Economic Outlook – 11 March 2018

US

• Employment growth strengthened in February with businesses adding 313,000 new jobs. That pushed the three-month average up to 242,000 after a net of 54,000 jobs also revised job gains in December and January higher. Strength was widespread across industries, including gains of 50,000 in retail, 28,000 in financial services and 61,000 in construction, which likely benefited from a return to less severe winter weather. Nevertheless, the unemployment rate was unchanged at 4.1% amid the largest monthly increase in the labor force since 2003. The labor force participation rate rose 0.3 points to 63.0, which puts it back at the top end of the past two year’s range. Average hourly earnings were up 0.1% (0.149% before rounding), barely missing expectations for a 0.2% increase. February average hourly earnings were up 2.6% from a year ago compared to 2.5% in 2017.
• The ISM non-manufacturing index suggests that the economy continues to expand at a solid clip. The index edged down 0.4 points to a still-strong 59.5 after setting a cycle high in January. Current activity edged up and a 12-year high in new orders suggest near-term momentum remains positive. Higher input costs may be becoming more of a concern for businesses, however. The prices paid component of the ISM non-manufacturing survey ticked down almost a point but, at 61, still indicates input costs rising at nearly the fastest pace in a number of years. Cost concerns were more ubiquitous in the comments section. Respondents ranging from construction and mining to health care and hospitality specifically mentioned higher prices. Although more impactful for the manufacturing sector, where input prices are rising more dramatically, recent tariff plans could intensify cost pressures.
• Following a week of uncertainties, President Trump finally signed a tariff order, officially imposing a 25.0% and 10.0% tariff on imported steel and aluminium respectively with the exemption of neighbouring Canada and Mexico. The exemption provides bout of relief to US markets and alleviates major concerns of an imminent global trade war as the agreement was seen to be “milder” compared to what was initially intended. The proposed tariffs have been fuelled in part by the Trump administration’s concerns over the trade deficit. The most recent monthly trade print is unlikely to allay their concerns. In January, the trade deficit widened by $2.7 billion to reach the largest gap since October 2008. Lower exports of goods and services drove the increase, as imports were more or less flat over the month. The drop in exports was driven by some of the more volatile categories like aircraft and petroleum products.
• The Fed’s Beige Book painted a picture of an economy that is humming along. Fed districts universally reported labor market tightness and heightened demand for qualified workers. Several districts reported increasing compensation as a result of the tax cuts that came into effect at the start of the year. The report also suggested that businesses are increasingly passing on increases in input prices. A variety of forces are expected to push inflation higher this year, the only question is how quickly.
• Stocks rebounded from the previous week’s losses, bringing all of the major indexes back into positive territory for the year to date. The technology-heavy Nasdaq Composite Index fared best and managed to set a new intraday high on Friday. The small-cap Russell 2000 Index also performed especially well. Along with information technology shares, financials, industrials and business services, and materials shares led the S&P 500 Index’s gains, while utilities stocks lagged.
• Investors faced a number of crosswinds during the week. The economic environment appeared to be the most prominent tailwind, with stocks recording their biggest gains for the week on Friday, following the release of the Labor Department’s closely watched employment survey. The report revealed that employers had added more jobs than expected in February, along with upward revisions to previous months’ gains. More significant for the markets, however, seemed to be a slowdown in the growth of average hourly earnings, from a year-over-year pace of 2.8% in January to 2.6% in February.
• CPI core inflation numbers are due to be released on Tuesday. The numbers are expected to come in at 0.2% month-on-month (1.8% year-on-year, down from 1.9% year-on-year in January). There is not much to read into a few releases that came out stronger than expected, as there usually is some noise in the data.
• On Wednesday, retail sales numbers for February are due for release. Retail sales fell unexpectedly in January which points to a slowdown in consumer spending. Yet, this most likely was an accident, as consumer confidence remains extremely high. Moreover, industrial production data for February are due out on Friday. PMIs for February indicate that US manufacturing expansion continues. Still, numbers concerning industrial production are usually quite volatile on a monthly basis.

UK

• The UK Services PMI surprised on the upside in February, increasing to 54.5 (from 53.0 in January). The consensus expectation for February was 53.3. The PMI composite increased to 54.5 in February, from 53.5 in January. The consensus expectation was 53.6. Sentiment in the services sector was pulled up by incoming new business, current business activity and employment. According to the survey, business activity rose at the fastest pace for four months and new work saw the strongest upturn since May last year. Service providers commented on particularly marked B2B sales growth in February, helped by the improving global economic backdrop. However, there were also reports that stretched household budgets were still holding back domestic consumer demand. Employment numbers were expanded to the largest extent since last September, driven by stronger-than-expected sales growth and subsequent efforts to expand business capacity. Despite pressure on operating expenses from higher staff salaries and transport costs, the latest data indicated a moderation of input price inflation to its lowest since August 2016, according to the survey. Some firms noted that exchange-rate-driven cost pressure had stabilised in recent months. Despite current business picking up, future expectations edged down in February and were lower than the historical average, although higher than the average for 2017.
• There are no exciting data releases or scheduled events this week. The focus will be on Brexit ahead of the important EU summit on 22 and 23 March. It is likely that the two sides can reach an agreement on transition relatively fast but uncertainties remain about the future relationship, where there are still significant disagreements between the EU and the UK.

EU

• At last week’s policy meeting, the ECB decided to remove the easing bias in its asset purchase programme by excluding the possibility of increasing the programme’s size or duration. The decision was unanimous within the Governing Council; as a consequence, the ECB is finally left with a more or less neutral monetary stance. Even though few would have expected the ECB to make use of this bias ahead of its removal, it still signals another baby step away from the present easy monetary policy. This possibly pushes the next step closer toward an outright tightening bias in the forward guidance, which would likely exclude key interest rates remaining low for an extended period of time. That said, this step would not be taken until June at the earliest, when a gradual rising trend in inflation is likely to have become more visible. Furthermore, Draghi stressed that there was not much discussion about other policy changes.
• The Eurozone economy grew 0.6% quarter-on-quarter in Q4 2017, slowing from the 0.7% quarter-on-quarter increase in Q3 2017 while producer prices rose at a much slower than expected 1.5% year-on-year in January 2018. Investor sentiment turned softer in March 2018 in line with recent sentiment-based surveys while growth in the service sector moderated in February 2018 as seen in PMI reading.
• Major European indexes ended the week firmly in positive territory, as investors seemed to shrug off geopolitical uncertainties (notably, the possibility of heightened trade frictions with the US). One notable exception was Germany’s DAX 30, which ended the week lower. Germany is a heavy exporter of steel products, automobiles, and machinery and is particularly exposed to the new tariffs. The Italian election that was held the previous weekend featured gains for anti-establishment parties and resulted in a hung parliament in which no single party or alliance won enough seats to easily form a coalition government. Nevertheless, investors kept Italy’s benchmark FTSE MIB Index in positive territory for the week. The pan-European index STOXX 600, the UK’s FTSE 100, and France’s CAC 40 were also higher for the week.
• Early in the week, European Commission officials presented European Union member states with a list of more than 100 US products valued at €2.8 billion that could be affected in response to President Trump’s promise to impose a 25.0% tariff on foreign steel and 10.0% on foreign aluminium (a move that Trump followed through on before the week ended). While Canada and Mexico were exempted, European countries were not (as of yet). Shares of European steel makers and automakers (huge consumers of steel and, in some cases, aluminium) were lower for the week, as investors were seemingly spooked about the future implications that the tariffs would have.
• In the euro area, the wage growth figure for Q4 2017 is due for release on Friday. Since H2 2016, there has been a gradual rising of wage pressure as the unemployment rate has continued to decline. However, the wage pressure still remains significantly lower than its historical average despite the unemployment rate being close to the NAIRU, which is probably due to labour market slack observed in broader unemployment measures. Wage growth pressure is key to pushing core inflation upwards and thus key for the ECB’s monetary policy decisions.

China

• The official manufacturing PMI index fell a full index point from 51.3 in January to 50.3 in February. On the contrary, manufacturing PMI from Markit increased slightly from 51.5 to 51.6. Both indicators might be distorted by the timing of the New Year holidays, but Markit usually seems to better adjust for the New Year than the official statistical bureau. Hence, less emphasis should be put on the drop in the official index. Still, the increase in Markit’s index is only marginal, the trend for both PMIs is likely to be downward.
• China set an annual economic growth target of about 6.5% this year, one of several key targets unveiled at an annual legislative meeting as the country seeks to maintain steady growth while curbing financial risk. The 2018 GDP growth target is broadly in line with last year’s target of about 6.5% or higher. China reported its economy expanded 6.9% in 2017, marking its first pickup in annual economic growth since 2010. Other targets released at the National People’s Congress in Beijing included an annual deficit target of 2.6% of GDP, down from 3% in the past two years, signalling the government’s concern about the risks of rampant borrowing by local governments. Officials also reaffirmed their view that prudent monetary policy will remain neutral in 2018 and that they would ensure liquidity at a reasonable and stable level, according to reports.
• The outgoing head of the People’s Bank of China (PBOC) said that policymakers would depend less on credit-driven growth as China seeks higher-quality economic growth. The PBOC also plans to rely less on M2 (a traditional gauge of money supply) when determining how to adjust interest rates in favour of indicators such as inflation and employment, according to remarks made by PBOC governor Zhou Xiaochuan. China is expected to announce a successor to Zhou, who is stepping down after 15 years as the country’s top central banker. The naming of the new PBOC governor is set to occur after the National People’s Congress votes on 19 March.
• The key movers in China this week are industrial production, retail sales and fixed asset investments, all released on Wednesday. The data are expected to confirm the picture of moderate slowdown. In general, the industrial production data has been generally weaker than most other data as it has shown no sign of rebound in the past two years.

Sources: Wells Fargo, T. Rowe Price, Handelsbanken Capital Markets, Hong Leong Bank, Danske Bank, TD Economics