Economic Outlook – 2 December 2018

US

• The US Federal Reserve has seemingly been on autopilot for the past two years, raising rates on a quarterly basis except in September 2017, when it announced plans to shrink the balance sheet. But minutes of the November meeting of the Federal Open Market Committee released this week indicate the Fed might switch off the cruise control after another rate hike in December. Some FOMC members expressed uncertainty over the timing of additional hikes while a few pointed to slowing global growth, the effects of trade policies and US dollar strength as downside risks. Markets have begun to price in fewer rate hikes, with only two additional hikes fully anticipated at present, well below the Fed’s current median forecast for five more. Earlier in the week markets were boosted by comments from Fed chairman Jerome Powell, who said rates are approaching a range the central bank judges to be neutral for the economy, which investors interpreted as a sign that the tightening cycle may be nearing an end in the next few quarters.
• Signals of slowing activity (which underscore the concerns raised in the Fed minutes) are most apparent among the interest-rate-sensitive housing and auto sectors, but other indicators also showing signs deceleration. Initial jobless claims have been trending up in recent weeks, rising to a six-month high in the most recent data, while capital goods orders have also turned south, suggesting business investment growth may also be easing.
• The second estimate of Q3 US GDP left headline growth unrevised at an annualised pace of 3.5%. Personal consumption was revised lower, but declines here were balanced by modest upward revisions to investment spending. The volatile trade environment also caused a larger than initially reported build in inventories, although this was offset by a greater drag from net exports.
• Solid US GDP growth underpinned strength in Q3 US corporate profits, with before tax profits rising 10.3% on a year-ago basis, which is the fastest pace since 2012. But, while domestic profits continue to exhibit the strength of the US economy, slow global growth and recent dollar strength caused foreign profits to slip USD7.7 billion in Q3.
• There are few signs of inflationary pressures. After hitting 2.0% in July, core PCE inflation fell to 1.8% in October. The recent trend is even softer, with price growth averaging just 1.2% over the past three months.
• US consumers remained confident in November. After reaching an 18-year high in October, consumer confidence fell this month, but remained at a still elevated reading of 135.7. The three-month average remained at a cycle high, and suggests current optimism will sustain strong consumer spending to end the year. Consumers’ expectations regarding rate-sensitive purchases (autos, homes and major appliances) six-months ahead have remained elevated; suggesting little evidence of higher rates weighing on consumers.
• While confidence suggests strong spending to end the year, personal income shot up 0.5% in October, with every category of income improving over the month. Personal spending rose a strong 0.6%, but the prior month’s increase was revised slightly lower.
• US benchmark West Texas Intermediate crude oil prices fell below USD50 a barrel this week despite talk of a significant production cut from OPEC plus Russia. Falling oil prices were once a tailwind for the US economy but now that the country is the world’s largest producer, falling prices cut both ways. Big swings in capital expenditures in reaction to the price of oil can impact the overall US economy. Oil production’s geographic concentration can also have a significant impact on state and local economies. The price of oil will be a focus, along with trade, at this weekend’s G20 summit, with Saudi Arabia expected to bear the brunt of any production cuts.
• The major US indexes bounced back from their second correction of the year, with the S&P 500 Index recording its best weekly gain since December 2011. The large-cap indexes and the technology-heavy Nasdaq Composite Index outperformed the smaller-cap benchmarks, and higher-valuation growth shares outpaced slower-growing value stocks for the first time in a month. Health care and information technology shares outpaced the rest of the S&P 500 Index, while materials shares performed worst. The large financials sector struggled as longer-term interest rates fell, threatening bank lending margins. Energy shares also lagged as domestic oil prices fell below USD50 per barrel for the first time in over a year.
• Investors in US markets were also encouraged by positive sales data over the Black Friday weekend. In particular, Internet sales from Wednesday through Black Friday surged by 26.4% over the same period in 2017, according to data tracked by Adobe Systems. Store traffic declined between 5.0% and 9.0% versus the year before, but the drop was smaller than many had feared.
• The economic data and Powell’s comments pushed the yield on the benchmark 10-year Treasury note to dip below the 3.0% threshold for the first time since mid-September. The investment-grade corporate bond primary calendar was active and exceeded expectations, as many issuers appeared to have been waiting for better equity conditions to bring deals to the market. While buyers also appeared to react to improved sentiment, the market struggled at times to absorb the heavy new supply.
• In the US, job reports for November are due out on Friday. Nonfarm payrolls are expected to rise around the current trend of 190,000. However, the most important part of the job reports is the average hourly earnings. It seems the tighter labour market continues to put upward pressure on wage growth. In November, average hourly earnings are expected to rise +0.3% month-on-month, which would take the annual growth rate to 3.2% rounded up.
• On Monday, ISM Manufacturing data are released. Markit PMI seems to be a better indicator for manufacturing as ISM manufacturing has been too high compared to reality over the past couple of years. ISM is expected to move lower but it has been stubbornly high for longer than expected.

UK

• The European Union signed off on the Brexit agreement with the United Kingdom and now the deal faces ratification by the British Parliament on 11 December. If lawmakers do not ratify the pact, the odds of a disorderly Brexit process will increase significantly. An analysis released last week by the Bank of England projects that in the case of an untidy Brexit, the UK economy will contract by 8.0% in the immediate aftermath. The central bank foresees a nearly 33.0% decline in house prices, a 48.0% dive in commercial real estate values and a 25.0% slump in the value of the pound.
• The debate in the House of Commons on the Brexit deal ahead of the vote on 11 December begins on Tuesday. The debate will take five days (eight hours per day) on Tuesday, Wednesday, Thursday, Monday 10 December and Tuesday 11 December. Looking at the parliamentary arithmetic, it seems unlikely the deal will pass the first time (more than 400 MPs have said or hinted they will vote against the deal) and it seems that PM Theresa May’s team is already planning to hold another vote in the House of Commons, either later in December or in January, perhaps after some new negotiations with the EU. The problem is that the EU has clearly stated that it is not possible to change much in the deal, so any changes would be minor and the question is whether this is enough for the MPs to vote in favour of the deal.British house price growth picked up slightly this month from October’s five-year low, but the future outlook remains depressed by an uncertain economy and a squeeze on household budgets, according to mortgage lender Nationwide. Annual house price growth rose to 1.9% in November from 1.6% in October, a bigger pick-up than the average forecast in a Reuters poll of economists, while monthly growth was also stronger than expected at 0.3 %.
• British consumers’ confidence fell to its lowest level in almost a year as their view of the economic outlook for the next 12 months sank to its weakest since shortly after 2016’s Brexit vote. The GfK consumer sentiment index fell to -13 in November from -10 in October, the lowest reading since December 2017 and below economists’ average forecast in a Reuters poll.
• There are no market movers in the UK this coming week.

EU

• The unemployment in the EU rate was steady at 8.1% in October, while consensus saw a decline. Hence, the unemployment rate has stayed on 8.1% for four months, and this represents the most severe slowdown on the labour market of the past four years. The number of unemployed actually rose for the first time in 15 months. The softer labour market sentiment barometers had suggested this, and point to a still stable development in the coming months. The slowdown is probably especially due to the increasing capacity constraints, while softer demand in recent quarters is likely to also having an increasing influence.
• The pan-European Stoxx Europe 600 Index was up slightly after a week filled with geopolitical tensions, as investors sorted through conflicting signals on Brexit and braced for the weekend G-20 meeting.
• In the euro area, the key release next week will be Q3 wage growth data, which is due on Friday. Already released German and Spanish figures point to further acceleration in Q3. In light of the latest disappointing PMIs and weak Q3 GDP growth, a further increase in wage growth from the 2.3% in Q2 will be welcome news for the ECB ahead.
• Following renewed optimism about a potential budget compromise last week, markets will also keep a close eye on the ECOFIN Council meeting on Tuesday, which could lead to a formal start of an excessive deficit procedure (EDP) against Italy.
• Leaders of the world’s major economies are gathering in Buenos Aires for their annual summit. However, the meeting between US president Trump and China’s president Xi Jinping on the sidelines of the event is likely to dominate news coverage. They are both trying to lay the groundwork for a ceasefire in the ongoing trade war between the two countries. Investors hope the two sides will reach enough common ground to dissuade the United States from increasing tariff rates on Chinese imports in early 2019 and adding levies on more categories of goods. It is hoped a negotiating framework will be agreed to, setting the stage for intensive negotiations. However, China’s reluctance to alter its state capitalism model could be a major stumbling block in advancing the negotiations.

China

• On Friday, China reported that its official Purchasing Managers’ Index (PMI), a gauge of manufacturing activity, fell more than forecast to its slowest growth in two years. Beneath the negative economic headlines, however, China’s economy is in better shape than it was several years ago after Beijing pushed through tangible reforms. This year, Beijing has stepped up targeted stimulus measures that should help put a floor under slowing domestic growth and cushion the economy from the effects of reduced US trade. While the recent barrage of trade-related news has hurt investor sentiment, the real impact on China’s economy and companies is expected to be less severe than originally forecasted.
• The private version of PMI manufacturing from Caixin will be released this coming week. There is a high risk that it will fall below 50 in November after dropping to 50.1 in October.

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