Economic Outlook – 16 October 2022

USA

• Consumer Price Index jumped 0.4% in September, twice the pace expected by consensus (+0.2%). Prices in the energy segment fell 2.1% as declines for gasoline (-4.9%) and fuel oil (-2.7%) were only partially offset by a 2.9% gain for utility gas services. The cost of food, meanwhile, sprang no less than 0.8%. The core CPI, which excludes food and energy, rose 0.6%, two ticks more than the median economist forecast of +0.4%. Prices for ex-energy services progressed 0.8% on strong gains for shelter (+0.7%), medical services (+1.0%), and transportation (+1.9%), this last segment boosted by increases for motor vehicle maintenance (+1.9%) and insurance (+1.6%). The cost of core goods stayed flat in the month. Prices for new vehicles (+0.7%) and tobacco/smoking products (+0.2%) continued to advance while those for used vehicles (-1.1%) and apparel (-0.3%) retreated. YoY, headline inflation clocked in at 8.2%, down from 8.3% the prior month but still one tick above the consensus forecast. The 12-month core measure went from 6.3% to a 40-year high of 6.6%

• CPI data exceeded expectations once again. As anticipated, lower gasoline prices weighed on the headline index, but this was more than offset by yet another steep gain in the food category. The core CPI, for its part, continued to be supported by broad-based gains in the services segment, which recorded its strongest monthly progression since August 1990 (+0.8%). The price of shelter advanced at a brisk pace and is now up 6.6% on a 12-month basis, the most since 1982

• Retail sales stayed flat in the U.S. in September instead of increasing 0.2% as per consensus. The previous month’s print, meanwhile, was revised from +0.3% to +0.4%. Sales of motor vehicles/parts contributed negatively to the headline print, contracting 0.4%. Without autos, retail outlays increased a consensus-topping 0.1% as gains for general merchandise (+0.7%), non-store retailers (+0.5%), clothing (+0.5%) and eating/drinking establishments (+0.5%) were only partially offset by declines for miscellaneous items (-2.5%), gasoline stations (-1.4%) and electronics (-0.8%). In the end, sales were up in 7 of the 13 categories surveyed. Core sales (i.e., sales excluding food services, auto dealers, building materials, and gasoline stations), which are used to calculate GDP, were up 0.4% in the month

• September’s retail sales figures were roughly in line with consensus expectations. Gasoline stations weighed on the headline number but that was to be expected given the drop in pump prices during the month (the data does not take price variation into account). Without this category, outlays edged up 0.1%. That’s not to say goods consumption was strong in September. Analysts’ expectations were quite low to begin with and for a good reason: Real disposable income has remained more or less flat over the past 12 months as wage growth failed to keep up with inflation. Consumer confidence has dropped as a result. The impact of this phenomenon on goods consumption may however have been exacerbated by the shift in consumer demand towards services following the full reopening of the economy. This shift seems to have continued in September, with outlays at restaurants and bars advancing for the second month in a row, a sign that services spending may have continued to expand in the third quarter of the year

• The Federal Reserve published the minutes of its two-day policy meeting held September 20-21. The decision to hike the fed funds rate 75 basis points was expected but the accompanying Summary of Economic Projections was a bit of an eye-opener, as another major hawkish adjustment to the dot plot sent short term yields immediately higher. For the nearer-term meetings (i.e., November and December), the market has largely now adopted the Fed’s telegraphed stance

• A key theme runs through these minutes: Inflation is still too high and the Fed will not rest until they are confident that inflation is brought to heel. While FOMC participants chose to lay down what could be called a “softish” landing in their Summary of Economic Projections, these minutes spell out unambiguously where the risks lie. Namely, risks to the growth outlook are skewed to the downside and the risks to their unemployment rate projections are skewed to the upside. In other words, the Fed knows that their actions could drive the economy into a recession but, at least for the time being, they will suggest that this might be the price worth paying for price stability. That said, there is a line in the sand somewhere where there is too much weakness in GDP and labour markets. Many participants have even implied as much. However, that point is far right now, which means more rate hikes and tighter financial conditions are on deck

• The Producer Price Index for final demand increased 0.4% in September, marking a first hike in three months and topping the consensus forecast calling for a 0.2% increase. Goods prices climbed 0.4% on a sizeable increase in the food (+1.2%) and energy (+0.7%) segments. Prices in the services category rose 0.4%. The core PPI, which excludes food and energy, grew 0.3% on a monthly basis, in line with the consensus. Year over year, the headline PPI eased from 8.7% to 8.5%, one tick above the level expected by consensus. Excluding food and energy, it remained stable at 7.2% instead of gaining a tick as expected by consensus

• The Import Price Index (IPI) retraced 1.2% on a monthly basis, less than the consensus calling for a 1.1% drop. September’s print resulted in a 3.7% decline in the IPI for the third quarter of the year. The headline print was negatively affected by a 7.5% retreat in the price of petroleum imports but, even excluding this category, import prices still shed 0.5%, marking a fifth decline in a row for this indicator. On a 12-month basis, the headline IPI eased from 7.8% to a 19-month low of 6.0%. The less volatile ex-petroleum gauge sagged from 4.3% to 3.7%, its lowest level since February 2021

• The University of Michigan Consumer Sentiment Index rose from 58.6 in September to a still depressed 59.8 in October. The increase was due to an improvement in current perspectives while longer-term ones darkened. The former improved from 59.7 to 65.3, while the latter dropped from 58.0 to 56.2. Consumers deemed that buying conditions for durables have improved thanks to unclogging supply chains. Twelve-month inflation expectations increased to 5.1%, while the 5/10-year expectations climbed to 2.9%. These increases in inflation expectations were tied to an uptick in expected gas prices

• The NFIB Small Business Optimism Index recorded its third consecutive monthly increase, edging up 0.3 point to 92.1. This, however, was still well below the index’s historical average of 98. The net percentage of firms that expected the economic situation to get better worsened significantly from -42% to -44%. It thus remained indicative of a gloomy outlook The net percentage of firms that expected sales to grow improved from a 27-month low of -29% in July to a still low -19% in August and further to -10% in September. Flagging prospects did not seem to affect hiring plans too much: 23% of firms said they expected to expand payrolls in the coming months, up from 21% in August and comfortably above the long-term average for this indicator

• The major indexes were mostly lower this week, as third-quarter earnings reporting season began in earnest and investors weighed inflation data and their implications for Federal Reserve policy. By the end of the week, the S&P 500 Index had surrendered nearly half of its gains since its March 2020 bottom. Within the index, the typically defensive health care and consumer staples sectors outperformed, while consumer discretionary and communication services shares lagged, dragged lower by heavily weighted Amazon.com, Tesla, and Meta Platforms (parent of Facebook). Likewise, slower-growing value stocks handily outperformed their growth counterparts. Stocks saw their biggest move on Thursday, with a sharp early drop followed by a 5.5% surge to the upside in the S&P 500 Index, marking its largest intraday move since March 25, 2020. The bond market was closed Monday in observance of Indigenous Peoples Day (previously known as Columbus Day)

UK

• The UK economy unexpectedly shrank 0.3% sequentially in August due to a fall in industrial output. Meanwhile, the labor market tightened further. The unemployment rate fell to 3.5% in the three months through August, the lowest level since 1974, as the number of economically inactive people (those neither working nor seeking a job) jumped by a record amount. Wages, including bonuses, rose 6.0% year over year

• The Bank of England’s Monetary Policy Committee is expected to raise interest rates by a record 100bp on 23 November, and a further 50bp rise in December. Looking to 2023, and a further rise of 25bp in February (admittedly this could be rolled into the December rise), taking overall rates to 4%. This could be the peak and that the MPC will leave rates at this level through 2024. Investors remain far more hawkish, their expectation at the moment is that rates will hit 5.75% by May of next year (and in the last fortnight long end Gilt expectations have been as high as 6.33%). Even this slightly lower expectation seems unduly harsh; the GDP figures this morning show the economy slowing more sharply than anticipated (down 0.3% in August) as a result of the rate raises already implemented, while the energy price cap means than the peak of inflation is almost certain to be now, with inflation falling away over the rest of the year and into 2023.

• The key question is what happens to Gilt rates (while lower sterling does facilitate the importation of inflation, that might not be sufficient for the Bank to target an exchange rate, particularly against the dollar). The next big event is going to be the Budget on 31 October where the Chancellor will set out his plans to bring the deficit down and put the government finances on a more stable long-term footing

• Extreme volatility returned to the market for long-dated gilt-edged securities this week as the Bank of England made clear that it would wind up its temporary bond market support program on Friday, as scheduled. Soaring interest rates pressured the government of Prime Minister Liz Truss into abandoning additional pillars of her tax-cutting and deregulation agenda amid a revolt within her Conservative Party. Last week, Truss jettisoned the unpopular cut in the United Kingdom’s top tax rate to 40% from 45%, and on Friday she reversed a plan to cancel Boris Johnson’s corporate tax hike slated for April, which will raise the rate from 19% to 25%. Early on Friday afternoon, as part of the policy reversal, the embattled Truss asked for the resignation of Chancellor of the Exchequer Kwasi Kwarteng and replaced him with former Foreign Minister Jeremy Hunt. Truss addressed the media on Friday afternoon in London, saying spending will grow less than previously planned but that Hunt will “drive our mission to go for growth

EU

• European Central Bank (ECB) Governing Council member Pablo Hernandez de Cos, governor of the Bank of Spain, said some shocks in the ECB’s downside scenario appear to have materialized, indicating that the economy could soon contract. ECB Vice President Luis de Guindos reportedly said that the central bank is prepared for a possible technical recession (two consecutive quarters of negative growth) accompanied by high inflation. Meanwhile, Austria’s central bank governor, Robert Holzmann, appeared to strike a less hawkish stance. He said that the bank needs to hike interest rates by only 1.25 percentage points by year-end to get close to neutral, or the rate at which monetary policy neither stimulates nor impedes growth. Some policymakers, including ECB President Christine Lagarde, have indicated that rates might have to keep rising into next year

• Industrial production in the eurozone climbed 1.5% sequentially in August—much more than forecast and partially reversing a 2.3% monthly drop in July. Industrial output in France and Italy rose sharply but fell in Germany. The trade deficit, meanwhile, swelled for a 10th consecutive month in August to almost EUR 51 billion, up from EUR 34 billion in July, due to the higher cost of energy imports. The German government slashed its economic forecasts for the next two years because of price increases, energy shortfalls, and supply chain disruptions caused by Russia’s invasion of Ukraine. Output this year is now expected to be 1.4%, down from the previously projected rate of 2.2%. The forecast calls for gross domestic product to shrink 0.4% in 2023

• Germany has indicated it may back the idea of the joint issuance of European Union debt to cushion the impact of the energy crisis. The proceeds of the bond sales by the highly rated EU would then be distributed to lower-rated countries as loans instead of grants. In 2020, a similar scheme saw bond proceeds divvied out as both grants and low-interest loans

• Shares in Europe were little changed after suffering a sharp pullback in the week prior. In local currency terms, the pan-European STOXX Europe 600 Index ended slightly lower. Major indexes on the Continent rose. Germany’s DAX Index advanced 1.34%, France’s CAC 40 Index gained 1.11%, and Italy’s FTSE MIB Index tacked on 0.14%

CHINA

• China reported that tourism revenue during the weeklong National Day break, typically a peak period for travel and consumption, fell 26% from a year ago and was equal to 44% of the revenue in 2019 as coronavirus restrictions led many people to stay close to home. Last week, the state-run newspaper People’s Daily stated in a commentary that China must stick to zero-COVID because the policy is key to stabilizing the economy and protecting lives. The commentary dampened hopes that Beijing would relax the country’s zero-tolerance approach to the coronavirus anytime soon, despite its impact on China’s economy

• The People’s Bank of China (PBOC) will focus on supporting infrastructure construction and enabling quicker delivery of home projects, according to PBOC Governor Yi Gang. The central bank will also step up the implementation of prudent monetary policy and provide stronger support for the real economy, he added

• The yuan, which fell to a near 28-month low in September, traded at 7.191 per U.S. dollar late on Friday after hitting a two-week low on Thursday, when U.S. inflation data stoked concerns of more outsized rate hikes. The yuan has lost more than 10% against the dollar this year and is on track for its biggest annual loss since 1994, when China unified its official and market rates, according to Reuters

• China’s stock markets rose after the weeklong National Day Holiday, lifted by supportive central bank comments and anticipation of policy signals during the Communist Party Congress, a twice-a-decade gathering of the country’s political elite that began on Sunday. The broad, capitalization-weighted Shanghai Composite Index added 2.07% and the blue chip CSI 300 Index, which tracks the largest listed companies in Shanghai and Shenzhen, gained 1.32% from the pre-holiday closing levels, Reuters reported

Sources: T. Rowe Price, Handelsbanken Capital Markets, MFS Investments, M. Cassar Derjavets

2022-10-17T17:09:58+00:00