Economic Outlook – 12 August 2018

US

• US Consumer Prices matched expectations and edged up 0.2% in July. The monthly gain kept the headline index at a 2.9% increase on a year-to-year basis, the fastest pace in six years. Energy prices were a drag on the headline figure and dropped 0.5 % for the month, mostly the result of lower gas prices. Excluding food and energy prices, the core index also rose 0.2% during the month. Before rounding however, core prices came in on the high side of expectations and grew 0.24%, pushing prices 2.4% higher compared with last year. Much of the monthly increase in core prices was owed to a 0.3% gain in services, notably in housing, which also rose 0.3%.
• The overall US Producer Price Index fell short of expectations and showed no change in July. However, the underlying details showed that prices continue to trend higher. June’s soft top-line reading was the result of a drag from declines in several volatile sectors. The trade services price index, which is measured by changes to retail and wholesale margins, fell 0.8%, while food decreased 0.1% and energy declined 0.5%. The “core-core” measure, which excludes food, energy and trade services, rose slightly more than expected and increased 0.3% during the month. Over the past 12 months, “core-core” prices for U.S. producers have now risen 2.8%.
• JOLTS data for June revealed that the number of job openings was essentially unchanged at 6.7 million during the month. However, job openings are near a record high and remain well ahead of the 6.1 million open positions posted a year ago. The number of job openings has also now exceeded the number of unemployed for the fourth consecutive month. Most industries saw the number of job openings increase in June, notably in financial activities and wholesale trade. The construction and manufacturing industries also saw the number of open positions increase during the month, both hitting fresh new cycle highs. The quit rate was essentially unchanged at 2.3%, but also sits near its highest point of the expansion. The elevated level of the quit rate signals that workers continue to have a high degree of confidence in the labor market.
• US Initial jobless claims fell to 213,000 for the week of August 4. On a four-week moving average basis, jobless claims are well below the 241,500 registered in the same period last year. The continued low level of jobless claims is consistent with an increasingly shallow pool of available labor.
• The US put in place tariffs on an additional $16 billion in mainly Chinese industrial goods, bringing to $50 billion the total volume of imports from China subject to the new 25% levies. China quickly matched the US action as the country’s state media highlighted China’s readiness for a protracted trade war with the US. Strong July export data from China was a surprise for the market, though some analyst suggest exporters are trying to ship goods to the US ahead of further tariffs.
• The major US benchmarks ended mixed for the week after a downturn Friday drained earlier gains. The large-cap indexes recorded losses, while the technology-heavy Nasdaq Composite Index and the smaller-cap benchmarks moved modestly higher. The S&P MidCap 400 Index set a new record high at midweek, as did the broadest market benchmarks, the Russell 3000 and Wilshire 5000 indexes. Within the S&P 500 Index, technology and Internet-related shares fared best, while the typically defensive consumer staples and real estate segments lagged. Relatedly, growth stocks handily outpaced value shares.
• Another round of trade disputes appeared to be behind the market’s pullback on last Friday. In retaliation for Turkey’s jailing of an American pastor, President Trump announced in a tweet that the US was doubling its tariffs on steel and aluminium imports from the country. A broad decline in the Turkish lira and other emerging market currencies weighed on Wall Street alongside other global markets.
• A modest flight to the perceived safety of US Treasuries on Friday helped bring the yield on the 10-year Treasury note down to its lowest level in nearly a month. An increase in the municipal new issuance calendar spurred some weakness in the segment early in the week.
• Next week will be quite in terms of data releases in the US. Retail sales for July are due on Wednesday, which are likely to show that private consumption remains the main growth driver in the US. Manufacturing production in July, also due out on Wednesday, is interesting too.

UK

• The preliminary estimate showed UK GDP growing 0.4% in Q2, up from 0.2% in Q1. This was in line with the estimate of the Bank of England (BoE) and the market consensus. Year-on-year growth in Q2 increased slightly to 1.3% in Q2, from 1.2% in Q1. According to the ONS, the Q2 numbers likely show unwinding of some adverse weather effects in Q1, however the effects are hard to quantify. Abstracting from these quarterly movements, the underlying trend in real GDP is still one of slowing growth, according to the ONS.
• British house prices edged up last month as widespread falls in London weighed on gains further north, while smaller landlords quit the rental sector due to less favourable tax treatment, a survey showed on Thursday. The Royal Institution of Chartered Surveyors’ (RICS) monthly house price balance rose to +4 in July from an upwardly revised +3, in line with economists’ forecasts in a Reuters poll.
• Ian McCafferty, who is set to leave the Bank of England’s monetary policy committee at the end of the month, said the era of low interest rates is set to last for another twenty years. Factors that have suppressed global interest rates since the 1980s, such as weak productivity growth and a buildup of savings by the baby boomer generation, will remain intact during the next two decades, he said. In the near term, rate hikes will be limited and gradual, according to the central banker.
• Currency markets took to heart comments from the United Kingdom’s trade minister, Liam Fox, that there is a 60/40 chance of a “no-deal Brexit.” Without a deal, the UK could leave the European Union next March without having a pact in place outlining the future relationship between the two. Fox blames intransigence on the part of EU negotiators for the rising risk of no deal being struck. Meanwhile, Bloomberg reports that British prime minister Theresa May is stepping up the government’s preparations for any breakdown of Brexit negotiations. The pound fell to its lowest level in a year, slipping as low as 1.2725 against the dollar.
• On Tuesday, the jobs report for June will be made available. The unemployment rate is expected (3M average) to fall from 4.2% to 4.1%, as the single-month figure needs to make a big jump for it not to fall, given it fell to 4.0% in May.
• CPI inflation for July is due out on Wednesday. In general, the inflation prints will be interesting to follow in H2 18, as the Bank of England is too optimistic on the inflation outlook. CPI inflation is expected to fall to 2.3% year-on-year from 2.4% year-on-year in June.

EU

• A plunge in the Turkish lira has rattled the European Central Bank, according to the Financial Times. The Turkish currency has fallen over 73% year to date and more than 18% just overnight. Turkish local currency government bond yields have surged above 20%. The currency crisis has raised concerns among regulators that several large European lenders are overly exposed to Turkey. As is often the case, Turkish borrowers have significant exposure to debt denominated in euros and dollars, so as the lira falls, their ability to pay back those debts erodes. The Turkish crisis has helped push the euro to its lowest level against the dollar, around 1.1450, in over a year.
• Italy’s young government has begun budget negotiations, and its bond market is growing nervous as a result. The antiestablishment coalition promised a flat fax, a universal basic income and a rollback of increases in the retirement age. Markets are concerned that Italy could break EU budget caps if the government puts in place all of its campaign promises. 10-year Italian government bonds yield over 2.5% more than equivalent German bunds, compared with 1.15% this spring, before the 5-Star/League coalition took office.
• Most European equities ended the week lower amid fresh trade war angst and concerns late in the week about the ramifications of Turkey’s plummeting currency on European banks. Mixed corporate earnings results also weighed on some market sectors. The pan-European STOXX 600 Index ended the week lower by about 0.5%. The German DAX 30, which is highly reactive to global trade uncertainty, France’s CAC 40, and Spain’s IBEX 35 all fell about 1.5% for the week. European bank stocks suffered some of the steepest losses.
• Stocks weakened later in the week after the Financial Times reported that the eurozone’s chief financial watchdog raised concerns about the exposure of some of the currency area’s biggest lenders to Turkey (namely Spanish bank BBVA, Italian bank UniCredit, and French bank BNP Paribas) in light of the lira’s dramatic fall this year. So far, the Turkish lira has lost more than 30% against the U.S. dollar in 2018, and it fell to an all-time low at the end of the week. The wing of the European Central Bank that is set up to monitor the activity of the region’s biggest banks has begun over the last couple of months to look more closely at European lenders’ links with Turkey.
• The second estimate of EU GDP growth for Q2 is due for release on Tuesday. The initial growth estimate disappointed at 0.3% quarter-on-quarter, compared with the consensus forecast of 0.4% quarter-on-quarter and the ECB’s forecast of 0.5% quarter-on-quarter. No revision is expected on Tuesday.

China

• The Chinese currency slid for the ninth-straight week as a global currency sell-off triggered by Turkey’s financial troubles compounded worries about China’s trade fight with the US. After rising earlier during the week, the yuan erased its gains on Friday amid fears that Turkey’s currency woes could spill over onto the mainland. The Turkish lira plunged as much as 14% to a record low on Friday as investors worried about deteriorating relations with the US. The yuan’s ninth weekly decline marks the currency’s longest losing streak since China adopted its current foreign exchange regime in 1994.
• Earlier in the week, Beijing said that it would levy 25% tariffs on an additional $16 billion worth of US imports starting August 23, the same day that the US plans to start collecting 25% extra in tariffs on $16 billion of Chinese goods. The escalating tariff cycle comes as the People’s Bank of China (PBOC) has stepped up efforts to stabilise the yuan. Earlier in the week, the PBOC urged state-owned lenders to prevent “herd behaviour” that could lead to runaway foreign exchange trades, Bloomberg reported. That move followed a measure the previous week that makes it more expensive for investors to bet against the yuan.
• The key movers in China next week are industrial production, retail sales and fixed asset investments, due for release on Tuesday. All three indicators signalled a moderate slowdown in the first half of 2018, reporting figures well below those at the end of 2017.

Sources: Wells Fargo, MFS Investment Management, T. Rowe Price, Reuters, Handelsbanken Capital Markets.