US
The Federal Reserve maintained its stance on monetary policy at its October Federal Open Market Committee (FOMC) meeting, holding its short-term target rate steady. The meeting was largely a non-event; however, language in the statement was adjusted to show less concern about the impact of global developments and financial markets on the overall economy than were expressed in the September FOMC statement. Despite downgrading its assessment of current economic conditions, the Fed appeared to leave the door open to a hike in the funds rate in December.
During the week, a read of economic activity in the third quarter became available. The advance report showed that real GDP growth slowed to a 1.5% annual pace. At first glance, the pullback in activity is disconcerting, especially given that the Federal Reserve will likely carefully weigh every data point until the December FOMC meeting. Much of the slower pace in real GDP growth was due to a sharp slowdown in inventory accumulation. Inventories shaved an eye-popping 1.44 percentage points from the headline, which is the largest drag since late 2012.
In the coming quarters, inventories are expected to have negligible effects on real GDP growth. The details of the report, however, are a little more encouraging. Moreover, before the December FOMC meeting, the Fed should have ample opportunity to assess economic data and communicate its thinking on monetary policy.
Real private sales to domestic purchasers, which excludes government spending, inventories and trade, rose to a 3.2% pace in the third quarter following a 3.9% increase in the second quarter. This measure is a better gauge of the underlying momentum in the U.S. economy. Other components of the report that were more sanguine were consumer spending, business fixed investment, residential and government purchases. Consumer spending continues to be a key driver of U.S. economic activity, with improvement seen in both durable and nondurable goods.
Also registering a disappointing reading during the week, new home sales came in much lower-than-expected. New construction sales fell a sharp 11.5% in September to a 468,000-unit pace, which marked the lowest level since November 2014. Although the monthly data look disappointing, weakness in sales for newly-constructed units appear to be out of step with other housing data. Housing starts and builder sentiment both continue to paint a picture of an improving housing market. Moreover, mortgage applications for the purchase of a home and household formations are both trending higher. Labor market conditions and household formations are both improving and should boost demand for new homes.
Still reeling from a stronger dollar and low commodity prices, durable goods orders were also lackluster during the month, falling 1.2% in September. That said, there may be brighter days ahead as the pace of dollar appreciation slows and commodity prices find a bottom. For the factory sector, the worst may well be behind.
Looking at consumption, a common lament among economy watchers is that households have not been spending the proceeds of the oil-price-driven surge in real incomes. Unfortunately, the missing oil effect is a myth: consumption has responded to the drop in oil prices much as expected. Households’ real disposable incomes (aggregate incomes adjusted for inflation and changes to taxes and transfers) have increased by 3.6% since July 2014 when oil prices began to drop, while real spending has increased by 3.8%.
As a consequence, the personal saving rate, at 4.6%, is slightly lower than it was in July last year and is only 0.3 percentage points above its post-crisis trough. The benefits of lower oil prices are also reflected in the composition of spending. Light vehicle sales have jumped 10% since the peak in gasoline prices; vehicle miles travelled have been growing at the strongest pace since the early 2000s, while core retail sales are up by more than 4% in real terms.
If real consumption growth has closely tracked real income growth where does the myth of the missing oil effect come from? The story first gained traction when the personal saving rate surged between November and February, as consumption growth was sluggish despite the plunge in oil prices during that period. In hindsight, the missing consumption was simply a timing issue. Much of the US experienced an unusually bad winter. It is also common for consumers to wait until they are sure that lower oil prices will be sustained before committing to large purchases. The episode serves as an example of why it is wise not to put too much weight on short-term data fluctuations and rely more on longer-run trends, as well as the lessons from past experiences.
However, it is not all peaches and cream on the consumer front. When the gaze is shifted from the rear-view mirror and look ahead, real consumption growth will probably slow over the next year. Unless oil prices drop further and the dollar appreciates significantly, headline consumer price inflation is likely to pick-up to between 1.5% and 2% by the end of 2016. If the current rate of nominal disposable income growth is maintained, real income growth will slow to a little less than 2% over the same period.
That implies that if the current personal saving rate remains unchanged, then the expansion in real consumption will also slow significantly, bringing GDP growth down with it. Two things could change this dismal equation. One would be the re-ignition of the dormant wealth effect, which would allow personal spending to grow more quickly than disposable incomes. Unfortunately, that seems unlikely, leaving hopes of continued strong consumption increases resting on an acceleration in nominal labour income growth.
Stronger labour income gains could come from two channels: a pick-up in the growth rate of the number of hours worked in the economy and faster nominal wage increases. The first is improbable given that employment growth appears to have peaked for the current cycle. That leaves wages to take up the slack. Wage growth has been sluggish because spare capacity in the labour market has not yet been fully eroded and because of the turgid pace of productivity expansion.
In theory, wage and productivity growth should begin to rise when the economy reaches full employment sometime next year and firms substitute increasingly scarce labour for cheaper capital. The ability of the economy to keep growing at an above-trend pace over the next few years rests on that also being true in practice.
EU
The fact that QE works through the signal effect was confirmed once again after the ECB press conference a little over a week ago. Speculation about further monetary policy measures at the upcoming ECB Council meeting in early December drove the euro and yields down and share prices as well as market-based inflation expectations up. However, such effects apparently fizzle out after a few months at the latest, as experience gained with the bond purchases underway since March 2015 shows.
Over the longer term, in contrast, the so-called “portfolio rebalancing” channel takes effect according to the ECB, i.e. banks shall use the additional liquidity especially for granting more loans. But last week’s Bank Lending Survey shows that also in this regard the track record of the first six months of bond purchases is sobering. Apparently, lending has hardly been boosted.
According to the commercial banks’ responses, the first obstacle was that despite the broad based purchases of euro central banks about half of the commercial banks had no additional
ECB liquidity, because they either sold no bonds to the central banks and/ or did not receive additional liquidity indirectly via rising deposits of the private sector at the bank. And as for the other half of the banks, which at least had additional ECB liquidity at their disposal, only a minority used the funds for lending. On balance, roughly 85% of the banks said that QE has not increased lending, and practically no bank saw a “considerable” effect of QE. Liquidity is obviously no key factor that limits lending.
For Germany, the only country that released national results, the outcome was even more extreme. Only three banks stated that they had received ECB liquidity from bond sales. And these three banks emphasised that they had not used the liquidity at all, i.e. neither for granting loans nor for other purposes (asset purchases, refinancing).
If the ECB draws the conclusion that QE works primarily via the signal effect, this suggest that the central bank will try to surprise the market with striking steps, i.e. it will not only extend the purchase programme as widely expected but also increase the monthly purchase volume noticeably
Looking at some interesting KPIs, annual CPI inflation increased to 0.0% in October from previously -0.1%. The increase was expected as the negative annual base effect from the oil price one year ago subsided. But the increase in CPI proved broadly based, as Core CPI unexpectedly increased to 0.9% year-on-year (y/y) from the previous 0.8%. Inflation for both non-energy industrial goods and services correspondingly rose a notch. The October increase was hinted at by yesterday’s increases in Germany, Spain and Belgium.
Looking ahead, the base effect on headline inflation will kick in even stronger in the coming three months, taking the inflation rate comfortably above zero. Sluggish wage growth should still act to limit core inflation, however.
At the same time, the unemployment rate surprised on the downside by reaching 10.8% in September compared to an expected 11.0%. The August rate was revised down to 10.9%.
Across countries, the decrease was widespread, but with the greatest decline in Spain over the past two months while France increased slightly. Looking at the EC unemployment expectations, the trend is still sloping downward.
There has been plenty of belt-tightening going on across the Eurozone since the financial crisis. Retail sales volumes fell by 8% from their peak in early 2008 to trough at the end of 2012, as the double-dip recession took its toll on spending. Households trimmed spending most aggressively on clothing (-9%) and audio visual equipment (-13%) over this period, although even the more typically stable food sales fell by a full 6%.
However, consumers have started to make up for lost time since the recovery began in earnest in 2013. Sales have now risen almost 5% from their trough and are currently up 2.1% year-on-year (y/y) according to August data. Higher spending has not only been seen in the retail sector. New vehicle registrations for the region as a whole are up more than 10% y/y according to September data. This upturn in spending has not been driven by changes in saving behaviour.
The household savings rate for the currency union has remained broadly stable during the early stages of recovery. Instead, it has been increases in real disposable incomes that have helped to support purchasing power. The Eurozone has created more than two million jobs since it swung out of recession in 2013 and the purchasing power of these wages has been boosted by extremely low inflation.
UK
In the UK, the main event is the November meeting of the BoE’s Monetary Policy Committee (MPC). The MPC is expected to keep the Bank Rate and the stock of purchased assets unchanged at 0.50% and GBP375 billion, respectively. Another 8 to 1 vote is possible and this will keep the Bank Rate unchanged against increasing it immediately. That said, it is more likely that the vote will be 7 to 2 than 9 to 0 as both Martin Weale and Kristin Forbes are leaning towards a hike.
The minutes will acknowledge that domestically generated inflation pressure is increasing as higher nominal wage growth is due to a tighter labour market and not increasing productivity growth. Both GDP growth and employment growth were 0.5% quarter-on-quarter (q/q) in Q3, suggesting that productivity growth was flat. The BoE will also publish a new Inflation Report in connection with the policy announcement and the minutes.
The BoE will revise down its projections for GDP, inflation and unemployment, at least in the short term. Growth in Q3 was below the BoE’s expectation of 0.6% q/q. In the minutes from the October meeting it was stated that inflation would likely stay below 1% until spring due to the lower oil price. Unemployment has declined by more than anticipated in the latest Inflation Report. Note that Bank Staff will assess the pass-through from the exchange rate to inflation through import prices.
According to the BoE, import prices have declined by less than suggested by the appreciation of GBP. This assessment has the potential to be a very important part of the Inflation Report since the BoE has expressed concerns from time to time about the strong GBP.
Looking back, the past week started off with a set of sentiment numbers from the Confederation of British Industry that came out clearly weaker than expected. New export orders fell at the fastest pace in three years, probably on the back of the pound’s strength. Total new domestic orders decreased over the quarter for the first time since April 2013 and manufacturers’ optimism about both their business situations and export prospects for the year ahead fell to the greatest extent since October 2012.
Firms mentioned concerns about the global political and economic conditions and their impact on export orders. “Manufacturers have been struggling with weak export demand for several months, because of the strength of the pound and subdued global growth. But now they’re also facing pressure back home as domestic demand is easing”, says Rain Newton-Smith, CBI Director of Economics.
Tuesday brought about the first GDP numbers for the third quarter and they came out slightly lower than market expectations, at 2.3% y/y against the average market forecast of 2.4%. Construction and manufacturing were down 2.2% and 0.3% respectively and it seems that UK growth is still too reliant on services and consumer spending. CBI Director of Economics Newton-Smith, concluded: “Consumer spending, improving productivity and wages continue to bolster UK growth.
But the weaker global outlook, combined with the strength of sterling will keep the pressure on UK manufacturers, as our recent surveys show”. When the Bank of England publishes its quarterly inflation report next week, it will probably see the figures as another reason to delay the rate rise which markets are currently expecting in the first quarter of 2017.
The Nationwide house price index showed that UK house prices increased by 0.6% in October, with the annual pace of price growth moving up to 3.9% from 3.8% in September. “Over the past five months annual price growth has remained in a fairly narrow range between 3% and 4%, broadly consistent with earnings growth over the longer term. While this bodes well for a sustainable increase in housing market activity, much will depend on whether building activity can keep pace with increasing demand” commented Robert Gardner, Chief Economist at Nationwide.
CBI reported sales volumes growth slowed in October, disappointing retailers’ expectations of a repeat of the September surge, data show. October sales slipped to a net balance of 19%, down from the extremes of September (49%) and lower than the expectations of 35%. However, the number is not bad, as a clear majority of companies still enjoy better-than-average-sales. The effect of better sales on the back of the Rugby World Cup is still hard to calculate and divide between the two months of October and November.
The macro statistics of the week ended with the GfK Consumer Confidence coming in slightly lower than expected. It was a four-month low at +2, although still high by historical standards. The good news on the domestic front, with households lifted by wage growth, low interest rates and near-zero inflation, is being tempered by concerns about our ability to shrug off the global downturn.
China
Key focus in China will be on the PMI manufacturing data for October, both the official PMI manufacturing from NBS which is released on Sunday and the Caixin PMI manufacturing released on Monday. While the Caixin PMI was weak in September, the NBS PMI increased.
The latter suggests that the bottom of the PMI cycle has been reached as the change in NBS PMI is a good leading indicator for the level of PMI. The Caixin PMI is expected to show an increase in October to 47.7 from 47.2 (consensus 47.6) and for the NBS PMI to rise for the second month in a row to 50.0 from 49.8 (in line with consensus). The expected rise in PMI should be positive for EM assets as fears over a sharp slowdown in China ease further. The positive effect will be somewhat dampened, though, by the fact that reduced uncertainty also makes it more likely the Fed will tighten soon.
On Friday, Chinese FX reserves are released for October. Following the record high decline in August of USD94 billion, FX reserves fell by much less in September, USD43 billion, pointing to reduced capital outflow out of China. The outflow in October is expected to be similar with a decline in the FX reserves of around USD30 billion. If right, it should further lessen fears over a Chinese hard landing. Overall, the Chinese yuan is strong (by yuan standards) this morning, rising 0.62% against USD after the PBOC said it was considering a trial program in its Shanghai free trade zone that allows domestic investors to directly buy overseas assets.
That announcement puts a little more stalk into last week’s rumors that China would be discussing fully opening the capital account by 2020 at this past week’s plenum, even if it only represents a very small baby step in that direction. In the lead-up to the IMF’s official decision on CNY inclusion in the Special Drawing Rights (SDR) basket, a series of similar micro-announcements are to be expected that will likely inspire more confidence in capital account liberalization.
China’s government made two key announcements this week at the end of its Fifth Plenary Session, one of which should have important implications for global financial and real estate markets. The first was an official end to the one-child policy, announced in a one-line tweet. The communication method may hint that even China’s government doesn’t believe this policy change will have major implications for the economy. It is true that additional child-rearing costs will reduce household saving rates and boost demand, which explains why the share price of companies selling diapers and baby products shot up on the announcement. But few analysts anticipate a baby boom, largely because of the underwhelming response to earlier measures to loosen the one-child policy.
Given China’s porous social security net, many couples will stick with the “one or none” plan as they save up to care for aging parents. (Perhaps with this in mind, the government also announced that it would extend critical illness insurance to the other half of the population without it.) And yes, some upturn in fertility rates will help shore up the working age population (which is currently shrinking), but not for a couple of decades. China’s economic growth is likely to downshift to 6½% next year.
However, a second key policy change could have a material impact on global markets, including housing markets in Los Angeles, New York, San Francisco, Sydney, Vancouver and Toronto. China’s government said it would proceed with a pilot program in Shanghai’s Free Trade Zone that allows individual investors to directly purchase overseas stocks, bonds and real estate. The program, called Qualified Domestic Individual Investor (QDII2), will allow individuals with at least one million yuan of net financial assets (about US$160,000) to invest up to half of their assets abroad. (The first QDII program, which was launched before the global financial crisis, allowed for the purchase of foreign stocks through fund managers.) This extends the government’s goal of liberalising the yuan to increase its worldwide usage by allowing capital to flow more freely to, and out of, China.
Sources: Commerzbank, Handelsbanken, Standard Life Investment, Danske Bank, BMO Capital Markets.
