Economic Outlook – 13 December 2020

US

• The Consumer Price Index rose 0.2% in November after holding steady the month before. The result overshot consensus expectations for a 0.1% print. Energy prices overall were up 0.4% month-on-month as lower gasoline prices (-0.4%) were more than offset by higher prices for electricity (+0.5%), gas (+3.1%) and fuel oil (+3.6%). The cost of food, meanwhile, sagged 0.1% on softness in the “food at home” segment (-0.3%). The core CPI, which excludes food and energy, climbed 0.2%. Prices for excl. energy services were up 0.2%, boosted by decent gains for motor vehicle insurance (+1.1%) and airline fares (+3.5%). Also, prices for core goods edged up 0.1% as gains for apparel (+0.9%), household supplies (+0.9%), alcoholic beverages (+0.4%) and tobacco products (+0.3%) were only partially offset by declines for used vehicles (-1.3%) and medical care commodities (-0.3%). Year-on-year, headline inflation clocked in at 1.2%, the same as it did in October. Core inflation, too, was unchanged, pegging in at 1.6%.

• The Producer Price Index (PPI) for final demand advanced 0.1% on a monthly basis after gaining 0.3% in October. Goods prices rose 0.4% on increases for both food (+0.5%) and energy (+1.2%). Prices in the services category were flat month on month. The core PPI, which excludes food and energy, climbed just 0.1%. Year-on-year, the headline PPI gained three ticks to 0.8%. Excluding food and energy, it also advanced three ticks to 1.4%.

• The University of Michigan Consumer Sentiment Index surprised on the upside in December, rising 4.5 points to 81.4. Consensus expectations were for a 76.0 print. The improvement stemmed in part from a 4.2-point gain in the expectations sub-index to 74.7, the latter likely boosted by positive vaccine news. The current conditions tracker also rose, from 87.0 to 91.8, and that despite rising Covid-19 caseloads across the country. The result of the presidential election continued to affect the result of the survey. While sentiment among Democrats registered its biggest gain since April 2012 (from 73.6 to 86.3), it continued to slip among Republicans (from 83.7 to a 4-year low of 80.3).

• The NFIB Small Business Optimism Index cooled from 104.0 in October to 101.4 in November. The net percentage of polled firms that expected the economic situation to improve dropped from 27% to an eight-month low of 8%. This was not really surprising in light of the surge in COVID-19 cases across the country and the toughening of social distancing measures in some states. Capital spending intentions, meanwhile, stayed roughly the same (from 27% to 26%), as did the share of respondents expecting higher sales going forward (from 11% to 10%). On a more positive note, the ratio of businesses planning to hire in the coming months increased from 18% to 21%.

• The Job Openings and Labor Turnover Survey (JOLTS) showed that positions waiting to be filled rose from 6,494K in September to 6,652K in October after plunging to a six-year low of 4,996K back in April. Despite this gain, job openings remained down roughly 5.0% on their pre-pandemic level. Gains in the sectors of health care/social assistance (+122K), manufacturing (+33K), real estate/leasing (+22K), education (+19K) and accommodation (+14K) were offset only in part by declines in the sectors of transportation (-34K) and finance/insurance (-29K). October’s survey also showed 5,812K hires, down slightly from 5,886K the prior month and the lowest that they have been in six months. There were 5,107K separations reported, 1,680K of which were layoffs or discharges. The quit rate (number of voluntary separations/total employment), for its part, stayed put at 2.2%, a level just two ticks below this indicator’s pre-pandemic peak. The rebound in quits is encouraging in that it may reflect growing confidence among employees and stiffer competition among employers.

• Regarding the FED policy, mar­kets expect that the policy rate will not see a hike until 2024. That’s a long time from now and if inflation does pick up, it could very well move sooner. Still, with the Federal Reserve signaling an increased willingness to tolerate inflation above its 2% it will take a convincing move to budge expectations.

• A bipartisan group of lawmakers released the broad outlines of a USD 908 billion package, which included both Republican demands for a liability shield for businesses against coronavirus claims and Democratic demands for assistance to state and local governments. Leaders on both sides expressed continuing reservations about the proposal, however, while other lawmakers demanded that any package also include a new set of direct payments to individuals.

• The major indexes hit new highs on Wednesday but pulled back to end the week mixed. The small-cap Russell 2000 Index outpaced the large-cap S&P 500 Index for the fifth consecutive week and recorded a modest gain. Within the S&P 500, the energy sector outperformed by a wide margin, as international (Brent) oil prices crossed USD 50 per barrel for the first time since the onset of the pandemic. Information technology and real estate shares underperformed. The week was also notable for the initial public offerings (IPOs) of Airbnb and DoorDash, two of the largest to date in 2020. Shares in both internet companies rose sharply once trading began. According to Renaissance Capital, 2020 is on track to be the highest volume and busiest IPO year since at least 2014.

• In terms of data release, the highlight of the week will be the central bank’s monetary policy meeting. With benchmark rates down to what many policymakers see as the effective-lower bound, no changes on that front are expected. The big question is whether the Fed will tweak its asset purchase program. In the wake of November’s disappointing employment report, some analysts suggested the Fed might use next week’s meeting as an opportunity to shift QE toward the longer end of the yield curve, thereby providing more stimulus to the economy. Recent communications suggested the central bank still viewed its QE program as providing substantial support to the economic recovery. Although the rise in COVID-19 cases could temporarily slow the rebound, positive announcements about vaccines point to more solid growth in the second half of 2021. It’s not clear that the economy will require more stimulus in this context, especially if Congress can come to an agreement for a new fiscal stimulus. The Federal Reserve Board members’ latest economic projections will also be available following the meeting.

• The release of November’s retail sales data will also be watched closely. Vehicle sales and gasoline prices edged down during the month, hinting at weak contributions from auto dealers and gasoline stations. The expansion might have slowed in other categories too, as government benefits became less generous and pent-up demand started to ease

• The recovery in industrial production could have continued, helped by an expansion in the manufacturing sector. Mining output may also have contributed positively, reflecting a rebound in oil production.

• The week will provide some important information about the state of the housing market with the publication of November’s building permits and housing starts. The latter could have stayed roughly stable at 1,530K, as builders continued to make up for the time lost during lockdown.

EU

• The ECB kept its policy rates at current levels. The Governing Council also reiterated that the key ECB interest rates will “remain at their present or lower levels until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within its projection horizon, and such convergence has been consistently reflected in underlying inflation dynamics. The Governing Council further decided to top up the PEPP by EUR 500bn to a total of EUR 1,850bn. The duration of PEPP was further extended until “at least” March 2022. In addition, reinvestment of the principal payments from maturing securities purchased under the PEPP will continue until “at least” the end of 2023. As expected, the ECB also decided to make the conditions of its targeted longer-term refinancing operations (TLTRO III) more favourable by extending “the period over which considerably more favourable terms will apply by twelve months, to June 2022. Three additional operations will also be conducted between June and December 2021. “Moreover, the ECB raised the total amount that “counterparties will be entitled to borrow in TLTRO III operations from 50 % to 55 % of their stock of eligible loans. In order to provide an incentive for banks to sustain the current level of bank lending, the recalibrated TLTRO III borrowing conditions will be made available only to banks that achieve a new lending performance target”. The Governing Council also extended to June 2022 the duration of the set of collateral easing measures adopted by the Governing Council on 7 and 22 April 2020. This will ensure that “banks can make full use of the Eurosystem’s liquidity operations, most notably the recalibrated TLTROs”. The ECB will also add four additional pandemic emergency longer-term refinancing operations (PELTROs) in 2021, and net purchases under the asset purchase programme (APP) will continue at a monthly pace of EUR 20bn with similar duration, and expected reinvestments of principal payments continuing, as before.

• The European Union passed the EUR 1.8 trillion budget, which includes a EUR 750 billion coronavirus recovery fund, for 2021 to 2027 after Hungary and Poland dropped their objections to tying payments to rule of law principles. The fund will start distributing money to needy member states in the second half of next year in the form of grants, raised via EU debt issuance, and loans.

• European shares fell on concerns about the rising numbers of coronavirus cases in key economies and uncertainty surrounding a post-Brexit trade deal and U.S. stimulus measures. In local currency terms, the pan-European STOXX Europe 600 Index ended the week about 1.00% lower, while Germany’s DAX Index fell 1.39%, France’s CAC 40 declined 1.81%, and Italy’s FTSE MIB tumbled 2.15%.

• Next week in the euro area, Flash PMIs are out. It will be interesting to see whether services PMIs have reached a trough in November and start rising again in December. At least, the expectations components were quite promising in the November PMIs and activity in large parts of the euro area is increasing again, although from low levels.

UK

• GDP increased 0.4% month-on-month in October. While the economy was still expanding, the pace has fallen from the 2.2% and 1.1% achieved in August and September. Overall, the economy is 7.9% smaller than at the start of the year. On a sector-by-sector basis, it is notable that accommodation and food services continued to face significant difficulties, decreasing by 0.37% in October, muting the increases in manufacturing (0.16%) and health work (0.14%). The spike in restaurant activity in August, driven by the eat out to help out programme, clearly increased revenue, but the sustainable trend rate of recovery was nowhere near as robust, with the result that activity fell away over the autumn.

• The Bank of England said it would review the test that borrowers must pass if they want a mortgage, raising the prospect of obtaining home loans more easily. The BoE introduced a tougher “affordability” test in 2014 to ensure that borrowers do not become a threat to financial stability by taking on debt they cannot afford to repay if interest rates were to rise by 3 percentage points. The assumption of such a jump in rates has now become more questionable due to the very low BoE base rates and a global fall in borrowing costs. The BoE test sets limits on how high the loan can be in relation to a person’s income. Banks have already been reining in high-loan-to-income mortgages since the economy began coming under pressure due to COVID-19.

• Hopes rose last week that a post-Brexit trade deal was in reach, but optimism has faded as negotiators have failed to work out acceptable rules for UK access to EU markets and an enforcement mechanism to adjudicate disagreements. UK Prime Minister Boris Johnson warned last night that talks may very well fail since the EU seeks to keep the UK locked in its orbit. Talks continue, with Sunday seen as a final deadline. Contingency planning for a no-deal Brexit has ramped up on both sides of the channel in recent days, with disruptions in trade flows seen as likely early in the new year even if a deal is reached, given how long the negotiations have gone on. Markets are pricing in the increased risk of no deal. The pound has fallen about 2.5% versus the dollar this week while UK gilt yields have declined and the yield curve has flattened.

China

• The Consumer Price Index slipped 0.5% in November from a year earlier, marking the biggest pullback in 11 years. The easing of price pressures stemmed in large part from a decline in the food category, where prices dropped 2.0% on a 12-month basis. Just a few months earlier, prices had soared 11.2% year-on-year in August. Pork prices, in particular, had doubled in the wake of an African swine flu outbreak last year. In November, however, they were deep in deflation territory at -12.5%. Excluding food and energy, inflation remained tepid at 0.5% year-on-year, a sign that household demand continued to be sluggish. Finally, the headline PPI gauge came in at -1.5% year-on-year.

• Concerns that US sanctions will target more Chinese companies outweighed generally positive data for money, credit, and merchandise trade. China’s November exports climbed an unexpectedly large 21.1% from a year earlier, marking the strongest growth since February 2018. Foreign inflows into the country’s bond market rose strongly last month to USD 15 billion, almost double October’s inflow. China recorded a large increase in net holdings of short-term negotiable certificates of deposit, reflecting foreign investors’ positive views on the renminbi (RMB) currency. The RMB was broadly flat for the week, slipping 0.2% against the US dollar. The yield on China’s 10-year sovereign bond rose 2 basis points to 3.32%.

• In bond market news, semiconductor company Tsinghua Unigroup became the latest state-backed entity to default on its bonds. The once high-flying company, partly owned by China’s Tsinghua University, said it couldn’t repay the principal on a USD 450 million bond due Thursday, a move that would trigger cross-defaults on another USD 2 billion of debt. Tsinghua had received the strongest government backing of any chipmaker under Beijing’s plan to develop China’s semiconductor industry. Its default is the latest sign of credit stress facing state-linked borrowers as the central government has shown more willingness to let weaker companies fail. Defaults in Asia’s offshore high yield market, which is dominated by Chinese issuers, have totaled roughly USD 9 billion so far this year, or a default rate of roughly 3%.

• China equities fell on renewed tensions with the US after a second major index provider removed some Chinese companies from its benchmarks following a Trump administration executive order. The large-cap CSI 300 Index sank 3.5%, its biggest weekly drop since September, and the Shanghai Composite Index shed 2.8%. Sentiment weakened after S&P Dow Jones Indices (S&P DJI) said it would remove 21 Chinese companies from its global stock and bond benchmarks after the US Defense Department earlier this year designated the companies as having ties to China’s military.

Sources: T. Rowe Price, Reuters, MFS Investment Management, National Bank of Canada, Danske Bank, Handelsbanken Capital Markets, M. Cassar Derjavets.