Economic Outlook – 18 November 2018

US

• The third quarter print of the US GDP data dominated an otherwise slow week of economic data. Real GDP topped consensus expectations and grew a solid 3.5% in Q3. The outturn represents a modest downshift from the 4.2% registered in Q2; however, the US economy continues to grow at a strong rate that is likely above the long-run potential rate.
• Consumer and government spending remained strong in Q3, while fixed investment and net exports were a drag. Real personal consumption expenditures rose 4.0%, driven in part by the boost to disposable income that was delivered by reductions in personal income tax rates earlier this year. The effects of fiscal stimulus showed up in a 3.3% jump in government spending, the strongest sequential rate of growth in more than two years. An added boost was provided by a rebuild of inventories amounting to USD 76 billion, which added 2.1 %age points to the overall GDP growth rate.
• Fixed investment spending declined 0.3% on a dip in both nonresidential structures and residential fixed investment, which fell 7.9% and 4.0%, respectively. Deteriorating affordability and higher building costs may be exerting some drag on the housing market. Business spending was stronger elsewhere, as real spending on intellectual property grew 7.9% and spending on equipment edged up 0.4%. Net exports were also another area of weakness in Q3, shaving off 1.8% from the top-line GDP growth rate, a reversal from the tariff inspired jump in exports in Q2.
• New home sales declined 5.5% to a 553,000-unit pace; new home sales have fallen for five out of the past six months. The West registered a 12% drop, while the South posted a smaller 1.5% decline. Inventories rose for the sixth consecutive months to a 7.1 months’ supply, the highest since 2011. New home prices also dropped as the median price fell 3.5% year-over-year. New home sales are up 3.4% on a year-to-date basis and are faring slightly better than existing homes sales, which are trending lower relative to their year-ago pace. However, a 0.5% rebound in September’s Pending Home Sales Index indicates that existing homes sales may improve in coming months. Pending home sales are based on signed contracts and lead existing home sales by roughly two months.
• Durable goods orders came in stronger than expected and rose 0.8% in September. Much of the gain occurred from a nearly 120% surge in defence orders. Aside from defence, orders were more modest. Transportation orders rose just 1.9%, while civilian aircraft orders dropped 17.5%. Orders for non-defence capital goods excluding aircraft fell 0.1%, the second consecutive monthly decline.
• Consumer price index (CPI) data for October showed headline inflation rise to 2.5%, mainly due to rising energy prices. Core inflation, on the other hand, edged down to 2.1% (from 2.2%). Over the past three months, core prices have risen an average of just 1.6% (annualised), suggesting little cause for alarm on the price front.
• A relatively soft inflation environment is giving support to the more dovish voices on the FOMC. In comments made last week, Chair Powell struck a balanced tone, but gave a nod to some of these more dovish elements. In particular, he noted the conditions that could lead the Federal Reserve to slow its pace of rate hikes over the next year. Slowing global economic growth, fading fiscal stimulus, and the lagged impact of past rate hikes are three factors that the Fed is monitoring.
• In a sign of how fickle commodity markets can be, the price of a barrel of West Texas Intermediate (WTI) crude oil fell to its lowest level in nearly a year a month after reaching a one-year high. WTI spiked above USD 76 in early October, pressured by supply fears ahead of the looming re-imposition of US trade sanctions on Iran. However, an increase in US shale oil inventories overwhelmed the curbs on Iranian crude, sending prices tumbling nearly USD 20 over the last 6 weeks. Oil futures declined for a record 12 consecutive days before ending that streak on Wednesday amid reports of deeper-than-expected OPEC production cuts.
• US stocks fell for the week after a downturn on Monday saw the S&P 500 Index record its worst decline in a month. The major indexes reached a low point on Wednesday but remained above recent lows established on October 29. Heavily weighted technology and Internet shares continued to perform poorly. Amazon.com shares entered a bear market on Monday, down over 20% from the all-time high they established in late August. Apple shares also fell sharply to start the week, dragged lower by news that a supplier to the extensive iPhone supply chain expected to reduce shipments to the company. Amazon’s decline weighed on the consumer discretionary sector, which performed worst within the S&P 500 Index. Materials, real estate, and industrial shares outperformed, with the latter helped by rise in 3M shares following a favourable outlook from the company for 2019. For the third-consecutive week, slower-growing value shares generally outperformed higher-valuation growth stocks.
• Equity market weakness and the decline in crude prices caused a flight to the perceived safe haven of Treasury bonds during the week, resulting in a sharp drop in yields. The municipal market saw a healthy new issuance calendar, which, combined with elevated dealer inventories and cash outflows from funds, set up the sector for lacklustre performance early on. Tobacco bonds, in particular, sold off after the FDA released a proposal intending to ban menthol cigarettes. While the overall muni market was able to stabilise later in the week, selling in tobacco bonds continues as investors digested the details of potential increases in FDA regulation.
• In the US, the Markit PMIs for November are due out on Friday, which will provide more information about the current growth momentum. Overall, manufacturing growth seems to be strong but points to a softer expansion. Manufacturing PMI is expected to stabilise around its current level of 55.7.
• This week also brings housing starts and building permit data for October. Recently, the housing market has looked a bit shaky, but numbers for September were probably influenced by the hurricane season.

UK

• Months of negotiations between the UK and the EU came to an end last week with both sides agreeing on a draft withdrawal treaty. The agreement was endorsed by prime minister Theresa May’s cabinet on Wednesday evening but hopes for the treaty’s eventual passage dimmed greatly after Dominic Raab, the man who negotiated the Brexit agreement, resigned as Brexit Secretary on Thursday. Raab said that the proposed regulatory regime for Northern Ireland presents a “very real threat to the integrity of the United Kingdom” and that he cannot support an indefinite backstop arrangement where the EU holds veto power over the UK’s ability to exit the customs union. Three other cabinet ministers also resigned and additional letters of no confidence from members of May’s Conservative Party were submitted, raising the threat that May could face an imminent leadership challenge. Against this chaotic backdrop, it is difficult seeing the treaty, which many Brexit proponents perceive as a cave to EU demands, passing parliament in its current form. An EU summit to ratify the deal has been scheduled for November 25. The UK Parliament is expected to vote in mid-December.
• British retail sales growth unexpectedly slowed to a six-month low last month, as shoppers held off winter clothing purchases due to mild weather and cut back on other goods after a heavy-spending summer. Retail sales volumes in October alone dropped by 0.5% from September, in contrast to average forecasts in a Reuters poll of economists for them to rise by 0.2%.
• British inflation unexpectedly held steady in October, according to data on Wednesday that raises the prospect that the rate could return to target faster than the Bank of England expects. Consumer prices rose at an annual pace of 2.4% in October, the joint-lowest inflation rate since March 2017, the Office for National Statistics (ONS) said.
• There are no market movers in the UK this week.

EU

• The Italian government refused to meet demands from the EU to reduce its 2019 budget deficit or risk being fined under the EU’s excessive deficit procedure. However, the government said safeguards would be taken to ensure that the deficit does not exceed 2.4% of GDP if economic growth does not meet its optimistic projections. Italy is trying to revive economic growth, blaming years of EU-imposed austerity for the country’s lack of economic progress.
• The pan-European STOXX 600 Index fell more than 2.0%, as Brexit fears and Italy’s budget standoff with the European Union (EU) continued to unsettle markets. The FTSE 100 Index lost about 1.3%, and the German DAX and French CAC 40 Indexes both finished lower. Banks were among top decliners on worries that the UK would leave the EU without a deal. The pound came under pressure, falling about 1.24% against the US dollar, and the euro dropped about 0.6% versus the greenback.
• Germany posted a 0.2% quarter-on-quarter decline, owing in part to bottlenecks caused by new auto emissions standards. A bounce back is expected in Germany as well, though the European economy has been losing momentum for much of 2018 as the pace of global trade has slowed this year. While US growth has been quite robust so far this year, concerns are mounting as to whether it can withstand a deeper global soft patch.
• In the euro area, PMIs for November are due on Friday. In October, manufacturing PMI fell for the third successive month and came in at 52.0 and services fell to 53.7 from 54.7 in September. Another decline is expected in manufacturing PMI due to the still negative order-inventory balance and forecast the November print to come in at 51.5. For Service PMI it will be interesting to see whether the weaker activity in October was of a temporary or more persistent nature. The former is more likely and hence there could be scope for a small rebound in service PMI to 54.
• ECB minutes from the 25 October meeting will be released on Thursday. During the meeting, no significant new policy guidance was announced. However, the minutes may contain colour on the upcoming crucial 13 December meeting, in terms of ending the APP and the shift to more conventional policy tool guidance.

China

• The monthly activity indicators confirmed that growth is slowing across the board in China. Most importantly, retail sales growth slowed unexpectedly from 9.2% year-on-year in September to 8.6% in October. Thus, also households seems to be holding back amid trade war fears and deteriorating growth outlook. The weaker retail sales figures were already signalled by the weak car sales figures. Growth of industrial production did improve slightly from 5.8% to 5.9% year-on-year, but less than it fell the month before. Production is buoyed rather than dampened by the trade war, but only temporarily as exports to the US are moved forward before tariffs likely are raised from 10.0% to 25.0% at year-end. The only real positive surprise in the October data was fixed asset investments, which grew more than expected in year-to-date terms. The rebound is almost entirely driven by a policy-induced jump in investments in infrastructure. Fixed investments within industry and construction slowed.
• Chinese officials have been sending conciliatory signals on trade to US negotiators in advance of a planned meeting between US president Donald Trump and China’s Xi Jinping late this month on the sidelines of the G20 conference in Buenos Ares. China is believed to be considering making concessions to the US on intellectual property protections, opening markets in some key sectors and increasing purchases of some US goods, such as soybeans. Few see a comprehensive trade agreement being stuck when the leaders meet, but there is hope that a short-term ceasefire can be achieved while negotiations over thorny issues, such as China’s subsidies to favoured industries, are hashed out.
• There are no market movers in China next week.

Sources: Wells Fargo, T. Rowe Price, Reuters, Danske Bank, MFS Investment Management, Handelsbanken Capital Market, TD Economics.