Economic Outlook – 18 February 2018

US

• Headline US CPI increased 0.5% in January, and registered a 2.1% year-on-year increase. While energy prices played a large role in boosting the CPI, core CPI, excluding food and energy prices, rose 0.3%, the largest gain since last January. While the year-ago gain is unchanged from December, core CPI has increased at a 2.9% three-month annualised rate. This indicates that year-ago rates should strengthen in coming months. With inflation trending upwards recently as prices firm, the Fed may continue its tightening policy and raise rates.
• Inflation is also rising on the producer side, as the US Producer Price Index (PPI) for final demand rose broadly in January, by 0.4%. Both headline and core prices rose 0.4%, with increases in goods, services and construction. On a year-on-year basis, core PPI rose 2.5%, which is the strongest since 2014. Input prices for services has been slightly stronger than for goods, but the moderate rise indicates inflation should continue firming.
• US retail sales growth came in 0.5% points lower than expected, posting a 0.3% decline in January. The primary culprits for the drop were a 1.3% decline in motor vehicle and parts dealers’ sales, a 0.4% drop in furniture stores’ sales, a 2.4% drop in building material and garden equipment sales and a 1.2% drop in health and personal care stores’ sales. It appears that there are some seasonal factors in January’s report, as retail sales have typically been weaker during Q1 since the recovery from the Great Recession. Control group sales were expected to increase a solid 0.4%, but came in flat on the month. However, the weak retail sales report combined with stronger inflation data raise some concerns.
• US industrial production (IP) also underwhelmed in January, falling 0.1% despite market expectations of a 0.2% gain. Mining is the culprit for this, falling 1.0%, though it comprises just 13.0% of Industrial Production. However, manufacturing was flat on the month, which allowed mining to drive the headline. This marks the second straight month of unchanged manufacturing output despite lofty ISM readings, which could partially be due to hurricane-related disruptions.
• US housing starts more than doubled expectations and rose 9.7% in January, following an upwardly revised 6.9% drop in December. The South led the growth in both starts and permits, increasing 21.9% and 5.4%, respectively. Starts are a historically volatile series, but the jump confirms high homebuilder confidence as improving job and wage growth, along with low for-sale inventory, means builders are selling homes just as fast as they can be built.
• US stocks carried over the momentum they had recaptured the previous Friday and recorded their best weekly gain since early 2013. The technology-heavy Nasdaq Composite performed best, helped by solid gains in the stocks of Apple and networking equipment maker Cisco Systems. Along with information technology, the financials, health care, and industrials and business services sectors also outperformed within the S&P 500 Index, while energy shares lagged despite a sharp rally in oil prices on Wednesday. Having entered correction territory, or a decline of 10.0% or more off recent peaks, the previous week, the indexes ended Friday with gains for the year to date and only 4.0% to 5.0% off their January highs.
• Buyers of investment-grade US corporate bonds also seemed to become more cautious despite strong equity performance. The midweek release of January inflation and retail sales data appeared to weigh on sentiment, in particular. However, the market retraced a portion of its losses, as light new issuance, improved risk appetite, and the relative stability in Treasury yields were supportive. High yield funds reported significant outflows, but improved equity performance and a handful of strong corporate earnings reports buoyed the market as the week progressed. Oil price weakness led to volatility among high yield energy bonds. Notably, however, bonds from riskier energy-sector issuers recovered from steep losses the previous week and outperformed higher-quality issues as investors sought to buy on the dip.
• This week, the Markit PMI service and manufacturing indices for February are due for release on Wednesday. Manufacturing PMI was confirmed at 55.5 in January, up from 55.1 in December, signalling the strongest improvement in the manufacturing sector since March 2015. Empire and Philly regional PMIs suggest ISM manufacturing, so Markit PMI should move slightly higher in February but the big gap between nationwide indices still remains puzzling.
• On Wednesday, the FOMC minutes from the January meeting are due to be released. The statement has not changed significantly but the minutes may give an overview of the different opinions within the Fed. In particular, there is interest on whether the minutes indicate if the tax reform will cause more rate hikes than the three hikes the Fed signalled in December.

Europe

• Tracking improvement in Eurozone data flow, the European Commission upgraded its growth forecasts for the Eurozone to 2.3% and 2.0% for 2018 and 2019 (previous 2.1% and 1.9%), expecting a return to solid growth despite a slight moderation from the 2.5% in 2017. Officials from the Commission said, “Europe economy has entered 2018 in robust health”, and that “unemployment and deficits continue to fall and investment is at last rising in a meaningful way”. Outlook on inflation remained subdued nonetheless, projected at 1.5% this year and 1.6% next year, still below the ECB’s 2.0% target, as subdued wage growth is expected to keep a lid on inflation. ECB also echoed the same in its monthly economic bulletin.
• European stocks ended the week higher, with most major indexes showing strength in a variety of sectors as concerns about rising interest rates and inflation apparently eased. The pan-European STOXX 600 index could not recover the steep losses it logged from the week before, but investor appetite for European shares was nevertheless robust, as the STOXX 600 rose around 3.0% for the week. Blue chip indexes, including Germany’s DAX 30 and the UK’s FTSE 100, also strengthened. Technology, banking, and natural resources shares were some of the notable out-performers.
• With corporate earnings reports in full swing, most European companies were topping earnings estimates. As of the end of the week, 54.0% of companies listed on the STOXX 600 had beaten estimates, and earnings to date had grown about 17.0% compared with the first quarter of 2017. Stripping out energy shares, earnings growth was 10.0%. Similar to the US, the strength in earnings mainly came from cyclicals and financials.
• This week in the euro area the February PMI figures are due for release on Wednesday. Manufacturing PMI saw a large fall to 59.6 in January and the leading order-inventory indicator has been declining since October 2017, pointing towards lower manufacturing output in the near future, while the extremely high optimism for the manufacturing sector is likely to be exhausted and head to lower levels. We expect manufacturing PMI to be 59.3 in February and believe that service PMI is also set for a similar decline to 57.6.
• The ECB minutes from the January meeting, when no changes were announced, will be released on Thursday. Attention should be focused on the (in hindsight) small sell-off and exchange rate volatility had at the time of the meeting; additionally, on any indications of when it could revisit forward guidance.

UK

• Stronger-than-expected short-term momentum suggests that consensus GDP estimate for 2018 might be too low and unemployment estimates for 2018 and 2019 a little high. A more hawkish Bank of England and short-term momentum lead analysts to expect a rate hike in May. However, the expectation for a hike is dependent upon the assumption that the UK and the EU are able to strike a transition deal. For this to happen it would take some serious political pragmatism on both sides, but history has shown us that this often kicks at last second.
• Focus remains on Brexit, as the important EU summit on 22^nd and 23^rd March is approaching. UK ministers are expected to follow up with speeches this week (after Boris Johnson kicked off with his speech last Wednesday). For now, the most important thing is that the UK and EU agree on transition, which we think should be relatively easy despite the tensions in the media.
• With respect to data releases, the labour market report for December on Wednesday is the most important, not least because markets are trying to assess whether the Bank of England will hike as early as May.

China

• China external trade figures surprised on the upside but this could be just a blip skewed by seasonal factors. At the local front, exports decelerated more than expected to increase only 4.7% year-on-year in December, dragged by slower growth in both manufacturing and commodity exports. Declines in intermediate and consumption goods imports added to signs of softer growth outlook ahead. Overall exports growth of close to 20.0% in 2017 will unlikely repeat itself, with single-digit growth pace expected in 2018 given a higher base effect last year, stronger currency and potentially lower CPO prices.
• Chinese stocks advanced in a holiday-shortened week, paring some of their big declines from the previous week’s global sell-off, as the country prepared for the Lunar New Year holiday. Each year, China’s economy slowly stops during the week-long holiday, the country’s most important annual ritual. Chinese mainland markets are closed from February 15 to February 21 this year, though trading was muted in the days before the holiday’s official start.
• Departing from its usual practice, the People’s Bank of China (PBOC) reportedly drained $216 billion from the country’s financial system in the weeks preceding the holiday. The PBOC’s recent austerity, following years in which the central bank routinely pumped money into markets to ensure ample liquidity for banks and investors, was seen as part of Beijing’s ongoing crackdown against excessive risk-taking fuelled by readily available money. For over a year, Chinese officials have acknowledged the dangers imposed by the country’s credit-fuelled economic growth and pledged to de-risk its financial system. Many analysts regard China’s deleveraging campaign as long overdue and necessary to forestall a severe credit crisis, which they believe poses a key risk for the global economy.
• The main focus in China this week is the house prices for January. After rising sharply in 2016, house price inflation moderated in 2017, to around 5.0% year-on-year. The expectation for this level of house price is to continue increasing in 2018. While home sales have slowed down, there are some signs that the financial tightening has started to ease a bit. In addition, there is a shortage of homes in the big cities, driving continued support for house prices.

Sources: Wells Fargo, T. Rowe Price, Handelsbanken Capital Markets, Hong Leong Bank, Danske Bank.