Economic Outlook – 9 July 2017
- The ISM manufacturing index kicked off the fireworks a day early on Monday, climbing to 57.8 in June. This was the best print for the index since August 2014 when oil was still nearly $100 a barrel. The details of the report were broadly encouraging for both current and future activity. The production subcomponent rose to 62.4 from 57.1, and only two industries (apparel, leather & allied products and textile mills) indicated that production declined last month. In addition, the employment subcomponent rose to a three-month high of 57.2. The new orders, backlog of orders and new export orders subcomponents all increased in the month, which bodes well for momentum in the factory sector headed into Q3. The ISM’s services counterpart also topped expectations in June, albeit in a less dramatic fashion. The non-manufacturing index climbed to 57.4 from 56.9 in May, spurred by a pick-up in new orders. Taken together, these survey-based measures of economic activity are near multi-year highs, which bode well for economic growth in the near-term.
- The US trade deficit narrowed in May, reflecting an $855 million increase in exports and a $223 million decline in imports. Taking a longer-term view, export growth has returned to positive territory after dipping into negative territory last year. The collapse in commodity prices depressed the value of industrial exports while deceleration in global economic activity last year weighed on other categories of exports. The stabilisation in commodity prices and stronger economic growth in many of the nation’s major trading partners are giving a boost to the value of American exports this year.
- The minutes from the June FOMC meeting painted the picture of a Fed that continues to hold its cards close to its chest. There continued to be little clarity around the timing of changes to the Fed’s reinvestment policy, with some participants preferring to start the process within a couple months, whereas others supported holding off until later in the year. The reaction to the FOMC minutes was generally mild, with the selloff in US.
- Employers added 222,000 net new jobs in June, the second strongest print of 2017. Job gains were broad-based, with healthy hiring in construction, government and leisure & hospitality. The unemployment rate rose a tick to 4.4% amid a 361,000 person surge in the labor force. The major weak spot in the report was another sideways print for average hourly earnings growth (bottom chart). The lack of a marked acceleration in earnings reinforces our belief that the Fed will maintain its slow and steady approach to tightening policy in the months ahead.
- China services and manufacturing PMI surged to a three-month high of 54.9 and 51.7 in June, underscoring resilience growth in the second quarter of the year. Despite ongoing supply side reforms, data show no signs of abrupt economic slowdown in the first half of the year and post early indication that the economy is poised to achieve its targeted 6.5% annual growth this year.
- Euro zone’s factory gate inflation rose 3.3% year-on-year in May, slowing down from the 4.3% year-on-year increase in April amid moderating price growth in Germany, France and Italy. CPI dropped to a six month low in June, accentuating ECB’s stance to keep monetary policy accommodate at this juncture. CPI increased 1.3% year-on-year in June after growing 1.4% year-on-year in May, strengthening the case for gradual exit from ECB’s stimulus program. On a brighter note, core CPI increased at a quicker pace of 1.1% year-on-year (May: +0.9% year-on-year).
- Even though today’s forum speech by the ECB president, Draghi, was in line with previous statements, it seemed to encourage EUR bulls. Aside from sounding generally upbeat on the economy, it was worth noting the following phrase from the speech: “As the economy continues to recover, a constant policy stance will become more accommodative, and the central bank can accompany the recovery by adjusting the parameters of its policy instruments – not in order to tighten the policy stance, but to keep it broadly unchanged”. Draghi preferred to stress the need for an unchanged policy stance, which measures the monetary policy “parameters” relative to economic strength, in order not to get behind the curve. That requires tighter parameters if the economy grows stronger (as the ECB expects) and thus a de facto tightening of the policy instruments. However, one can discuss whether an “adjustment in parameters”, as the ECB states, is less activistic than a change in the monetary policy.
- In Italy, Banca Monte dei Paschi di Siena, the world’s oldest bank, received a bailout from the Italian government this week, getting €5.8 billion in state aid. As a result, the bank will slash staff by about 20% and close 600 branches while shedding €28.6 billion in nonperforming loans over the next four years. Italy bailed out two Venice-based lenders last month. The Italian government said it believes no further state intervention in the banking sector will be required.
- The Bank of England (BoE) is an inflation targeting central bank. When activity growth is sub-par, monetary policy becomes accommodative to insure inflation is not running too slow; when growth exceeds potential, it has to be slowed down through monetary tightening to be sure inflation is not running out of control. The current issue for the BoE is not about energy inflation but about imported inflation, which is linked to the external value of the pound. Following the Brexit referendum, the pound collapsed. In effective terms, it has lost around 13%, resulting in an upward trend in the prices of imports, which in turn led to inflation accelerating quite markedly. As long as the pound does not further depreciate, inflation will eventually decelerate. The purchasing power losses due to imported inflation could even result in markedly lower inflation after base effects do disappear. In this case, monetary policy should remain accommodative. However, where the pound to depreciate further, higher inflation would persist and second-round effects could appear. The rate hike in August is still a possibility, given the abrupt change in Governor Carney’s words and the near 50-50 split within the committee.
Sources: Wells Fargo, MFS Investment Management, HongLeong Bank, Handelsbanken, BNP Paribas.