Economic Outlook – 22 October 2017
- The modest 0.3% gain in industrial production for September would have likely been larger had it not been for the quarter percentage point drag from Hurricanes Harvey and Irma. Industrial production fell at a 1.5% annualised rate in the third quarter, but according to Fed estimates, this figure would have been an increase of at least 0.5% had it not been for the weather disruptions. Looking into the few remaining months of the year and assessing the outlook for 2018, industrial production is likely to accelerate modestly. The dollar’s early strength in 2017 has largely reversed, which will likely boost investment plans for export-dependent producers. Moreover, energy prices have broadly stabilised, which has lifted mining output once again.
- Housing starts were also unable to escape the wrath of the storms, declining 4.7% in September, much more severe than the consensus estimate of -0.4%. Likewise, permits fell 4.5% but remain nearly 8.0% above starts and set the table for a rebound in the coming months. While repairs on damaged homes are not counted as starts, they may impact starts by worsening labor shortages and driving material prices higher. It is likely that some projects may simply have been put on hold. September’s drop in starts highlights the significance of Florida and Houston as huge housing growth markets. Housing starts in the South comprise nearly 50.0% of all starts in the US.
- Existing home sales surprised to the upside rising 0.7% month-over-month. However, sales in the South were -0.9% on the month, coming at the heels of a 5.7% contraction in August.
- US import prices rose 0.7% in September, buoyed by a 4.5% increase in petroleum prices. Excluding fuel, prices rose 0.3% in September and are up 1.3% over the past year. The rise in non-fuel products was fairly broad, with industrial supplies, foods, autos and capital goods all posting gains. The firming in import prices can partially be traced to weakening in the broad trade weighted dollar over the past nine months. However, prices for US exports also continued to move higher in September. The rebound over the past year has largely been driven by a recovery in commodity prices as well as capital goods exports as the global economy has strengthened.
- Speculation is rife on who will be the next Fed Chair. Yellen, whose term expires in February, had a meeting at the White House this week. Trump has also met with noted Stanford Professor John Taylor, of the eponymous “Taylor Rule.” Also in the running are former Fed governor Kevin Warsh, and current Fed governor, Jerome Powell. Right now online markets show Powell as the odds-on favourite. He is perceived as being least disruptive to markets, while still enabling the President to be seen to put his stamp on the Fed. Taylor and Warsh would represent a bigger change, and are perceived as more hawkish choices, as both would likely have set rates higher than they are now, if they had been Fed Chair.
- Investor sentiment readings continued to improve this week as US equities again pushed to record highs. The latest Investors Intelligence survey showed that 60.0% of Wall Street newsletter writers were bullish on the market, up from 47.0% in early September, while the American Association of Individual Investors sentiment survey showed that 40.0% of retail investors were bullish on stocks over the next six months, an above-average reading. Meanwhile the Merrill Lynch fund managers’ survey reported that cash is moving off the sidelines and into equities, bringing average cash balances down to 4.7%, the lowest level since May 2015. Cash levels would need to dip further to generate a contrarian sell signal though, according to the firm.
- The US Federal Reserve’s Beige Book, a report prepared in advance of each meeting of the rate-setting Federal Open Market Committee, said that the US economy continues to grow at a modest to moderate pace despite some disruptions from a series of hurricanes. Labor markets remain tight, with employment growth modest, according to the report. The Fed termed inflationary pressures as modest. Markets expect one more rate hike from the FOMC before the end of the year, probably in December.
- Republicans’ tax reform efforts passed another milestone this week as the Senate passed its budget resolution. The resolution does not settle the specifics of tax reform, but it does earmark $1.5 trillion for tax cuts. The work of containing tax cuts to that amount from an estimated price tag of around $2.4 trillion will be done by the tax legislation writing committees in the House and the Senate. While details are scarce, the Senate budget gets back to balance through very steep spending cuts. This could exert a meaningful drag on growth, potentially offsetting any near-term boost from tax reform.
- The most important data release is core capex for September due on Wednesday. Core capex is expected to have risen 0.2% month-on-month after two very strong months, which would still be a sign that the investment recovery continues.
- The first estimate of Q3 GDP growth is due on Friday, which is likely to have been affected negatively by the hurricanes, making it more difficult to estimate. While the Atlanta Fed’s GDP indicator says growth was 2.7% quarter-on-quarter AR, the New York Fed’s indicator says 1.7% quarter-on-quarter. Even in case of a weak print, it should be temporary and it would not change the view that the US is in the middle of an expansion.
- On Tuesday, preliminary Markit PMIs for October are due. The service index shows that the service sector remains the main growth driver but the large gap between ISM manufacturing and Markit PMI manufacturing remains puzzling, hence Markit PMI manufacturing is expected to close the gap a little by increasing.
- UK government bonds rallied after comments by Bank of England (BoE) officials raised uncertainty about whether the central bank will hike rates in the near term, despite inflation rising to its highest level in five years. In testimony on Tuesday, several members of the BoE’s Monetary Policy Committee questioned the need for imminent rate increases. However, Office for National Statistics figures published during the week showed consumer price inflation for the year through September was 3.0%, the highest since 2012. The yield on 10-year gilts finished Friday at 1.33%, down for the week.
- On the economic front, UK unemployment held at its lowest point in more than 40 years, although wage growth continues to lag inflation. T Rowe Price traders noted that the latest economic data reinforced market sentiment that the BoE would likely increase rates in November.
- The first estimate of Q3 GDP growth on Wednesday. According to the soft economic indicators released so far, GDP growth was around 0.3% to 0.4% quarter-on-quarter, with 0.4% being the consensus estimate. The subcomponents are not disclosed but it is likely growth was held back by a combination of negative real wage growth and Brexit uncertainties, which have slowed private consumption growth and business investment growth, respectively.
- China’s 19th Communist Party congress began last week in Beijing, kicking off with a three and a half hour speech by President Xi Jinping. Economic reform took a back seat to the theme of national rejuvenation in the speech. Xi will be given a second five-year term atop the party at the end of the meeting. China reported that its economy grew at a 6.8% annual rate in the third quarter, down a touch from the 6.9% pace registered in the first two quarters of the year.
- While the USD/CNY has shown rather large movements since the spring, the effective, or trade-weighted, CNY has been relatively stable. In general, the volatility in the effective CNY index during the past year has finally been lower than the volatility in the USD/CNY. This supports the view that the authorities are finally targeting a stable, effective exchange rate rather than focusing on the USD/CNY itself. China’s authorities are, despite liberalisation of the FX regime, still able to control the exchange rate via interventions and changes to capital controls.
- The key focus in China this coming week will continue to be the 19th congress of the Communist Party and presentation of the new Standing Committee (SC) of the Politburo. The Congress ends on Tuesday and the day after, the SC will be made public. Xi Jinping is likely to have more of his ‘own’ people in the SC. It will be interesting to see whether the number of members is kept unchanged at seven or reduced to keep power on fewer hands supportive of Xi Jinping. It will also be known whether the ‘seven up, eight down’ informal rule will be respected. It says that a member of the SC can stay on if he’s 67 or under but retires if the age of 68 has been reached. If the rule is respected, five out of seven members will be replaced. Also in focus will be whether Xi Jinping will designate a successor to take over when he is due to step down in 2022.
- On the economic data front, industrial profits and property prices will be released. Profit growth is likely to have stayed robust around 20% year-on-year due to decent activity and rising producer prices. However, a more slowing of property price inflation is expected. Home sales for September pointed to further slowing in demand, as year-on-year growth moved into negative territory for the first time since early 2015.
- The European Council met last week, but deferred a decision on whether or not Brexit negotiators had made sufficient progress on a series of issues to allow the talks to move on to the topic of the future relationship between the United Kingdom and the European Union. While negotiations appear to be bogged down, German chancellor Angela Merkel said that she is hopeful talks will be able to progress to future trade matters in December.
- European stocks ended the week flat to slightly lower, with the pan-European STOXX 600 index dropping to a three-week low before recovering most of its losses following the US Senate’s latest steps toward implementing tax reform. Positive economic data from China spurred mining and commodity stocks, and bank stocks also showed some strength as the week closed. The German DAX index, which is heavily weighted in major multinational companies, touched an all-time high during the week, and the French CAC 40 Index surged to its highest level in five months.
- The most important event of the week is the ECB meeting on Thursday. The ECB is now likely to announce a QE extension of nine months at a pace of € 30 billion. A larger scaling down of purchases would ease future QE implementation and higher reinvestment volumes of maturing bonds would also add to the monthly QE flows in 2018. Apart from a scaling down of QE purchases, the ECB is expected to make no changes to its forward guidance at the upcoming meeting.
- The PMIs are due for release on Tuesday. Manufacturing PMI has been on a rising trend since August 2016, getting close to the post-financial crisis peak of 59.0 in February 2011. In October, manufacturing PMI is expected to remain around the current level of 58.1, as the stronger euro may have started to affect new export orders adversely. After four straight months of decline, services PMI recovered in September to 55.8 and services PMI is expected to further increase in October to 56.2. Overall, the high PMIs support the hope for a robust growth for H2 in the euro area.
Sources: Wells Fargo, MFS Investment Management, Danske Bank, HongLeong Bank, TD Economics, T. Rowe Price, Handelsbanken Capital Markets