Economic Outlook – 24 October 2021

• September instead of rising 0.1% as per consensus. Adding to the disappointment, the prior month’s figure was revised down from +0.4% to -0.1%. As a result, industrial production fell 1.3% below its pre-pandemic level in September after surpassing that mark for the first time in July. Manufacturing output sagged 0.7% MoM as production sank 7.2% MoM in the motor vehicles/parts segment owing to the continued impact of semiconductor shortages. Excluding autos, factory production still decreased 0.3%, a second consecutive decline for this indicator. Production in the utilities segment, meanwhile, slipped 3.6% as cooler weather across the country reduced demand for electricity. With hurricane Ida disrupting activity in the energy sector early in the month, mining output retraced 2.3% (the Federal Reserve’s report estimated that outages related to the storm subtracted 0.6 percentage point from total industrial production). Specifically, oil/gas well drilling registered a first decline in 13 months (-1.2%) and remained 29.9% below its level of March 2020

• Capacity utilization in the industrial sector moved from 76.2% in August to 75.2% in September. In the manufacturing sector, it fell from 76.5% to 75.9%

• Markit’s flash composite PMI came in at 57.3 in October, up from 55.0 the month before and the highest since July. The rate of expansion was among the fastest recorded over the survey’s 14-year history. As COVID-19 caseloads continued to ease, services providers noted a marked improvement in operating conditions; the headline non-manufacturing gauge jumped from 54.9 to a 3-month high of 58.2. New work piled up at the fastest clip in three months but “more intense capacity pressure amid […] labour issues and supplier delays” meant that output could not keep up with demand. As a result, work backlogs lengthened the most on record. Trying to cope with the inflow of orders, firms expanded their payrolls for a 16th consecutive month, although some panelist reports “issues finding candidates and filling open positions.” Higher transportation costs, rising wages and soaring material prices was responsible for the second steepest increase in input prices on record. At least some of that increase was passed on to clients. To be sure, prices charged by non-manufacturing firms rose the most in the survey’s history. The manufacturing sub-index, for its part, slipped from 60.7 to a still-elevated 59.2, “as goods producers continued to be severely hampered by material shortages and supply chain delays.” Indeed, while the inflow of new orders remained sharp overall, lengthening delivery delays (the longest lead times on record) meant output growth was the slowest in 8 months. The indices tracking input and output inflation climbed to new all-time highs

• Housing starts softened from 1,580K in August to 1,555K in September (seasonally adjusted and annualized), undershooting by far the 1,615K print expected by analysts. The monthly drop stemmed entirely from a decrease in the multi-family segment (from 500K to 475K). Groundbreaking in the single-family segment, meanwhile, remained unchanged at 1,080K units

• Building permits, for their part, sank from 1,721K to a 12-month low of 1,589K. Permits issued for single-family units edged down from 1,050K to 1,041K, while applications for multi-family dwellings plunged from 671K to 548K. September’s disappointing starts report provides further evidence of the slowdown in activity in the housing sector. Supply chain delays, the high cost of building materials and labour shortages could very well be dampening enthusiasm among builders at present, though demand seems to be fading as well. In October, a net 54% of respondents to a University of Michigan poll deemed buying conditions for houses to be bad because prices were too high. In this regard, the Case-Shiller 20-City Home Price Index showed that prices rose 20.0% in July, the steepest increase on record. High prices need not in themselves translate into a collapse in residential construction

• Existing-home sales advanced 7.0% to 6,290K (seasonally adjusted and annualized), their third increase in four months. Although this figure was down 6.5% from last October’s peak of 6,730K, it remained comfortably above the pre-recession peak of 5,700K. Contract closings for single-family dwellings progressed 7.7% in August to an eight-month high of 5,590K, while those for condos increased 1.4% to 700K. The inventory-to-sales ratio moved down two ticks to 2.4, indicating extremely scarce supply. (According to the National Association of Realtors, a ratio <5 indicates a tight market.) Listed properties remained on the market for 17 days on average, matching the all-time low in this regard

• Initial jobless claims eased from 296K to a post-pandemic low of 290K in the week to October 16. Continued claims, meanwhile, fell from 2,603K to 2,481K, also their lowest level since the start of the COVID crisis. According to the latest edition of the Fed’s Beige Book, overall economic activity in the United States expanded at a “modest to moderate” pace in September through to early October, a slight downgrade from the “moderate” clip reported in the prior iteration of the survey. The report attributed this deceleration to “supply chain disruptions, labour shortages, and uncertainty around the Delta variant of COVID-19”. Consumption spending continued to increase countrywide although auto sales remained constrained by low inventories and rising prices. The manufacturing sector grew at a solid pace, while the real estate market remained “healthy” despite a slight slowdown

• After months of relative complacency, the bond market is no longer holding back expressing its concerns about more persistent inflation pressures. With the Fed’s tapering schedule now priced in, this week’s steepening of the yield curve reflects a reassessment of the policy path, with the first rate hike pulled forward to September of 2022

• Hopes for additional fiscal stimulus also appeared to bolster sentiment. Negotiations continued between Democrats in the U.S. Senate over the size of the Biden administration’s proposed social infrastructure bill. Rumors circulated at midweek that West Virginia’s Senator Joe Manchin might even leave the party if the cost of the legislation wasn’t trimmed from roughly USD 3 trillion to under USD 2 trillion. But investors seemed cheered by reports that the Democratic leaders were also prepared to scrap tax rate increases to spare the deal. At a CNN town hall event on Thursday evening, President Biden said that his party was close to striking a deal and that increased corporate taxes were unlikely to be included in the legislation

• The S&P 500 Index, Dow Jones Industrial Average, and S&P MidCap 400 Index all moved to record highs, seemingly helped by a series of positive earnings surprises. Further reflecting the strong investor sentiment, the Cboe Volatility Index (VIX) also fell to its lowest level since the beginning of the pandemic. Along with real estate and utilities stocks, health care shares led the gains within the S&P 500, boosted by insurance providers. Communication services shares were strong through much of the week, but social media stocks dropped sharply on Friday following downward guidance from Snapchat parent Snap, which the company blamed on new privacy settings on Apple’s iPhones. Energy shares also underperformed following strong recent gains

• UK retail sales for September have come out at -1.3% YoY, -0.2% MoM. Retail sales (ex-fuel) were down -2.6% YoY, -0.6% MoM. This follows the revised -0.6% drop in Retail sales in August. This makes a fifth consecutive month of falls, the longest period of declines in at least 25 years. For some time there has been a shift in spending from retail to services; clearly this has scope to continue as retail sales are still 4.2% higher than they were pre-pandemic. Overall, the latest GDP figures showed that the UK economy was now only 0.8% below its pre-pandemic level. Thus, any recovery was already arguably over and there are concerns about the headwinds of rising taxes, rising inflation (at least short term) and consequentially rising interest rates, clearly many consumers have the same concerns

• Bank of England Governor Andrew Bailey sent a fresh signal on Sunday that the British central bank is gearing up to raise interest rates for the first time since the onset of the coronavirus crisis as inflation risks mount. Bailey said he continued to believe that the recent jump in inflation would be temporary but that a surge in energy prices would push it higher and make its climb last longer, raising the risk of higher inflation expectations. Investors are speculating that the BoE might become the first of the world’s biggest central banks to raise rates, either later this year or early in 2022

• Headline CPI came out at 3.1% YoY, 0.3% MoM, the August figure of 3.2% was the highest since March 2012. The August figure had incorporated a reasonable base effect in that in August 2020 there had been the Eat Out to Help Out programme and, to a lesser extent, reductions in Value Added Tax across the same sector. The result was comparing this year’s prices against it pushed up restaurant inflation, which drove up overall inflation by 0.4% in August. The very slight reduction in this month’s figures comes mostly from a falling away in the restaurant base effect, the largest upward contribution to the September CPIH came from transport (0.91%), (read: petrol prices and used car prices), with further large upward contributions from housing and household services (0.69%), restaurants and hotels (0.34%), and recreation and culture (0.31%)

• The eurozone flash Composite PMI declined below expectations to 54.3 in October compared with 56.2 in the previous month. The Manufacturing PMI declined to 58.5, still above expectations, compared with 58.6 the month before, and the Services PMI was below expectations at 54.7 compared with 56.4 previously. Meanwhile, growth slowed particularly in Germany, at its lowest level since February, and in France growth declined to its weakest since April. Supply chain pressures continue to weigh on this month’s PMI release. Manufacturing output and services business activity declined further, even as suppliers’ delivery times deteriorated, and both input and output prices increase across both sectors. This makes the headline manufacturing PMI index appear stronger than it actually is. Whereas employment growth increased in both sectors, estimates of future activity deteriorated in the manufacturing sector and new orders and new export orders declined. This contrasts with the services sector where the corresponding measures increased

• Jens Weidmann said he would quit as president of Germany’s Bundesbank for personal reasons at year-end—more than five years before his latest contract expires. A strong critic of the European Central Bank’s ultra-loose monetary policy during his 10 years at the helm, Weidmann announced his resignation almost a month after the center-left Social Democratic Party (SPD) defeated the center-right Christian Democratic Union-led government of outgoing Chancellor Angela Merkel in national elections

• Shares in Europe rose as optimism about corporate earnings season overcame worries about the potential risks if central banks tighten monetary policy as economic growth loses momentum. In local currency terms, the pan-European STOXX Europe 600 Index ended 0.53% higher. The major indexes were mixed. Germany’s Xetra DAX Index eased 0.28%, while France’s CAC 40 Index was little changed. Italy’s FTSE MIB Index ticked up0.31%

• China’s third-quarter GDP grew a disappointing 4.9% as industrial activity rose less than expected in September, according to the National Bureau of Statistics of China. That missed expectations of a 5.2% expansion, according to analysts polled by Reuters. Many factories had to stop production in late September as a surge in the price of coal and a shortage of electricity prompted local authorities to abruptly cut off power. Industrial production rose by 3.1% in September, below the 4.5% expected by Reuters. Real estate and related industries, which account for about a quarter of China’s GDP, also came in weaker than expected, up 7.3% from a year ago compared with the expected 7.9% figure
• Just before the end of a 30-day grace period, Chinese property developer Evergrande has made a key interest payment due 23 September, according to Chinese state media newspaper Securities Times. That will allow Evergrande to avoid a widely expected default. The $83.5 million interest payment on the indebted company’s March 2022 offshore bond was being watched closely by investors after Evergrande warned twice in September that it may default. Several Chinese officials sought to reassure homebuyers and markets this week that the rout in the property sector would not be allowed to trigger a full-scale crisis. Chinese developers have increasingly taken on debt over the past few years, particularly in overseas markets

• Credit agencies continued to downgrade ratings on several developers amid fears of a liquidity crunch resulting from a property sector slowdown and slower economic growth. Moody’s Investors Service, Fitch, and S&P Global Ratings each took rating actions as the outlook for the sector grew more uncertain. Fitch downgraded Central China Real Estate to B+, while Moody’s downgraded Central China Real Estate to B1/B2 and cut its ratings on several other developers. The actions followed S&P’s downgrade of Greenland Holdings and E-House, two of the country’s larger developers, the previous week. Meanwhile, China’s President Xi Jinping called upon the country to “vigorously and steadily advance” legislation for a nationwide property tax. Most analysts believe that such a levy would curb rampant housing market speculation, but the idea has reportedly run into widespread pushback from ruling Communist Party members

• On the energy front, Chinese authorities sought to allay a growing energy crunch with state planner National Development and Reform Commission (NDRC), saying that it would “guide coal prices back to a reasonable level.” The NDRC’s assurances sent coal prices plummeting, with some key benchmarks falling by as much as 15% in a single session. However, prices are still up 170% over a year ago after they hit record highs earlier in the week. China is the world’s biggest producer and consumer of coal, viewed as a leading economic indicator since it is used to power about 60% of the country’s power plants

• China’s stock markets advanced as the large-cap CSI 300 benchmark rose 0.6% and the Shanghai Composite Index added 0.3% after officials sought to calm fears about the property sector and China Evergrande Group made a delayed coupon payment, sparking a rally in the cash-strapped developer’s bonds and shares. Chinese stocks got off to a weak start after data released Monday showed that the country’s gross domestic product (GDP) rose a lower-than-expected 4.9% in the third quarter from a year ago as power shortages and property sector curbs reined in expansion

Sources: T. Rowe Price, Wells Fargo, National Bank of Canada, TD Economics, MFS Investment Management, M. Cassa Derjavets.