Economic Outlook – 18 March 2018

US

• Retail sales edged down 0.1% in February, with broad-based declines in a number of categories. Excluding auto sales, total sales rose 0.2%. The closely watched control group, which feeds into the calculation for GDP, rose a modest 0.1% for the month following a flat reading in January. Much like the business investment sector, a stark divergence has emerged between the “soft” consumer confidence data and the “hard” consumer spending data.
• Inflation readings in February continued to support a faster pace of price increases this year. Both the headline and core CPI index rose 0.2% for the month, taking the headline reading to 2.2% on a year-over-year basis. Producer prices rose 0.2%, or 2.8% on a year-over-year basis. Import prices surprised to the upside, posting a 0.4% increase for the month. Non-fuel import prices rose at an impressive 0.5% rate, marking the largest monthly gain since 2011. Leading up to the March announcement of steel and aluminium tariffs, import prices for both metals were already up by double digits this past year.
• Housing starts fell 7.0% in February to a 1.24 million-unit pace. Single family starts rose 2.9% to a 902,000-unit pace, while the more volatile multi-family starts declined 26.1% to a 334,000-unit pace. Housing starts are typically quite volatile in the first quarter.
• Industrial production bounced back in February, rising 1.1% in the wake of January’s 0.3% decline. Utilities output declined 4.7% after rising 1.3% in January. Manufacturing output rose 1.2% on the month after a downwardly revised 0.2% decline in January. Capacity utilisation rose for the month but remains below its historical average, implying that more capacity can be brought online, reducing the need for further business fixed investment.
• Estimates ranging between $30 billion and $60 billion in retaliatory tariffs were floated in the press this week as the Trump administration takes took aim at the Chinese expropriation of US intellectual property. The tariffs could be imposed in the very near future as a follow-up to a months-long investigation into China’s trade practices. The administration is said to be targeting Chinese technology and telecommunications companies in retaliation for China forcing US companies to transfer intellectual property to China in exchange for access to China’s vast market. Elsewhere on the trade front, the United States imposed tariffs of up to 22.0% on certain types of paper imported from Canada.
• Confidence among US corporate CEOs, small business owners and consumers continues to rise. The Business Roundtable CEO Optimism survey hit a 15-year high this week, while the National Federation of Independent Business’ Small Business Optimism measure hit a 34-year high. Finally, the University of Michigan Consumer Sentiment Index hit its highest level since 2001. Of the three, the surge in CEO confidence may be the most notable, given that upbeat CEOs are more likely to approve large investments in capital expenditures. Rising capital expenditure tends to eventually filter into increased productivity and, ultimately, higher wages.
• Former Wall Street economist and television personality Lawrence Kudlow, a longtime free-trade advocate, was named this week to replace Gary Cohn as director of the National Economic Council. An early Trump supporter, Kudlow is expected to be a moderating force against the president’s protectionist instincts. The appointment is notable in that Trump did not name Peter Navarro, his pro-tariff trade advisor, to the post, perhaps to mollify Wall Street. Also this week, President Trump replaced embattled secretary of state Rex Tillerson with CIA director Mike Pompeo. In making the move, Trump noted the differing approaches taken by himself and Tillerson to the Iran nuclear deal.
• Stocks fell modestly for the week after a Friday rally broke a four-day losing streak for the Standard & Poor’s 500 Index and partially compensated for earlier losses. Small- and mid-caps outperformed larger shares. Within the S&P 500, utilities and real estate shares fared best, helped by a decline in longer-term Treasury yields, which make their healthy dividend payments more attractive in comparison. Conversely, the much larger financials sector, which sees lending margins squeezed by lower interest rates, was among the market’s weaker segments. Materials shares also performed poorly. Friday was a so-called “quadruple witching day,” one of four days in the year in which four types of options and futures contracts expire simultaneously, typically resulting in heightened volatility and trading volumes.
• The subdued growth and inflation data led to a modest decrease in the yield on the 10-year Treasury note, which bottomed on Wednesday morning before rising again later in the week. (Bond prices and yields move in opposite directions.) Municipal bonds underperformed, although light new muni issuance continues to be met with steady demand. Investors seem to be looking for riskier, higher-yielding investments given the uncertainty surrounding interest rates and with tax season on the horizon.
• In the US, this week brings the FOMC meeting, the first with Jerome Powell as Chair. The Fed is expected to increase its target range by 25bp to 1.5% to 1.75%, as the economy is strong. Among other things, Powell’s testimony from February points to a continuation of the gradual hiking cycle, as he expects inflation to increase and stabilise at 2.0%, so he does not view the economy fundamentally differently from Janet Yellen. As everyone expects a hike, the updated ‘dots’ are more important and the Fed is expected to maintain the three hikes signal for this year but show more confidence in the signal, as more of the dovish members now seem to support this.
• On Thursday, Markit PMIs are due for release. In January, the manufacturing PMI fell from 55.5 down to 55.3 but despite this slight downfall, the level of the PMI numbers is still the highest since March 2015. There are signs suggesting the phase with increasing growth in the manufacturing sector is over but manufacturing PMI is expected to stabilise at a high level. Optimism remains high as consumer confidence rose further in February.

Europe

• Investors had expected strong economic growth to lift Eurozone inflation closer to the European Central Bank’s target near 2.0% over the course of 2018, but in recent months, the opposite has taken place. Consumer price gains were revised lower to just 1.1% year over year in February. The slowing inflation rate could call into question market anticipation that the ECB will end its quantitative easing program late this year. Early this week, ECB president Mario Draghi said, “We still need to see further evidence that inflation dynamics are moving in the right direction. So monetary policy will remain patient, persistent and prudent”.
• The Eurozone observed the biggest fall in its industrial production in more than a year at 0.1% month-on-month in Jan-18 as energy production dwindled whereas both durable consumer goods and intermediate goods abated as well.
• European equities ended the week mixed amid relatively low trading volumes, disappointing inflation numbers for the Eurozone, and political uncertainty about the prospects of a trade war and other geopolitical tensions. At the start of the week, the pan-European benchmark STOXX 600 gained ground following the strong US jobs report the week before. Germany’s DAX 30, Spain’s IBEX 35, and France’s CAC 40 all trended higher in what T. Rowe Price traders coined a “Goldilocks” environment in which trade concerns had calmed, oil prices were steady, and volatile bond yields and interest rate uncertainty were no longer forefront topics. By midweek, investor sentiment turned more negative.
• In the euro area, the PMI figures for March are due for release on Thursday. For two consecutive months, there has been a manufacturing PMI decline. After peaking at 60.6 in December 2017, it declined to 58.6 in February. A further decline is expected to 57.6 in March. The leading order-inventory indicator has been moving into negative territory, while the 2017-euro appreciation is expected to drag on the high manufacturing PMI. Overall, manufacturing PMI is likely to remain at a high level despite its decline.

UK

• Philip Hammond delivered his first Spring Statement following his decision to move the Budget to the autumn and abandon having two main fiscal events each year. No tax or spending changes were expected this time. The focus was on updated estimates on the UK economy from the Office for Budget Responsibility (OBR), and whether or not the revision left more room for manoeuvre. However, the estimates from the OBR were hardly changed, and, if anything, to the downside. While the GDP growth estimate for this year was lifted by 0.1 percentage points (p.p.) to 1.5%, growth estimates for 2019 and 2020 were left unchanged at 1.3% for both years and for 2021 and 2022. GDP growth estimates were taken down by 0.1 p.p. to 1.4% and 1.5% respectively. According to the OBR, the upward revision to GDP growth in 2018 is entirely due to a stronger-than-expected global economy. In 2019-20 a stronger contribution from net trade is fully offset by expected weaker domestic demand, which again is caused by higher interest rates. GDP growth in 2021 and 2022 is expected to be lower than in November as the near-term cyclical boost to growth from stronger global activity fades and as higher interest rates continue to weigh on private consumption growth.
• UK stocks dipped following a report by the Organisation for Economic Cooperation and Development (OECD) that forecast Britain would miss out on buoyant global economic growth over the next two years and grow more slowly than the other Group of Twenty leading economies. Slowing consumer demand and rising inflation were acting as key weights to growth in the UK, the OECD said.
• The most important event this week is the EU summit on Thursday and Friday, when the ambition is to formalise the transition deal, with the EU leaders expected to approve the EU’s guidelines for the framework of the future relationship. Based on recent news stories, it seems like an agreement on transition is just around the corner, as only a few issues remain outstanding.
• The Bank of England (BoE) is due to hold one of its smaller meetings on Thursday without updated projections or a press conference. Any major shifts in policy signals are unlikely, as the BoE has said it will not pre-commit to a hike this time around. The BoE is also expected to hike in May but will look out for CPI inflation and the labour market report due out during the week.

China

• Monthly activity indicators for China were stronger than expected for the beginning of the year. As usual, January and February data are combined. Industrial production grew by 7.2% year-on-year in January-February, up from 6.2% year-on-year in December. This strong performance despite the authorities’ effort to fight air pollution, which dampens industrial output, was likely mainly driven by strong global demand, as exports also grew strongly in January-February. Fixed investment growth also picked up more than expected to 7.9% year-on-year, with the pickup being broad-based as infrastructure, property and industrial investment growth all improved. Retail sales growth accelerated from 9.4% year-on-year in December to 9.7% year-on-year in January-February, only slightly below expectations.
• China announced that it would merge its banking and insurance regulators, a long-awaited move that aims to tighten control of the country’s financial sector and curb the risks that have accompanied years of rapid credit growth. Under a proposal released at the country’s annual legislative meeting, Beijing plans to merge the China Banking Regulatory Commission and the China Insurance Regulatory Commission. The People’s Bank of China (PBOC), the central bank, will gain new powers to draft financial sector regulations, in addition to determining monetary policy. Combining the nation’s banking and insurance watchdogs marks China’s biggest financial industry overhaul in over a decade. The shake-up comes as Chinese officials are seeking to deleverage the corporate sector and decrease riskier lending practices. It also follows a Communist Party congress last October that cemented the authority of President Xi Jinping, who has made containing financial risks a priority as part of a goal to put China on a more sustainable growth path. Earlier in March, China’s party-controlled legislature voted to abolish term limits on the presidency, a move that effectively allows Xi to rule indefinitely.
• The main number of interest in China next week is house prices. An unchanged pace of house price increases around 5.0% year-on-year is very likely. The housing market has cooled down over the past year in response to tightening measures.

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