Economic Outlook – 17 September 2017

US

• Consumer prices rose 0.4% in August, the largest monthly jump since January. Leading the index was a 2.8% rise in energy costs. Prices for gasoline had already been inching higher ahead of the Harvey-related surge late in the month. Core inflation rose 0.2% in August, which was the largest monthly gain since February. On a year-over-year basis, core inflation continues to undershoot the Fed’s 2.0% inflation target. Ex-food and energy, prices were up just 1.7% over the past 12 months. Following the firming in August, however, the recent trend looks stronger; over the past three months, the core index has risen at a 1.9% annualised pace.
• FOMC members have continued to telegraph that they are set to announce the start of balance sheet normalisation at next week’s meeting. The inflation data is unlikely to get in the way of that plan. What is likely to be affected, however, is the Fed’s Summary of Economic Projections. There will be three more readings on CPI and PCE inflation before the FOMC’s December meeting, but the soft patch hit in prior months is likely to lead to lower estimates of year-end core inflation, which may push out the members’ projections for the timing of the next rate hike.
• Headline retail sales dropped 0.2%, with auto sales trimming 0.3 percentage points from top-line growth. The decline in auto sales more than offset the boost from the 2.5% rise at gas stations. The surge in gasoline sales was largely expected, due to stocking up in storm-affected areas. Moreover, the 0.5% decline in building material sales on the month, suggests most of that spending took place in September – this category will likely see a boost in September as Houston and the state of Florida rebuild and recover from the storm.
• Industrial production data was also off sharply in August, declining 0.9%. Manufacturing production, which includes petroleum refining and petrochemical production in and around Houston, declined 0.3% in August, following a flat reading in July. Utilities posted the steepest drop, contracting 5.5%. Mild temperatures across the US led to lower usage of air conditioning. The weaker than expected data appears to be largely accounted for Harvey-related effects which are likely transitory in nature. The Empire State Manufacturing index for September, a regional purchasing managers’ index, suggests that beyond the recent weather-related industrial disruptions, factory activity remains strong.
• After a long period of stagnant income growth following the 2008 financial crisis, US median household income sustained strong growth for the second consecutive year, rising to 59039, a 3.2% more than a year earlier, after adjusting for inflation. Income rose across all ages, ethnicities and geographical areas. Simultaneously, poverty levels fell to 12.7%, the lowest level since 2007.
• In a preliminary analysis, Moody Analytics estimates that damage caused by hurricanes Irma and Harvey could cost between $150 billion and $200 billion to repair, but these figures are expected to change as more information is gathered. The economy could suffer an additional $20 billion to $30 billion in lost economic output from the two storms. As a result, Moody’s expects US GDP to decline a half point to 2.5% for the third quarter but added that it expects fourth-quarter GDP to rally, depending on rebuilding efforts.
• Despite a barrage of headlines on the subject, the scope and timing of any tax reform remains unclear. At a Politico event on Thursday, US secretary of the treasury Secretary Mnuchin said that a widely anticipated blueprint on taxes due from the “Big Six” group of senators late this month will propose a specific corporate tax rate and discuss in detail the deductibility of corporate interest. He also said reports suggesting that negotiators are far apart are untrue. Reuters reported that Senator Orrin Hatch (R-Utah) said the Big Six will not dictate the direction that the Senate Finance Committee takes on tax reform. Reports noted that some Republicans viewed this comment as one that will widen rifts among Republicans in the Senate, House and White House and could jeopardise reform.
• In the US, the most important event next week is the FOMC meeting ending on Wednesday. No relevant change to the Fed funds target range, but instead expect the Fed to announce it will begin reducing its balance sheet (“quantitative tightening”) in October. Most details about how the Fed wants to do this are now public hence the announcement itself is not expected to have a major impact on markets, although some details about what level of the balance sheet the Fed targets in the long term are still unknown. With respect to the ‘dots’, the signal is likely to remain unchanged at one more hike this year and three next year. No major changes to the statement are expected despite low inflation, as the statement already says the Fed is monitoring inflation “closely”.
• On Thursday, the Fed Philly index for September will be released, which will give us the first signal about what to expect of the overall index. The extremely large gap between ISM manufacturing and Markit PMI manufacturing (58.8 vs 52.8) is puzzling us and perhaps the ‘truth’ is somewhere in between. The ISM is probably a bit too high, but the Markit figure is probably a bit too low, and hence the Philly index is likely to fall somewhat whereas the Markit manufacturing PMI to increase is due to increase. However, the numbers may be somewhat affected by the recent hurricanes, although it remains our base case that any impact should be short-lived. This has at least been the experience with some of the previous big hurricanes when looking at initial jobless claims, which shoot higher temporarily before falling again to the old trend.

China

• China data dump disappointed across the board, aggravating concerns over steeper growth slowdown. Retail sales and industrial production surprisingly moderated to 10.1% and 6.0% year-on-year in August while fixed asset investment decelerated more than expected to 7.8% year-on-year, its slowest in nearly 18 years. The latest prints implied softer outlook at both the consumption and investment front and coupled with easier exports gain released earlier, implied the slowdown in the China economy in the second half of this year is rather broad-based.
• The yuan strengthened 6.7% against the US dollar this year, recovering all of last year’s decline of 6.6%. However, the surge is causing a drag on China’s export growth and threatening to deplete profits for many manufacturers selling in foreign markets. In response to this, the People’s Bank of China has removed a deposit requirement for currency forward trades. This will make it less expensive for companies and investors to buy dollars while selling the yuan. In conjunction with this, the central bank removed the reserve requirement on foreign banks’ yuan deposits last week, which will potentially make it easier for foreign investors to bet against the currency. By the end of the month, China is also expected to phase out measures to limit its outbound investment and will instead put in place formal guidelines issued by its State Council in August that encourage foreign deals in areas such as technology.
• This week China releases house price inflation. While the annual price increase is still close to 10.0% there are tentative signs that the monthly increases are starting to slow down again. Judging from medium and long-term lending by households and home sales data, the cooling of the housing market is finally starting to kick in. This points to a further moderation in price increases. The sharp rise in prices is a problem for the government as it has fuelled speculative investments and made housing less affordable for medium income households. Hence several measures to take the froth out of the housing market have been taken over the past year.

UK

• As expected, the monetary policy committee (MPC) of the Bank of England (BoE) kept the policy rate unchanged at 0.25%. The QE programme was also left unchanged. The vote to keep the bank rate unchanged was 7 to 2. There were some warnings that the number of dissidents might increase to three. However, the tone in the press release and also in the minutes from the monetary policy meeting was clearly more hawkish than expected. The economic picture since the August meeting was not much changed, in the view of the MPC, but it was noted that, if anything, the picture was slightly stronger than anticipated. GDP developments seemed to be in line with expectations, but the labour market had been stronger and survey indicators were consistent with continued strength in employment growth. The MPC noted that the latest indicators were consistent with UK demand growing a little in excess of potential supply growth, and that there was now probably a fairly limited degree of spare capacity. The MPC also noted that underlying pay growth had shown some signs of recovery, albeit remaining modest. Headline and core CPI inflation in August were slightly higher than anticipated, and CPI is now expected to rise to above 3.0% in October.
• This week the most interesting economic release is retail sales for August due out on Wednesday. Retail sales is very volatile on a monthly basis and is a weak indicator of private consumption (accounts for less than 6.0% of GDP, according to ONS) but still markets move when retail sales surprise to either the up or downside. For what it is worth, it would be important to look for signs of whether private consumption growth remains weak due to the negative real wage growth and lower consumer confidence.
• On the political front, PM Theresa May gives a speech on Brexit in Florence on Friday. The key points of her speech are unknown what she will talk about but according to press reports (Financial Times) she will touch upon a transitional deal after the UK formally leaves the EU at the end of March 2019. Hopefully her speech will clear the air, as tensions between the EU and the UK have increased in recent weeks.

EU

• According to ECB calculations, European banks have significantly reduced their debt securities outstanding due within 3 years over the past decade. While their share still stood at 50.0% of total debt securities outstanding in 2008, it accounted for 40.0% in august 2017. The major factors behind this change are the new regulatory context and the interest rate environment. The Liquidity Coverage Ratio (60.0%), which came into force in October 2015 and will be gradually increased until January 2018 (100%), pushes banks to lower their net cash outflows by lengthening the residual maturity of their debt. Moreover, unsecured debt securities with a residual maturity over 1 year are eligible liabilities for banks loss absorption capacity (MREL for all EU banks since 2016 and TLAC for GSIBs, which will be introduced by an amendment to the MREL in the EU, from 2019). Banks also take advantage of the weakness of interest rates amplified by the ECB unconventional measures.
• On Tuesday the German ZEW expectations will be published. In August, the figure dropped from 17.5 in July to 10.0, which is the biggest drop since the drop in the July print following Brexit. The decline has been attributed to the weaker exports and the growing scandal in Germany’s automobile sector. Together with the appreciating euro’s pressure on exports this could cause economic sentiment to deteriorate. However, both business expectations and German PMIs increased in August, signalling still increasing optimism on the part of business. Overall, the ZEW expectations re expected to show a small decline to 9.5.
• On Friday, the PMI figures will be released. Euro area manufacturing PMI has been increasing steadily since September 2016, with only a bump down in July, from which it recovered in August when the figure was 57.4. Activity is strong, but the appreciation of the euro is bound to drag on export orders eventually. Manufacturing PMI is likely to remain strong, but moderate slightly to 57.2 in September. Service PMI has seen a declining trend since April 2017, although still in expanding territory. In August, both business activity and new orders reported their weakest figures since January. The new orders indicate further declines to come, and service PMI is expected to land at 54.2 in September.

Sources: Wells Fargo, MFS Investment Management, HongLeong Bank, Handelsbanken, TD Economics, BNP Paribas