Economic Outlook – 17 December 2017

US

• US economic data this week continued to signal moderate economic growth and inflation started to show signs of picking up. Following November’s performance, consumer prices are now up 2.2% on a year-on-year basis, while producer prices are now up 3.1%. The more recent inflation data combined with the rate hike out of the FOMC this week showed that monetary policy normalisation remains on track.
• At its policy meeting on 12 and 13 December, the Fed raised the target range for the federal funds rate by 0.25%. It also left its policy rate outlook for 2018 and 2019 unchanged, even as Fed officials forecast a short-term acceleration in economic growth and revised down their unemployment rate projections. Moreover, the labour market has continued to strengthen and economic activity has been rising at a solid rate, according to the statement. Household spending has been expanding at a moderate rate, and growth in business fixed investment has picked up in recent quarters. However, both overall inflation and inflation for items other than food and energy have declined this year and are running below 2.0%. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance. Finally, Charles L. Evans of Chicago and Neel Kashkari of Minneapolis voted against the action. They preferred to maintain the existing target range for the federal funds rate.
• US inflation data this week reinforced the idea that the downshift in inflation is likely behind. The headline Consumer Price Index rose 0.4% in November, while core inflation climbed 0.1%. Energy prices helped boost the headline CPI reading while softer lodging, airfare and apparel prices held back the gains in the core CPI. Looking at producer prices, the PPI for final demand rose 0.4%, while the core PPI measure climbed 0.3%. Import prices also accelerated for the month, climbing 0.7% following October’s 0.2% increase. Even with a slightly softer core CPI reading, the FOMC appears to be on track to hike rates three times in 2018 as other measures of inflation continued to edge higher.
• US retail sales data were one of the biggest economic data surprises of the week, climbing an impressive 0.8% in November. The strong start to the holiday shopping season was partially due to greater spending in electronic stores and non-store retailers, which captures online retailers. Gasoline station sales also rose 2.8% on the month with at least some of those gains reflecting higher prices in the nominally reported number. The retail sales control group, which feeds into the calculation of GDP, was revised higher for October and climbed an additional 0.8% in November.
• Republican leaders in the US House of Representatives and Senate worked out a compromise tax bill this week, although a few Republican Senators are still pushing for additional changes. The package is expected to be voted on in the Senate on Tuesday and in the House on Wednesday before being signed by President Donald Trump on Thursday, if all goes well for the Republicans. At the same time, a stop-gap funding bill to keep the government in operation until mid-January is in the works and needs to be passed by Friday 22 December when funding runs out. It appears that there is agreement between Democratic and Republican leaders on passing a continuing resolution that pushes a potential shutdown into mid-January. Highlights of the compromise bill include a 21.0% top corporate tax rate, a 37.0% top individual income tax rate and a near-doubling of the standard deduction, which should simplify tax preparation for many filers.
• Most of the major benchmarks recorded modest gains during the week, bringing the large-cap benchmarks and the technology-heavy Nasdaq Composite Index to new highs. The smaller-cap benchmarks lagged and remained a bit off the peaks they established early in the month. Within the S&P 500 Index, consumer discretionary and consumer staples shares led the gains, with the former helped by news of Disney’s purchase of much of 21st Century Fox (media companies are classified as consumer discretionary stocks). Materials and utilities shares lagged, and energy shares were also weak despite international (Brent) oil prices climbing above $65 on Tuesday, their highest level since June 2015. A late-November agreement between OPEC and non-OPEC member Russia to extend production cuts has pushed up prices, and recent pipeline shutdowns and other disruptions have provided further supply pressure.
• The most import event next week will be the release of PCE figures for November on Friday. CPI numbers (usually a good predictor of PCE) for November were weaker than expected. Based on CPI, PCE core is expected to increase 0.1% month-on-month (1.5% year-on-year versus 1.4% in October although October was very close to 1.5% year-on-year) and PCE headline to increase 0.3% month-on-month (1.8% year-on-year versus 1.6% year-on-year in October). Increasing energy prices drives the difference between the monthly increase in core and headline PCE.
• Friday also brings core CAPEX orders for November. CAPEX orders have gained strong momentum during the fall and the regional CAPEX plans suggest that this trend will continue. The average of the regional CAPEX plans is at its highest level since February 2007, indicating continued tail winds for core CAPEX orders in the coming months.

UK

• Theresa May suffered an embarrassing setback at the hands of members of her own party just a day before heading to Brussels to participate in a European Union summit at which European leaders are expected to say that the United Kingdom has made enough progress toward meeting major negotiating milestones that talks on the future UK-EU trade relationship may commence. The government was forced to accept changes to the EU Withdrawal Bill that would allow the House of Commons a final vote on any Brexit deal that the prime minister agrees with the EU. May had hoped to avoid that entanglement.
• The monetary policy committee (MPC) of the Bank of England (BoE) decided to keep the policy rate unchanged at 0.5%. The decision was unanimous. The MPC also voted unanimously to maintain the stock of corporate bond purchases and UK government bond purchases. Also, the language describing the outlook and the monetary policy assessment was left broadly unchanged. The BoE noted that recent news in macroeconomic data had been mixed and relatively limited, but that, overall, the general assessment of demand growing at a pace just above its reduced rate of potential, thereby generating a gradual pick up in domestic inflationary pressures, seemed intact. Regarding the short-term outlook, the BoE noted that some activity indicators had suggested GDP growth in Q4 might be slightly softer than in Q3. The labour market had remained tight and surveys had suggested that would continue. Earnings growth had been broadly as expected. The MPC continued to expect wage growth to pick up in the early part of next year, but noted that there remained uncertainties about that projection. The MPC judges that inflation is likely to be close to its peak and will decline towards the 2.0% target in the medium term.
• The most important release in the UK is the index of services for October on Friday, which is important for the assessment of growth at the beginning of Q4. According to PMI services, service sector growth has been muted in Q4.

EU

• The ECB did not announce changes in monetary policy, including its forward guidance. That was widely expected after the ECB, at the previous meeting on October 26, announced a reduction in monthly asset purchases and the extension of the programme. Instead, focus turned to the updated ECB staff forecasts for GDP growth and HICP inflation. According to Draghi, the officials did not discuss the design or end to QE. Also, Draghi explained that the officials did not discuss cutting the QE-inflation link in their guidance, but admitted that guidance for rates will gain in importance.
• The ECB delivered an upward adjustment to its growth forecast for 2017-19, especially 2018. Draghi described the recent performance as “a strong pace of economic growth” compared to the earlier assessment of “increasingly robust and broad-based economic expansion”, adding that it was a significant upward revision.
• This said, the first growth estimate for 2020 was lower than the one for 2019, indicating that a moderation will continue after 2018, although it is expected to be relatively benign. Regarding the inflation outlook, the ECB revised its 2018 forecast higher primarily due to higher oil and food prices. Draghi added that the ECB now sees inflation as ‘moderate’ in coming months versus its earlier assessment of a ‘temporary decline’ towards the turn of the year. More importantly, perhaps, was that the first estimate of inflation for 2020 was 1.7%, below that required for the ECB to hit its inflation aim. It suggests that the ECB signals limited need for tightening over its forecast horizon.
• In the euro area, the wage growth figures for Q3 are due for release on Tuesday. Wages have been increasing steadily since Q3 16 reaching 1.8% year-on-year in Q2 17. Although wage growth has increased, it is still well below the pre-crisis average (from 1996 to 2008) of around 2.4% year-on-year. Wage growth is not expected to catch up to the pre-crisis average in the near future, as inflation expectations and negotiated wages (especially in Germany) do not show an upward trend. The still-low wage growth is also one of the main drivers of expectation of low core inflation in 2018, despite the ECB arguing with its ‘super core inflation’ measure that underlying inflation pressures are building up.
• The German Ifo expectations are also due for release on Tuesday. Ifo expectations have been on the rise since 2016 and this measure of German business sentiment might not have reach its peak yet. Although ZEW expectations dropped to 17.4 in December, German PMIs released this Thursday showed another month of increases both in manufacturing and services.

China

• The US, the EU and Japan have formed an alliance to fight market distortions caused by China’s severe excess capacity, illegal subsidies and intellectual property abuses. The tree entities said they will work within the World Trade Organisation framework and with other multilateral groups to eliminate unfair competition by China and other countries. Media reports indicate Japan, fearful that the US would otherwise act alone, was the driving force in forging the common strategy.
• Chinese industrial production growth slowed slightly from 6.2% year-on-year in October to 6.1% in November, as expected by consensus. Fixed investments growth in year-to-date terms slowed as expected, but that corresponds to a rebound in the ordinary growth rate. Overall fixed investments were kept high by infrastructure projects, whereas construction (real estate investments) growth slowed another month, in a sign that the property boom is fading. Property sales growth, however, rebounded somewhat. Retail sales growth increased, though slightly less than expected, from 10.0% year-on-year to 10.2%. FDI has also picked up to 9.8% year-on-year reaffirming that China remains an attractive destinations for foreign investment.
• The latest monthly indicators coincided with several tightening measures announced by the People’s Bank of China (PBOC), which nudged the interest rates higher on various loans it charges to domestic banks. The PBOC also slightly increased the rates on its medium-term lending facility, one of several policy tools it created in recent years to monitor the country’s money supply. The PBOC’s adjustments came shortly after the US Federal Reserve raised short-term interest rates for the third time this year. Rising U.S. interest many analysts as the government’s deleveraging campaign picks up consider rates and an unexpected slowdown in China two key risks for investors in 2018.
• The cooling of the housing market will find a confirmation or a disproval with the release of property prices on Monday. A further decline in the annual house price inflation is possible as tightening measures start to bite.

Sources: MFS Investment Management, Danske Bank, Wells Fargo, HongLeong Bank.