Economic Outlook – 21 January 2018

US

• Weekly US jobless claims fell to 220,000 in the week ending 6 January, the lowest reading since 1973, when the US population was far smaller than today. The US Department of Labor reported last Friday that the US unemployment rate held steady at 4.1% In December.
• Industrial production rose 0.9% last month, which was stronger than expected. Part of the beat stemmed from a 5.6% jump in utilities output, as cooler weather blanketed much of the country. Utilities output accounts for a little over 10.0% of industrial production. Mining activity also posted a solid gain, increasing 1.6%. The sector has benefitted from the rebound in oil prices over the past year, which has helped fuel new drilling and production. Output is up 11.5% since last December when oil prices were more than 10.0% lower.
• Growth in the US manufacturing sector, which accounts for about three-quarters of industrial output, was more restrained. Production rose just 0.1% in December. That followed an upwardly revised gain in November and sharp upturn in October (following the unwind of hurricane distortions), leaving manufacturing output rising at a 7.8% annualised pace over the past three months. After a tough few years, the sector is now benefiting from much higher levels of business confidence, stronger global growth and a weaker dollar. Yet December’s modest increase along with the first of the January purchasing managers’ indices (PMIs), suggests activity may be cooling from the exceptionally strong levels implied by the latest ISM readings. Both the Philadelphia and New York Feds’ regional PMIs came in lower in January, although both remained solidly in expansion territory.
• US new residential construction also appeared to cool a bit in December. Housing starts fell 8.2% in the final month of the year after rising 12.0% over the prior two months. December’s drop largely reflected a return to more typical winter weather. With relatively little new construction occurring late in the year, seasonal adjustment can exaggerate month-to-month changes, and this December followed an unusually mild November. In December, permits were 9.2% higher than starts and suggest new construction will trend higher over the next few months. Builder confidence also remains at an exceptionally high level even after edging back two points in January.
• Shutdown in the US did happen at last: there have been 18 “funding gaps” since 1976, and three full shutdowns. The most recent shutdown in 2013 led to about 40.0% of federal government workers being furloughed, the equivalent of about 850,000 people, essential services will remain in place, including roles like air-traffic controllers, armed forces, and law enforcement. But many “non-essential” operations will be closed, like national parks, statistical agencies and the IRS, causing disruption in the lives of many Americans, particularly those federal employees who will not be paid during the shutdown. This will have a negative effect on growth in Q1. The Bureau of Economic Analysis (BEA) estimated that the last 16-day shutdown lowered real GDP by 0.3% (annualised) in Q4 2013. If the shutdown were to drag on, for example, for four weeks, it is estimated it would lower real GDP growth by 1.5%.
• The Paris-based International Energy Agency forecast this week that US crude output could surpass 10 million barrels a day in 2018, which would put US production ahead of that of Saudi Arabia and rival that of Russia, provided the OPEC-led production caps remain in place this year. The IEA expects a wave of US shale production to come on line this year in response to higher global oil prices. US production in 2017 was the highest in nearly 50 years, the IEA reported.
• The major US equity market indexes finished with modest gains for the holiday-shortened week. Stocks registered sharp gains on Tuesday, which saw the S&P 500 Index record its best one-day advance since November. Consumer staples stocks led gains within the S&P 500, while energy, industrials and business services, and real estate shares lagged. Smaller-cap stocks trailed large-caps.
• The government shutdown beginning Saturday morning diminished the appeal of US assets, pushing the US dollar lower and Treasury yields higher. (Bonds prices and yields move in opposite directions.) Municipal bonds outperformed Treasuries, helped by restrained supply due to light issuance during the shortened holiday week. Investors continued to focus their interest on longer-dated issues.
• With another round of NAFTA (North America Free Trade Agreement) negotiations set for next week and several US Department of Commerce investigations into Chinese trade practices winding up soon, markets are beginning to grow concerned that escalating trade tension could weigh on investor confidence. US president Donald Trump made pointed remarks this week on trade, saying that his preference is to pull the US out of NAFTA to increase leverage in negotiations with Canada and Mexico, though his advisors counselled against that course of action. Trump also suggested China could be subject to large fines as a result of intellectual property theft. Investors fear tit-for-tat trade sanctions will disrupt a period of unusually synchronised global economic growth.
• This week the most important release is the preliminary PMIs for January on Wednesday. Although Markit PMI manufacturing has trended up in the last six months, it is still a puzzle that the index is below the equivalent ISM manufacturing index. Given the big discrepancy, Markit PMI could rise further although the bad weather may have pulled in the other direction.
• The first release of US GDP growth in Q4 is due on Friday. According to Atlanta Fed GDPNow indicator, growth was 3.2% quarter-on-quarter annualised while the NY Fed GDP Nowcast indicator suggests growth was 3.9%, so in European terms that quarterly growth was in the range 0.8% to 1.0% (not annualised), so quite strong! If the annualised growth rate exceeds 3.2% quarter-on-quarter AR, it is the strongest pace since 2014. Consensus is right now 3.0%.

UK

• UK annual CPI inflation fell to 3.0% in December, in line with the market consensus. Core CPI inflation fell to 2.5% from 2.7% in November and was slightly lower than the market consensus of 2.6%. The annual PPI Input inflation fell to 4.9% from 7.3% in November, suggesting price pressures are continuing to ease. The deceleration in the 12-month CPI growth rate was fairly broad-based across categories, but the largest downward contribution came from transport, particularly airfares. The downward contributions were partially offset by prices for motor fuel, which increased between November and December 2017, having fallen a year ago. Tobacco prices also increased more than they did a year ago due to duty increases announced in the Autumn Budget of 2017.
• The jobs report for November is released on Wednesday. There are some signs that employment is no longer increasing at the same pace as previously or possibly has even stagnated. So in this jobs report signs about whether this was just transitory or not are important. The unemployment rate (three-month average) is likely to remain unchanged at 4.3%.
• On Friday, the first estimate of GDP growth in Q4 is due out. PMIs suggest GDP growth was 0.4% to 0.5% but the NIESR GDP estimate says it could have been as high as 0.6%. GDP growth is expected at 0.4% but given the indicators there are upside risks to this forecast. If the quarterly forecast is correct, the annual growth in GDP has slowed to 1.4% year-on-year, the slowest since Q2 2012. Growth accelerated in H2 2017 driven by higher manufacturing production growth, in line with the pick up in rest of Europe.

EU

• The headline that hogged the limelight this week is the hawkish tone from ECB signalling likelihood of rate hike earlier than initially expected. The ECB signalled a growing inclination to revisit its policy in “early” 2018, if the economy continues to expand and inflation heads back to the 2.0% target. The ECB Fiscal Council chief commented that “a rise in interest rate could actually be beneficial in relation to house prices.” ECB has been signalling that the days of super-low interest rates are coming to an end. ECB could begin raising interest rates sooner than expected, potentially as soon as Q4 this year after its QE programme expires in September.
• The January ECB meeting will be held on Thursday. Attention from financial markets will be on the timing of when forward guidance will be revisited on the back of the ECB’s December account which stated that the forward guidance ‘could be revisited early in the coming year [2018]’. These changes will relate to the QE and not the forward guidance on policy rate early in the year.
• Despite a trend of broadening eurozone economic recovery, December’s consumer price index (CPI) showed that inflation was slowing somewhat. Eurozone CPI came in at 1.4%, with core CPI stubbornly staying at 0.9%.
• In the euro area, the preliminary PMI figures are due for release on Wednesday. Both manufacturing and service PMIs rose yet again in December, climbing to 60.6 and 56.6 respectively. Activity remains high in the euro area and the PMIs is expected to remain at high levels. However, in line with the decline observed in IFO expectations in December, January’s PMI will show a decline. Manufacturing PMI is expected at 60.1 and service PMI at 56.2.

China

• China GDP grew by a higher-than-expected 6.8 % year-on-year in Q4, unchanged from Q3. However, on a quarterly basis, growth actual slowed from an upwardly revised 1.8% quarter-on-quarter in Q3 to 1.6 % in Q4. As usual, the two measures do not fully correspond, as emphasised by the fact that there were no revisions to the annual growth rate in Q3 despite the quarterly revision. It still seems to be the case that the annual growth rate, which is the most commonly watched measure, is remarkably stable and perhaps ‘smoothed’ intentionally.
• The monthly activity indicators for December showed a mixed picture of the current momentum. Retail sales growth dropped sharply whereas industrial production growth increased slightly despite expectations of unchanged growth. Fixed investments were in line with expectations.
• Though China’s economic performance consistently beat forecasts in 2017, analysts believe growth is already slowing, as Beijing has started cracking down on excessive lending and other financial risks. An antipollution campaign that started last fall targeting industries across the country is also expected to curb growth in 2018.

Sources: MFS Investment Management, Danske Bank, Wells Fargo, TD Economics, T. Rowe Price, Handelsbanken Capital Markets, Hong Leong Bank.