Economic Outlook – 18 June 2017

US

• The FOMC raised its short-term target rate 25 basis points at its June meeting to 1.25%, and published an addendum to lay the foundation for normalising the Fed’s balance sheet, with the caveat economic activity “evolves broadly as anticipated.” It is that anticipation that is causing the latest divergence in views between the Fed and financial markets on current and future economic conditions and whether the outlook substantiates an additional rate hike this year, and the start of the balance sheet reduction program, especially given the recent weakening trend in inflation.
• The May Consumer Price Index (CPI) was released on the morning of the FOMC meeting with headline and core prices coming in weaker than expected. On the back of weak energy prices, headline CPI slipped 0.1% from the month before, pulling the year-over-year reading down to 1.9%. Core CPI, which excludes food and energy, rose just 0.1% month-over-month, with the three-month annualised rate coming in flat during the month further underscoring the softening trend.
• The headline print for industrial production was unchanged in May but manufacturing output fell during the month. The pulse on the consumer also showed monthly growth with the headline slipping 0.3% in May. A silver lining in the report was the so-called control group, which feeds directly into the calculation of real GDP, being revised up sharply, highlighting the overall positive trend in spending.
• US manufacturing data indicated patchy but resilient expansion in the economy as empire manufacturing index and Philadelphia fed outlook index sustained at healthy level. In addition, small business optimism was broadly positive while NAHB housing market index hovered around a ten year high as firm labor market and low interest rate kept demand supported.
• Housing starts fell 5.5% in May to a 1.09 million-unit pace with single-family and multifamily tumbling during the month. Multifamily starts registered its fifth straight monthly decline underscoring the shift to single-family construction. This trend is also evident in apartment operating fundamentals where the occupancy rate peaked in mid-2014 and asking rent growth is moderating. Permits, which are less sensitive to weather fluctuations, also came in below expectations, falling 4.9%.
• The Trump administration announced a revised Cuba policy on Friday that will tighten rules on Americans traveling to Cuba and restrict US companies from doing business with entities controlled by the Cuban military. Exceptions will be made for US air carriers and cruise lines.
• Markit PMI manufacturing and service for June will be released on Friday. Manufacturing PMI has cooled off since it peaked at 55 in January. The current level of manufacturing PMI points to GDP growth around 1.6% and even though this does not sound impressive, and this level is representative of the underlying economic strength. Thus, no significant changes to the PMI manufacturing are expected. PMI service is expected to have increased to 54.2, thus supporting the view that the moderate growth will primarily be driven by the service sector.
• The coming week is heavy on speeches by FOMC members. Comments about what drove the decision about the June rate hike will be of interest, and for further details on quantitative tightening. Of particular importance is the speech by Evans (voter, dovish) on Tuesday since he may be one of the four FOMC members who expects no further hikes this year.

China

• China’s consumer prices advanced to a four-month high of 1.5% year-on-year in May (April: +1.2% year-on-year). The increase was largely driven by the rise in cost of housing and healthcare expenses. In addition, PPI surged 5.5% year-on-year last month (April: +6.4% year-on-year) due to diminishing impact from the recovery in commodity prices. China’s industrial production sustained a 6.5% increase in May as factories continued to drive growth going into the second quarter of the year. Household continued to splurge as retail sales advanced 10.7% year-on-year to 2.946 trillion yuan last month, offsetting downside risks from the slowdown in fixed assets investment in the first five months of the year (+8.9% vs +8.6%).
• The International Monetary Fund raised its gross domestic product forecast for China to 6.7% in 2017, up from its prior 6.6% projection, the second time the fund has boosted its outlook. China should embrace reform while growth is strong, the IMF said, since buffers are sufficient to ease the transition and to avoid sharp adjustments down the road.
• The main release in China next week is property prices. Despite a decent amount of tightening, China has struggled to cool the rise in house prices and in recent months the monthly increases have actually moved higher again. This is a key reason why China has continued to tighten towards the housing market. The recent increase in rates and yields is likely to feed into a slowdown in housing for the rest of the year, leading to a moderation in house price inflation.

UK

• As expected, the Monetary Policy Board (MPC) of the Bank of England (BoE) kept monetary policy unchanged. However, the vote to keep the policy rate unchanged was 5-3, a closer call than the previous time, when the vote was 7-1. The three members who voted against the decision to keep the interest rate unchanged wanted to raise the Bank Rate. The vote to keep the asset purchase programme unchanged was unanimous.
• CPI rose to a four year high of 2.9% year-on-year in May amid a weak Sterling, increasing speculation that a rate hike might happen sooner rather than later despite downside risks on Brexit negotiation on GDP growth.
• Credit rating agency Moody’s Investors Service warned this week that the minority government resulting from the recent snap election in the United Kingdom further complicates Brexit negotiations with the European Union. The latest political developments are a credit negative, and the government will likely be forced to put fiscal deficit cuts on hold, the agency said.
• There are no important data releases next week but focus remains on the political situation with the Queen’s Speech (which outlines the government’s legislative agenda for the coming parliamentary session) taking place on Wednesday 21 June (despite Theresa May not having agreed on a deal with the Democratic Unionist Party yet) and Brexit negotiations starting on Monday.

EU

• French president Emmanuel Macron’s Republic on the Move party is set to secure a significant majority in the National Assembly, based on voting in the first round of the two-round process. His party is projected to win as many as 450 of the 577 seats in France’s lower house, potentially giving him the ability to push through needed, but previously unpopular, reforms. The final round of voting takes place on Sunday, 18 June.
• According to recent barometers, GDP growth in the euro zone will likely accelerate further in the second quarter of this year. In the first quarter, growth out-performed several global peers, such as the UK and the US. The euro zone recovery has been remarkably sustainable over the past two years, albeit modest. So far, the recovery phase has been driven mainly by private consumption, although recently, investment spending has risen markedly.
• The consumer confidence is due for release on Thursday. Consumer confidence rose from -3.6 in April to -3.3 in May, which is its highest level since 2007. Consumer confidence is likely to increase further as employment continues to be a tailwind and uncertainty over a euro-breakup is fading with the outcome of the French election.
• On Friday, the PMI figures will be released. The manufacturing PMI rose from 56.7 in April to 57.0 in May while the service PMI declined from 56.4 in April to 56.3 in May, leaving composite PMI unchanged. Seemingly, the weak manufacturing PMIs observed in recent months in the US and China did not drag euro-area PMIs down in May, but could still weigh on the June figures. PMIs are expected to remain somewhat unchanged in June, as activity in the euro area is still strong, although risks seem tilted to the downside. The new orders is currently at a six-year high and the order-inventory balance, which is usually a good leading indicator, has started to diverge and could drag manufacturing PMI down in June.

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