Economic Outlook – 24 September 2023

Housing starts decreased 11.3% to 1,283K in August, a sharper decline than expected by consensus (1,439K). Adding to the disappointment, the previous month’s result was revised down from 1,452K to 1,447K. The August print was the lowest since July 2019, excluding the pandemic. The single-family (-4.3% to 941K) and the multi-unit (-26.3% to 342K) segments both contributed to the drop. Meanwhile, the number of homes currently under construction sagged 0.2% to 1688K. Both single-family and multi-unit dwellings under construction remained essentially unchanged in the month Housing construction activity could cool in the months ahead if homebuilder sentiment is any guide. In this regard, in September, the National Association of Home Builders Market Index slid five points to 45, a steeper decline than the one-point drop expected by consensus. This was this sentiment indicator’ second consecutive decrease. NAHB data also signaled a five-point drop in prospective buyer traffic: The corresponding gauge slipped from 35 to 30 Existing-home sales declined 0.7% in August to 4,040K (seasonally adjusted and annualized). Contract closings fell in the single-family segment (-1.4% to 3,600K) but increased in the condo segment (+4.8% to 440K). Combined with a slight decrease in the number of homes available on the market (-0.9% to 1,100K), the inventory-to-sales ratio remained stable at 3.3, the first time in six months that this figure has not increased. Overall, this ratio was still indicative of a very tight market. The was also true of the very quick turnover rate: Properties that sold in August 2023 had been on the market for only 20 days on average, compared with 34 days in February. The median price paid for a previously owned home stood at $407,100 in August, up 3.9% on a 12-month basis The Federal Reserve kept its policy rate unchanged at the 5.25-5.5 percent range, as anticipated by virtually all economists and fully priced in by the markets. For the second consecutive meeting, the Fed’s press release shows that the FOMC has been surprised by the overall strength of the US economy, now calling the current expansion “solid” rather than the “moderate” label used in July, and “modest” used in June. Apart from that, the statement is intact since July. Still, the Fed came out surprisingly hawkish, with a higher-than-anticipated policy rate outlook. The market reacted with higher interest rates, a stronger dollar and a weaker stock market. Another hike is not a done deal, however. At the press conference, Fed Chair, Jerome Powell, underscored that the FOMC feels that it is in a position to proceed carefully with policy. Powell continued to point to incoming data as one deciding factor, but also to “the evolving outlook and risks” – factors that have not been front and centre in the Fed’s policy-making recently. On the topic of risks, Powell pointed out that the list is long, that risks are more two-sided now (rather than previously focused on upside inflation risks), and also admitted that idiosyncrasies like a looming government shutdown and a potential expansion of the auto worker strike could impact the FOMC’s ability to properly analyse economic developments this autumn According to the FOMC’s new policy rate expectations, the ‘dot plot’, a majority of FOMC participants expect that one more hike would be appropriate, at “one of the two remaining meetings this year”, Powell added. 12 out of 19 participants stated such a position at this policy meeting, but since Powell gave no strong indication about this being an impending hike, there is a possibility that many of the voting FOMC members are currently against the idea of another hike. Like before, the Fed will keep policy “sufficiently restrictive” until inflation comes “down sustainably”. Stronger economic activity is broadly the reason why participants have upgraded their policy rate forecasts but still see the same above-target inflation outlook as before. But it is also apparent that the FOMC is exploring the possibility that the neutral interest rate has risen, at least in the short to medium term, requiring a higher nominal rate to generate the needed tightening This week’s jobless claims data continued to signal a robust labor market that has remained resistant to widespread layoffs. Initial jobless claims, which capture new applicants for unemployment benefits, fell to 201K for the week ending Sept. 16. This was the lowest weekly reading for initial jobless claims since January. Continuing jobless claims, which are a count of those who are currently receiving benefits, dipped slightly in the week ending Sept. 9. Continuing claims have moved sideways in recent months and remain near levels that are consistent with a historically low level of layoff. Slowing gross hiring and declining voluntary quits without a material increase in layoffs suggest that while demand for new workers is moderating, demand for existing workers continues to hold up The Leading Economic Index (LEI) declined 0.4% in August and has fallen for 17 consecutive months. Shaky consumer confidence, an inverted yield curve and weak new orders in the factory sector are the primary components weighing on the LEI. Economic growth is still expected to slow in the coming months and outright contract in the first half of 2024 as part of a mild U.S. recession Usually, US government funding battles are waged between the Democratic and Republican parties. But this year, a battle within the Republican caucus of the House of Representatives has upped the odds of Congress failing to pass legislation needed to fund the government beyond 30 September. Typically, there are a discrete set of issues that need to be worked out but this year a dozen or so representatives, many seeking different objectives, are preventing even agreement on a short-term resolution to keep the government running temporarily until a comprehensive agreement is reached. The Republican’s razor-thin five vote majority has empowered the small group of holdouts and has bedeviled the efforts of House Speaker Kevin McCarthy to avoid a shutdown. Investors are particularly uncertain over the outcome of this year’s budget battle given its unusual dynamics. One upshot of a shutdown that could impact soon impact markets would be the suspension of government economic data collection, something that would keep both investors and the Fed in the dark The percentage of US firms that are optimistic about the five-year business outlook in China fell to 52%, according to a survey conducted by the American Chamber of Commerce in Shanghai That’s the lowest level of optimism reported since the annual survey was introduced in 1999. 40% of the companies surveyed said they were redirecting or are looking to redirect elsewhere investment that was earmarked for China, up from 34% last year The major U.S. equity benchmarks declined for the week as investors reacted to hawkish forecasts from the Federal Reserve’s latest meeting and rising U.S. Treasury yields. The S&P 500 Index recorded its largest one-day loss in six months on Thursday on its way to a third-straight losing week. In addition to concerns about higher interest rates, worries about the impact of the United Auto Workers’ strike and the potential for a U.S. government shutdown may have also weighed on markets. Meanwhile, selling could have been exacerbated by tax-loss harvesting as fiscal year-end approached for some investors In terms of data release, new home sales is out on Tuesday. New home sales have proven to be a resilient area of a housing market that has been under pressure. Sales in the new homes market have risen over 14% since February, while sales in the existing home sales market have fallen 11% over the same time frame. Constrained supply and elevated prices in the resale market have redirected potential homebuyers toward new construction. While sales have trended higher, builder sentiment has retreated in recent months. The NAHB housing market index is now down to 45 in September following two months of declines Durable goods is out on Wednesday. Durable goods orders have been highly volatile in recent months, falling 5.2% in July after rising 4.3% in June. Aircraft orders, notoriously volatile month to month, have been an important driver of the volatility in the headline figure, with nondefense aircraft orders only moving less than 25% in either direction once this year. Stripping out transportation, new orders have been strong throughout the year, rising 0.4% in July and in six of the previous seven months. Core capital goods orders (nondefense excluding aircraft) have also been strong as of recently, and though only rising 0.1% in July, they are still up 1.7% at a three-month annualized rate.   

Inflation data for August has been released. The CPI was 0.3% MoM, 6.7% YoY, the key core inflation was 0.1% MoM, 6.2% YoY. Input inflation was 0.4% MoM0, -2.3% YoY, while output inflation was 0.2% MoM, -0.4% YoY. The Retail Price Index (now only used to determine the pay out of index linked Gilts and in some employment contracts) was up 0.6% MoM, 9.1% YoY. The falls were driven by falling food prices and areas such as accommodation and recreation which saw steep falls in their pace of inflation (no doubt driven by poor weather). These numbers will come as a relief to inflation hawks The Bank of England’s (BoE) Monetary Policy Committee (MPC) has surprised investors and forecasters by holding interest rates at 5.25%, a 25bp rise had been widely expected. The vote was close, splitting 5 to 4 in favour of holding interest rates steady. The vote was all the more surprising given the last meeting in early August saw the vote split three ways, with one MPC member voting to hold rates, two voting for a 50bp rise and the majority voting for a 25bp rise. Barring any data surprises, 5.25% will now prove to be the peak of UK interest rates in this cycle and that this level will be maintained until late spring next year, at which point a gradual easing in 25bp steps will be started. The Bank of England’s approach puts it in the same position as both the US Federal Reserve and the European Central Bank. All three central banks are looking for a prolonged period of interest rates being held at a level well above their neutral level (approximately 2.5%) to drive inflation back towards its target level of 2%. Given that it can easily take a year for the full effects of any changes to monetary policy to be reflected in the wider economy, a pause at this stage is warranted UK retail sales for August have come through; they were 0.4% MoM, -1.4% YoY. Retail sales ex fuel were 0.6% MoM, -1.4% YoY. What is also important to realise is that August was extremely wet (although not quite as wet as July) and declines in restaurant spending were an important element in the recent slowing inflation, so in light of the weather, these figures are somewhat surprising. In volume terms, sales were down -1.4%, while in value terms they were up 3.8%, indicating ongoing inflationary pressures. Food sales were notably up, while non store retailing (online sales) suffered. Online sales, having been some 20% of retail sales before Covid, have now settled at approximately 25% of retail sales. It is notable that there has not been an even distribution across the board of who is particularly affected by this change: Retail Parks are doing reasonably well, while Shopping Malls have suffered Amid an ongoing cost of living crisis in the United Kingdom, Prime Minister Rishi Sunak rolled back some of his government’s plans to reach net zero while also touting its world-leading progress to date. Among the measures is a five-year delay in a ban of the sale of cars with internal combustion engines, from 2030 to 2035. He also weakened plans to phase out gas boilers for heating. Sunak said that the debate over net zero is stuck between two extremes: those who want to abandon it, and those who want to go further, faster.

The composite output index rose marginally to 47.1 in September from 46.7 in August, slightly higher than market expectations at 46.5. The service sector output index ticked up 48.4 from 47.9 and the manufacturing output index remain unchanged at 43.4. All sub-components related to output and employment are below or much below historical averages, only delivery times (shorter than normal) and prices are above PMIs indicate a weak outlook for manufacturing as well as services, and confirm the consensus view of negative euro area GDP growth in Q3 and Q4. Price components in the service sector remain stubbornly high above historical average, confirming sticky inflation The Swiss National Bank (SNB) defied expectations and kept its key interest rate at 1.75%—the first time it has not hiked since March 2022. The SNB said that more increases are still possible if it becomes clear they are necessary to maintain price stability over the medium term The pan-European STOXX Europe 600 Index ended 1.98% lower as central banks signaled that interest rates will stay high for some time to come. Higher oil prices and poor business activity data also clouded the economic outlook. Major country stock indexes also fell. France’s CAC 40 declined 2.67%, Germany’s DAX lost 2.26%, and Italy’s FTSE MIB slipped 1.13%.   

No major indicators were released in China during the week. However, official data for August released the prior week provided evidence of economic stabilization in the country. Industrial production, retail sales, and lending activity rose more than forecast last month from a year earlier, although fixed-asset investment grew less than expected as the drop in property investment worsened On Thursday, China’s cabinet, the State Council, pledged to accelerate measures to consolidate the country’s recovery and continue supporting growth in 2024, state media reported. Senior officials acknowledged that while China faces economic challenges, historical trends suggest that the economy is set to improve over the long term. In a sign of investors’ concern about the health of China’s economy, China recorded capital outflows of USD 49 billion in August, the largest since December 2015, which pushed the yuan to a 16-year low against the U.S. dollar, according to Bloomberg. In response to the deteriorating growth signals, Beijing issued a flurry of pro-growth measures in recent weeks aimed at stimulating consumption and reviving the moribund property market In monetary policy news, Chinese banks left their one- and five-year loan prime rates unchanged after the People’s Bank of China (PBOC) kept its medium-term lending facility rate on hold the prior week, when it also reduced the reserve requirement ratio (i.e., the total amount of cash banks must hold as reserves) for the second time this year. The PBOC’s head of monetary policy, Zou Lan, said the central bank has ample policy room to support China’s recovery, raising expectations that there could be more easing following this month’s pause Chinese equities rose as investors grew more optimistic about the country’s economic outlook. The Shanghai Composite Index gained 0.47% while the blue-chip CSI 300 Index added 0.81%. In Hong Kong, the benchmark Hang Seng Index declined 0.7%, according to FactSet.      
Sources: T. Rowe Price, MFS Investments, Wells Fargo, National Bank of Canada, Reuters, TD Economics, M. Cassar Derjavets.