Economic Outlook – 24 June 2018

US

• US housing starts bounced back solidly in May following April’s upwardly revised 3.1% fall, rising 5% to a 1.35 million-unit pace. Both single-family (+3.9%) and multifamily (+7.5%) starts rose, but total permits fell 4.6% to a 1.30 million-unit pace. Not typically the load carrier, the Midwest drove starts this month, surging a massive 62.2%. Starts in all other regions fell in May, most notably dropping 15% in the Northeast, with smaller drops in the South and West. The huge jump in the Midwest is likely due to a later-arriving spring this year, which allowed builders to have a stronger-than-usual May. The region’s economic growth has improved significantly over the past year, largely due to manufacturing growth, and further ramping up in Midwestern homebuilding in coming months is likely. Across the country, builders continue to struggle finding lots and workers to meet the high level of housing demand.
• Existing home sales fell for the second straight month in May, slowing 0.4% to a 5.43 million-unit pace. Once again, the drop was due entirely to a slowdown in single-family homes, which fell 0.6%. The Northeast was the only region in May to see an accelerating sales pace in May, rising 4.6%. However, sales in this region are still 11.7% below the pace of this time last year. Inventory has risen slightly, climbing 2.8% to 1.85 million homes, but has fallen on a year-on-year basis for the past 36 months.
• Following an initially reported $128.2 billion current account deficit in Q4, financial markets expected further widening in Q1. The account balance came in at $124.1 billion in Q1, but due to revisions to Q4 data, this represented a widening of $8.0 billion over the quarter. As a percentage of GDP, the deficit has remained between 2% and 3% over the last several years, indicating that the economy is growing at about the same pace as the deficit. Foreign purchases of Treasuries and US corporate securities have been positive in each of the past five quarters.
• US trade tension drove risk-off sentiments sending the markets to a tumultuous start in the week as the Trump Administration mulls slapping tariffs on more Chinese import. The fear subsided somewhat in the middle of the week which saw the Nasdaq rallying to an all time high on Wednesday led by gains in tech shares only to be triggered by a Supreme Court ruling which allows states to collect taxes from online retailers (the ruling was overturned in 1992) leading to drop in online retailers shares.
• The narrowly focused Dow Jones Industrial Average performed worst, hurt by its focus on industrial firms and exporters as trade conflicts appeared to deepen. The technology-focused Nasdaq Composite Index fared better and reached a new record high at midweek, as did the small-cap Russell 2000 Index. Within the S&P 500 Index, the small real estate and utilities segments outperformed, helped by a decline in long-term bond yields, which makes their relatively high dividend payments more attractive in comparison. Industrials shares performed worst due to trade worries, dragged lower in particular by leading exporters Boeing and Caterpillar.
• The yield on the benchmark US 10-year treasury note ended roughly unchanged for the week. Municipal bonds largely followed US treasuries amid a risk-off tone in the market, and demand for new issues was mostly strong. Improved sentiment in Asia and Europe as the week progressed helped the investment-grade corporate bond market trade with a firmer tone, even as a wave of new deals hit the market and total issuance exceeded expectations. Technical conditions weakened toward the end of the week, however, due to a lack of interest in longer-term issues, somewhat lacklustre demand for new issues, and growing dealer inventories.
• PCE core inflation numbers for May are due for release. Based on CPI, PCE is expected to rise +0.2% month-on-month which translates into 1.9% year-on-year, up from 1.8%.
• On Friday, preliminary core capex figures are released. Overall, business investments have been increasing since summer 2016 but lately, they have stagnated – probably due to lower growth in the manufacturing sector. Figures for May will provide an impression of whether investments are heading higher again.

EU

• The flash Composite PMI for the Eurozone increased to 54.8 in June from previously 54.1. The PMI surprised on the upside (consensus saw a decrease to 53.9), finally giving weight to hopes that the slowdown in economic activity is temporary. Overall the level of PMI continues to indicate robust annual GDP growth of close to 2.5% in the second quarter as in the first quarter.
• In a volatile week for European equities, most of the major indexes ended lower. The pan-European STOXX 600 Index fell by about 2%, with most of the losses coming midweek, when automobile, mining, and technology stocks led the index lower. Also losing ground was the exporter-heavy German DAX 30. Escalating trade tensions between the US and Europe was one of the strongest market-driving events. Certain US goods, including bourbon, cranberries, and Harley-Davidson motorcycles, were among the €2.8 billion ($3.2 billion) worth of products that will now carry tariffs. The move came in response to new US tariffs on European aluminium and steel. Trade tensions weighed on mining and technology stocks, along with auto shares.
• Greece and its Eurozone creditors reached a deal on debt relief. Ministers agreed to extend the maturities on some €100 billion of Greek debt by 10 years, effectively leaving the country with only small repayments until after 2030. Creditors also negotiated a final release of €15 billion in bailout cash to Athens. Various news sources reported that the agreement brings to a close eight years of bailouts for the nation. Greek equity markets rallied on the news, and the yield on Greece’s benchmark 10-year note declined.
• The political situation in Italy, where the anti-establishment parties League and Five-Star Movement have formed a ruling coalition, has revived painful memories of the European sovereign debt crisis of 2011-2012. Both coalition partners have pledged to increase the fiscal deficit to fund new spending programs. The size of Italy’s government debt means that if Italy runs into trouble, the EU would not be able to bail out Italy in the way it did for Greece. Moreover, the coalition looks fragile and new elections cannot be ruled out, potentially paving the way for a more extreme populist government.
• In the euro area, the key event next week is the European Council meeting on 28-29 June. Several topics will be in focus: migration, Brexit, security and Eurozone reforms are on the agenda. Migration will be one of the hottest topics, especially following the pressure on Merkel from her CSU coalition partner to find an EU-wide solution to migration problems.
• On Friday, the June HICP figures are due for release. Headline inflation has surprised to the upside in May reaching 1.9% year-on-year driven by higher oil prices. This also has led the ECB to revise up its inflation forecast for 2018 to 1.7% (from 1.4%) in its new staff projection.

UK

• The Monetary Policy Committee (MPC) of the Bank of England (BoE) decided to keep the policy rate unchanged at 0.5% at its policy meeting. However, the majority this time shrunk from seven to six out of nine MPC members, as BoE’s chief economist, Andy Haldane, joined the ranks of the usual hawks, Ian McCafferty and Michael Saunders. A key assumption in the MPC’s May projections was that the dip in GDP growth in Q1 would prove temporary, with momentum recovering in the second quarter. The MPC’s assessment was that this judgement appeared broadly on track. The MPC noted that downside risks from geopolitical developments had increased, but saw the prospects for global GDP growth as largely remaining strong, and judged financial conditions as continuing to be accommodative. The MPC expected global GDP growth to bounce back in Q2, broadly in line with its expectations from May. At the same time, it said that there were signs that underlying global growth momentum, while still strong by historical standards, might have slowed slightly.
• Britain’s government borrowed less than expected last month, according to official data on Thursday that may cheer Chancellor of the Exchequer Philip Hammond but also increase pressure on him to spend more after years of deficit reduction. So far this financial year, the deficit totals 11.8 billion pounds, 26% less than in April-May 2017, though it is rarely possible to get a good steer on full-year borrowing trends this early in the tax year, which starts in April.
• For the markets in the UK, the focus this week will mainly be on the European Council meeting on 28-29 June, although the summit has become less important in terms of Brexit as the clashes between the EU and UK are most likely to be postponed to the October EU summit. However, Brexit remains a key driver for the pound and thus very sensitive to Brexit related comments from the Summit.

China

• China’s benchmark stock index ended the week on the verge of a bear market (commonly defined as a drop of at least 20% from its high) as China and the US exchanged more barbs on trade, compounding investors’ worries about China’s cooling growth. For the week, the benchmark Shanghai Composite Index shed 4.4% and the large-cap CSI300 Index fell 3.8%, marking the worst week for both gauges since February. Friday’s weekly drop pushed the Shanghai index down 19% from its latest high in January.
• On Monday, the Trump administration directed the US Trade Representative’s office to identify $200 billion in Chinese goods for additional tariffs of 10%, with another $200 billion afterward if Beijing retaliated. In response, China’s government promised to hit back with “quantitative and qualitative” measures. Later in the week, China’s state-run media called US protectionism a “symptom of paranoid delusions” and said that US measures to penalise China would ultimately backfire on US workers.
• On the data front the main release is industrial profits for May. Profit growth has trended down since Autumn 2018 but spiked from 3.1% to 21.9% in May. However, the series is quite volatile and a decline back to around 10% in June is possible.

Sources: Wells Fargo, T. Rowe Price, Handelsbanken Capital Markets, Reuters, Danske Bank