Economic Outlook – 15 April 2018

US

• Those who were hoping for signs of firming inflation were not disappointed. The inflation celebration was kicked off on Tuesday with the release of March’s producer price index (PPI), which rose 0.3% ahead of expectations for a 0.1% gain. Besides the energy component, all major sub-sectors saw prices rise last month. Moreover, this now marks the third straight month that the PPI for services advanced upward. A very used measure of inflation, core PPI, rose 0.4% and points to the underlying trend in inflation continuing to strengthen.
• Perhaps the most highly anticipated economic indicator last week was the consumer price index (CPI) report for March. Although the headline figure fell 0.1%, the decline can be entirely traced to energy, where prices fell 2.8%. Elsewhere, however, price gains were stronger and point to firming inflation. After what had been the strongest three-month run in 10 years, the core index increased an impressive 0.2%. Core services strengthened 0.3%, led by a rebound in shelter costs. Prices for medical services also strengthened notably, up 0.5%, after being flat last month.
• A third inflation metric, the import price index, was generally flat on the month in an otherwise price-firming environment. Fuel imports fell for the second month in a row, but are still up over the year. Despite the soft headline figure, ex-petroleum import prices rose 0.1% on the month.
• Recent months have witnessed a heightened level of anxiety surrounding a trade war with China. Fiery rhetoric from various figures have spooked markets and raised fears of heightened import prices as a result of tariffs. However, import inflation brought on by a possible trade war would likely be seen as transitory by the Fed. Furthermore, the Fed’s main focus is with consumer price inflation.
• On this note, news flow regarding trade frictions and ongoing (and potentially soon to be launched) trade negotiations were relentless the past week. The early focus was on apparently conciliatory comments from Chinese president Xi Jinping on steps his country will take to open markets to foreign competition. Markets were buoyed by the tone of his remarks, viewing them as aimed at improving relations with the United States. Chinese officials later stated that the speech was not a concession to the US and that China is prepared to retaliate. US president Donald Trump countered that the he would not call the present action a trade war but rather a negotiation.
• Regarding NAFTA, progress has been made, but it is unlikely that a deal will be announced this weekend at the Summit of the Americas in Lima, Peru. Negotiators now target early May, with the US having lowered NAFTA auto-content requirements from 85% from 75%. Trump, under pressure from farm interests, instructed the US trade representative and the head of his economic council to explore reentering negotiations on the US joining the Trans-Pacific Partnership, albeit only on terms more favourable than originally negotiated.
• Officials from North Korea and the US have been meeting directly in preparation for a summit meeting between Kim Jong and Donald Trump to be held in late May or Early June. Kim is said to be willing to discuss the denuclearisation of the Korean Peninsula. Preparatory talks are expected between the heads of the two nations’ intelligence agencies in the weeks leading up to the summit, and President Trump is expected to meet next week with Japanese prime minister Shinzo Abe.
• Minutes of the latest meeting of the Federal Open Market Committee show that the Fed is increasingly confident it will reach its 2% core personal consumption expenditures goal. Soft inflation data a year ago will likely push year-over-year comparisons above target in the months ahead, but that is unlikely to change the committee’s projected path of rate hikes, the minutes show. Overall, an upbeat economic outlook may make a slightly steeper path of rate hikes necessary, some members said.
• US stocks recorded solid gains and reversed the previous week’s losses. Markets remained volatile, however, as investors appeared to remain focused on the turbulent political environment rather than the upcoming release of first-quarter corporate earnings reports. The technology-heavy Nasdaq Composite Index performed best, helped by a rally in Facebook shares as investors seemed to react favourably to Facebook CEO Mark Zuckerberg’s testimony before Congress on Tuesday and Wednesday. While tech shares performed well, energy stocks led the gains in the S&P 500 Index, helped by a rally in crude prices to their highest level since late 2014. Real estate and utilities shares lagged as longer-term bond yields increased, making their relatively high dividends less appealing in comparison.
• Friday brought the release of the first major US first-quarter earnings reports, with JPMorgan Chase, Wells Fargo, and Citigroup all declining in early trading despite topping analysts’ estimates. Due in part to recent tax cuts, expectations for first-quarter profit growth are elevated, with analysts polled by FactSet anticipating that earnings for the S&P 500 as a whole will rise more than 17% on a year-over-year basis. If realised, this would be the strongest earnings performance since 2011, FactSet observes. Some anticipate that much of the benefit of the tax cuts to corporations’ bottom lines will be competed away in the coming quarters as firms invest in new capacity and raise wages. In addition, there is a prevailing sentiment of caution that the effect of the tax cuts on year-over-year earnings comparisons will inevitably be temporary.
• Retail sales in March are due out on Monday. Retail sales have been weak in recent months but the slowdown comes after a period with strong growth. Retail sales are very noisy but, given the high degree of optimism among US consumers, private consumption is likely to remain a growth driver.
• Industrial production data for March are due on Tuesday. It is quite volatile indicator but both PMI and ISM manufacturing are signalling the expansion is likely to continue.

UK

• UK industrial production increased by a meagre 0.1% in February after increasing 1.3% in January. The February reading was weaker than the consensus expectation of 0.4%. Manufacturing also disappointed, falling by 0.2% in February after growing by 0.1% in January. The consensus expectation for February was +0.2%. The largest contribution to growth in industrial production came from energy supply, which increased by 3.7%, following a decrease of 2.6% in January 2018. According to the ONS, the below-average temperatures in February had a positive impact on energy. On the other hand, production within manufacturing and mining and quarrying fell in February. Manufacturing, which was down by 0.2%, registered its first fall since March 2017. Within manufacturing, seven of the 13 sub-sectors decreased on the month, led by machinery and equipment. The weather was unusually inclement at the end of the month; however, despite snowfall in some areas of the UK in February, there was no evidence to suggest that the snowfall had any negative impact, according to the ONS.
• The UK blue-chip benchmark, the FTSE 100 Index, rose about 1%, but the index has been under-performing its European counterparts largely due to the strong pound, which weighs on the companies that convert non-UK profits back into the sterling.
• Brexit minister David Davis warned on that parliament could veto any final deal negotiated with the European Union unless it has a “substantive” idea of the future trading relationship.
• On Tuesday, the labour market report for February is due out. The annual growth rate of average hourly earnings excluding bonuses (3M average) is expected to increase to 2.8% year-on-year from 2.6% year-on-year, as the weight of the monthly fall in December 2016 becomes less important. The unemployment rate (3M average) is likely to remain at 4.3%.
• On Wednesday, UK CPI inflation data for March are due on Wednesday. UK CPI inflation is expected to be unchanged at 2.7% year-on-year in March, while core CPI inflation may have risen to 2.5% from 2.4%. CPI inflation is still expected to move lower this year, as food price inflation has peaked, energy prices are stabilising and the impact of past GBP depreciation is fading.

EU

• A second round of talks aimed at forming a government led by Italian president Sergio Mattarella failed to reach a breakthrough more than a month after the 4 March general election. Prospects for a coalition being formed in the near-term appear dim. Italy is being governed by a caretaker government, and if a new coalition cannot be formed, that condition could persist for some time, with fresh elections possible. Media reports suggest Mattarella may ask the leader of the centre-right coalition to try to form a government, but that effort is expected to fall short. Alternatively, the president may ask a parliamentary speaker to try to mediate between the parties. Mattarella said issues such as the crisis in Syria and growing international trade tensions showed why the parties should work hard toward forming a stable government.
• The pan-European STOXX 600 Index advanced around 1% for the week. Germany’s exporter-heavy DAX 30 also rose for the week, despite news that the country’s exports plunged in February, largely due to a strengthening euro. German markets were supported by news that consumer price inflation accelerated in March, and they were also lifted by a report that China’s imports increased in the latest period.
• According to its policy minutes published this week, the European Central Bank (ECB) pointed out that a strengthening euro and an increased risk of a global trade war could detract from the economic recovery currently underway in the Eurozone. Following the ECB’s warning, European markets were somewhat volatile as investors weighed the impact.
• In the euro area, there are no market movers this coming week.

China

• Despite the conciliatory tone of Xi’s speech, which elicited praise from President Trump, other reports suggested that the current spat will not be resolved quickly. Many of the measures that Xi described had been previously announced, and the Chinese president gave no new details about when they would be implemented. Moreover, Bloomberg reported that Chinese officials have lately expressed frustration with U.S. negotiators and that trade talks broke down earlier this month after the Trump administration demanded that China stop subsidising industries under its “Made in China 2025” plan. This state-backed plan, which aims to promote domestic companies in various technology-related industries, has been criticised by the U.S. and Europe for giving Chinese firms an unfair advantage on their home turf.
• There are no market movers in China next week.

Sources: Wells Fargo, T. Rowe Price, Handelsbanken Capital Markets, Danske Bank, MFS Investments, Reuters.