP growth was revised down to 2.0% in the third estimate, from 2.2% prior. The revision is due to slower consumer spending growth and smaller inventory accumulation than the government had previously estimated. This means first-quarter GDP growth was much softer than the previous three quarters, which averaged 3.1%. However, Q1 GDP has come in weaker in the last several years, suggesting that seasonal factors are partly to blame.
• US personal income grew 0.4% in May, up from 0.2% the month prior. Personal spending slowed to 0.2% growth, and April’s gain was revised down 0.1 percentage point to 0.5%. Given solid income and employment growth and continued strength in consumer confidence, consumption is expected to pick back up. Even with some slowing, consumption should be much more supportive of GDP growth in Q2 versus Q1.
• US stocks closed lower for the week. The technology-heavy Nasdaq Composite Index and the smaller-cap benchmarks fared worst after outperforming the previous week. Within the S&P 500 Index, energy stocks performed best as oil prices reached new four-year highs. Health care and consumer staples shares lagged, dragged lower by drug store operators amid concerns that Amazon’s acquisition of an online pharmacy could lead to intense price competition and possibly smaller profit margins for the incumbents.
• The yield on the benchmark 10-year Treasury note decreased over the week, while municipal bonds appeared to be well supported by pending July reinvestment flows and low supply. A softer tone led to a generally quiet investment-grade corporate bond market, although month-end buying picked up as the week concluded. Buyers were mostly focused on intermediate-term issues, while demand for longer-term issues remained sporadic. Although the primary calendar was much quieter than expected during the final days of the month, it was the busiest June on record in terms of total new issuance volume.
• After ramping up pressure on international trading partners in recent weeks, the White House made efforts to tone down the rhetoric this week. Plans to limit Chinese investment in US-based technology companies were scrapped in favour of more rigorous reviews by the Committee on Foreign Investment in the United States, an inter-agency body that reviews transactions for their national security implications. Markets were bolstered by the administration’s decision to back away from firm numerical limits on investments from China in favour of a more flexible approach. The move also was seen as a victory for more moderate government voices on trade, but a defeat for trade headliners. Roughly $35 billion in tariffs on select Chinese exports are set to come into force next Friday, leaving negotiators a narrow window to negotiate. However, all is not rosy on the trade front. Canada announced that it would place $19 billion of tariffs on American imports this Sunday in retaliation for US steel and aluminium tariffs. Also late in the week, US Treasury secretary Mnuchin denied rumours that President Trump is considering pulling the US out of the World Trade Organisation.
• ISM manufacturing for June is due for release on Monday. Regional PMIs indicate continued expansion but indicators for general activity and new orders fell this month. This supports the view that the US manufacturing indices should move lower in 3 to 6 months. Based on the regional PMIs and Markit PMI manufacturing, ISM for June is likely to remain unchanged.
• The most important release is the jobs report for June on Friday. Wages likely rose 0.2% month-on-month in June, which leaves the annual growth rate unchanged at 2.7% year-on-year. Even if wage growth surprises on the upside, one should not expect the Fed to accelerate its hiking cycle, as it has said it tolerates inflation exceeding the 2.0% target temporarily.

UK

• British services output, which makes up four-fifths of Britain’s economy, rose by 0.3% in April, its fastest pace since November 2017, the Office for National Statistics said. Compared with a year earlier, services output was 1.6% higher, picking up speed from the first quarter when it grew at an annual rate of 1.2%.
• Britain’s housing market perked up in May but there were more signs of caution among consumers ahead of Brexit next year, Bank of England figures showed last week. The number of mortgages approved for house purchase rose to a four-month high of 64,526 in May from 62,941 in April (above all forecasts in a Reuters poll of economists that had pointed to 62,200 approvals).
• This week it is time for the June PMI reports. In particular, the PMI services (due on Wednesday) will attract attention in order to see whether it is going to rebound or not. The Bank of England needs to see a rebound in growth to be able to hike the Bank Rate in August.
• The UK government is expected to publish its white paper on how it sees the future relationship with the EU on trade and customs after the EU summit (28-29 June).

EU

• While a summit of European Union leaders failed to make any progress on Brexit, it did reach an agreement on migration. EU member states will voluntarily open centres in order to determine whether individual migrants are granted asylum or returned home. The deal appears to have reduced pressure on German chancellor Angela Merkel from within her governing coalition, as the euro rose over a half percentage on the news.
• While the European Central Bank is expected to end its bond-buying programme at the end of 2018, it intends to lengthen the duration of its portfolio through a reinvestment programme beginning in 2019. Similar to the US Federal Reserve’s “Operation Twist”, the ECB will swap shorter-dated maturities for longer-dated ones in an effort to keep long-term interest rates lower in order to boost the Eurozone economy.
• Key European indexes ended the week lower, weighed down by uncertainty about global trade and political wrangling over immigration. Trade volumes were down significantly at the beginning of the week, an indication of investor uncertainty about the direction of the markets. Price traders noted. The pan-European STOXX 600 Index logged about a 1.0% loss and the export-heavy German DAX 30 was lower by close to 2.0%. Most of the losses came early in the week, as investors were seemingly worried that a global trade war would drag down the European economy. Some of the heated trade rhetoric between the US and European countries as well as China softened as the week progressed, fuelling a partial recovery in equities.
• The Eurozone headline inflation rate rose above the European Central Bank’s (ECB) target for the first time in more than a year on the back of rising energy prices. According to a preliminary estimate from Eurostat, headline inflation rose 2.0% in the 12 months to June, faster than the 1.9% annual increases in May. The ECB targets an inflation rate of just below 2.0%. However, core (less food and energy) inflation fell to 1.0% from 1.1% in the preceding month. At the country level, German inflation in June surpassed the ECB’s inflation target. German government bonds were little changed on the week, while Italian government bond yields eased.
• There is a lot of attention on German politics. The CDU/CSU party is due to meet to discuss the outcome of Angela Merkel’s attempts to form a EU-wide immigration solution. The Interior Minister Horst Seehofer could move ahead with his plan to turn away migrants at the border, which will become a reality if Merkel fails to come up with a satisfactory solution. This could eventually lead to a collapse of the government coalition.
• In the euro area, there are no market movers in terms of data releases this week.

China

• Last month China’s central bank announced that it would cut the reserve requirement ratio (RRR) for most banks by 0.5 percentage points in an effort to support economic growth by encouraging banks to expand their lending. Media reports estimated that the RRR change would add more than the equivalent of $100 billion to the Chinese economy. The RRR cut was the third of 2018. The forecast for China’s economic growth continues to remain moderate unless the People’s Bank of China (PBoC) becomes more aggressive in loosening monetary policy.
• The Shanghai Composite Index, China’s benchmark stock index, lost 1.5% for the week despite a sharp bounce higher on Friday after the country officially announced that it would further open its markets to foreign investment. The large-cap CSI300 Index fared worse, falling nearly 3.0%. June was the worst month for Chinese stock returns in more than two years, and both the Shanghai Composite and the CSI300 were among the poorest-performing major indexes in the world for the year to date. Fears of a trade war with the US continued to weigh on investor sentiment toward China.
• The Chinese PMI manufacturing for June is due this week. A decline following the recent soft hard data as well as the rising uncertainty over a trade war seems to be in order. This is not least reflected in the sharp equity sell-off in China.

Sources: Wells Fargo, T. Rowe Price, Reuters, Danske Bank