Economic Outlook – 12 July 2020

US

• The ISM non-manu­facturing index posted a 11.7-point jump to 57.1 for June. The improvement was broad-based as 3 of the 5subcomponents (and 14 out of 18 industries), reported posi­tive growth for the month. This data release is backward looking. With the pace of infections picking up in mid-June, these data will not cap­ture the current impact of COVID-19 on the economy.

• Higher frequency data provide a clearer picture of present state of the economy and it is concerning. The number of diners at restaurants have plateaued at very low levels. Ac­cording to OpenTable data, there are 65% less seated din­ers at restaurants now then there were a year ago.

• Employment is also beginning to be affected by the resur­gence of COVID-19. More households, specifically lower income households, are reporting declines in their income from employment. According to Homebase data, small businesses are once again beginning to lay off hourly employees. Large companies are also planning to let more workers go. United Airlines has told 36,000 employees they could be furloughed starting October. Brooks Brothers permanently closed 50 stores, and Apple and McDonald’s have either delayed reopening stores or announced new store closures due to rising COVID-19 cases.

• With the labor market under pressure and expanded un­employment benefit payments expiring at the end of this month, Congress needs to provide further aid to households and businesses. Talks are underway and Treasury Mnuchin said he supports another round of stimulus to individuals and an ex­tension of the Paycheck Protection Program under narrower eligibility criteria. However, he was less supportive of relief funding to state and local governments. On the whole, it is clear, without additional fiscal support, more economic turbulence in the second half of this year is to be expected.

• Analysts estimate that capital expenditures for large- and mid-cap firms will decline 12.0% this year, more than they did during the global financial crisis, when outlays declined 11.3%. Companies in the US are expected to cut capex spending by 22.0%.

• Presumptive Democratic US presidential nominee Joe Biden outlined a $700 billion economic recovery plan on Thursday, focusing on a “buy American” economic agenda. The former vice president’s plan includes $400 billion in government purchases of US-made goods and services over four years to revitalize the manufacturing sector and $300 billion in new research and development spending for new technologies and green-energy investments. Biden also struck a hawkish tone toward China in his speech, saying his administration would take aggressive trade enforcement actions against China. Biden earlier proposed raising the top tax rate on individuals to 39.6% from 37.0% and the corporate tax rate from 21.0% to 28.0%.

• Investors appeared to be particularly concerned that the impact of the resurgence in the virus seemed to be showing up in economic data. Atlanta Federal Reserve Bank President Bostic told a reporter that high-frequency data “suggest that the trajectory of this recovery is going to be a bit bumpier than it might otherwise.” Later that day, his counterpart at the Cleveland Federal Reserve Bank, Mester, told CNBC that it was likely “to take quite a long time to get back to where activity and employment was pre-pandemic.” St. Louis Federal Reserve Bank President Bullard struck a markedly different tone, telling CNBC that “I think we’re tracking very well right now” and predicting that the unemployment rate could fall as low as 7.0% by the end of the year.

• The major indexes ended mixed for the week, with large-caps outperforming small-caps. The technology-heavy Nasdaq Composite Index fared best and reached new record highs, thanks in part to strong gains for “work from home” shares, such as Amazon, Apple, Facebook and Netflix. The latter two also boosted the communication services sector, which outperformed within the S&P 500 Index, while energy shares were weak as crude oil prices fell back below $40 per barrel.

• Longer-term Treasury yields decreased through most of the week on growing coronavirus concerns and briefly slid to levels last seen in late April, aided by particularly strong demand in the Treasury Department’s 10-year note and 30-year bond auctions.

UK

• Moody’s warned that Britain will suffer the sharpest peak-to-trough economic slump of any major economy this year, and the coronavirus crisis will push up national debt as a share of GDP by nearly a quarter. Moody’s said the UK government’s latest £30 billion stimulus package would aid a gradual economic recovery but add further pressure to the UK’s fiscal position. “The UK’s public debt ratio will likely rise by 24.0% of GDP or more relative to 2019 levels,” a group of Moody’s analysts wrote in a note, taking the debt to 109.0% of GDP this year. “We forecast a contraction of 10.1% in the UK’s GDP for this year, but expect a gradual subsequent recovery on the back of the easing in lockdown measures, with growth rebounding to 7.1% next year.”

• UK Finance Minister Sunak pledged the additional £30 billion to support employment, on top of the £133 billion in coronavirus measures he has already unveiled. The money includes over £5 billion in accelerated infrastructure spending, about £9 billion for employers to retain workers through the end of January, funds for home insulation, and help for homebuyers and for hospitality firms. Still, business leaders warned that the measures were not enough to save jobs at risk in retail and manufacturing. Bank of England Governor Bailey warned banks in a letter last month to be prepared for negative interest rates in the UK. He said adapting to such a move would prove to be a “significant operational undertaking” that would require changes to computer systems, updating of financial contracts, and new communications for clients.

• Britain’s retail industry urged UK and European negotiators to reach a post-Brexit trade deal, warning that without tariff-free trade, consumers face higher prices from next year. The sector has already announced thousands of job losses due the coronavirus pandemic as wary shoppers stay away from the high street, and the next stage of the Brexit process poses a further challenge. Britain left the EU in January and is currently in a standstill transition period with the bloc to give the two sides time to fix a new relationship in everything from trade to security. Last week’s round of talks was cut short, with both sides saying that, while they wanted an agreement, they had yet to overcome the gulf in positions that could see Britain leaving the transition period without a trade deal.

• The British government is planning to remove Huawei equipment from its 5G network by the end of this year after a new government report revealed severe security issues associated with the gear. The UK joins the US, Australia, New Zealand and Japan in blocking the use of Huawei’s technology in their 5G networks. 

EU

• In an interview with the Financial Times, European Central Bank President Lagarde suggested that next week’s policy meeting is unlikely to yield fresh loosening measures. She pointed out that financial markets had calmed down enormously and that the central bank had done so much that it now has to assess the incoming economic data carefully. She warned, however, that an economic recovery would be constrained, uncertain, and fragmented.

• Europe is facing a deeper-than-expected recession in 2020 and a weaker-than-expected economic recovery. The EU gross domestic product is forecast to shrink 8.3% in 2020 and then to rebound 5.8% in 2021. The eurozone is predicted to contract 8.7%, with growth then accelerating to 6.1%. Both sets of numbers are worse than those unveiled in May.

• As European leaders prepare for a summit next week on an EU recovery package that would include grants and not just loans to needy member states, German Chancellor Merkel met Rutte, the prime minister of the Netherlands, which is a member of the so-called “frugal four” states that have thus far been opposed to the grants. (The other frugal four countries are Austria, Denmark and Sweden.) Merkel appears to be aiming for a compromise in which the grants would be made, but only in return for economic reforms in countries such as Italy, Spain and Portugal.

• European shares ended the week little changed, depressed by renewed concerns about a resurgence of coronavirus cases. Although the pan-European STOXX Europe 600 Index was flat, major European market indexes were mixed. Germany’s DAX Index rose 0.22%, but France’s CAC 40 Index eased 1.38%, while Italy’s FTSE MIB Index declined 1.12%.

China

• After rallying 16.5% in eight trading sessions, Chinese state media warned that the country’s bull market had become “crazy.” To cool the rally, a pair of state-owned funds announced that they would begin trimming holdings of stocks that soared. Additionally, regulators asked mutual fund companies to cap the size of new products. Stocks heeded the warning on Friday, pulling back around 2.6%.

• China’s June consumer price inflation rose 2.5%, in line with expectations. However, headline inflation is expected to decline in future readings as food price inflation continues to ebb on lower pork prices. A food basket tracked by China Reality Research fell to a 16-month low and an annual rise of 9.0%, down from 10.6% in May. More noteworthy was the continued decline in factory gate prices, which fell for the fifth straight month in annual terms. The producer price index fell 3.0% in June from a year earlier, underscoring the threat of deflation due to the coronavirus-induced demand shock, though it exceeded the consensus forecast and the prior month’s 3.7% drop.

• After June’s positive economic data, many analysts have upgraded their second-quarter estimates for China’s economic growth. Economists now expect a double-digit sequential rebound in China’s gross domestic product (GDP) after the first quarter’s record contraction. For the year, analysts forecast that China’s economy will grow between 2.0% and 3.0%. Next week, trade data will be in focus for any signs of divergence between domestic and external demand. Exports are expected to be strong amid soaring global demand for medical and personal protective equipment due to the coronavirus pandemic.

• Mainland stock markets surged after a state-run publication talked up the country’s recovery and appeared to officially endorse the rally in equities. A bullish editorial in the China Securities Journal set in motion a risk-on rally that sent the benchmark Shanghai Composite Index to a two-year high. By Friday, the large-cap CSI 300 Index and Shanghai Composite Index rallied 7.5% and 7.3%, respectively. In China’s fixed income market, domestic bonds sold off and yields rose.

Sources: T. Rowe Price, Reuters, TD Economics, MFS Investment Management, M. Cassar Derjavets.