Economic Outlook – 25 March 2018

US

• The Fed raised the upper bound limit one quarter of a percentage point to 1.75% on Wednesday in a widely expected move, despite less than positive data in Q1. Business fixed investment and household spending moderated from Q4, the policy statement acknowledged, but an upgrade to labor market conditions encouraged the FOMC. The decision to continue rate hikes amid softer economic data affirms the Fed’s confidence in this economy’s underlying strength and its determination to normalise rates. Looking further ahead seven Fed members now expect four or more rate hikes in 2018, three more than did in December. A majority of Fed members now expect three hikes in 2019, up from two hikes in December.
• The US current account deficit widened in Q4 to a nine-year high of $128.2 billion. The entire deficit comes from the goods sector, with a $214.3 billion deficit, which was partially offset by a $60.4 billion surplus in international services trade. Foreigners made $54.1 billion of direct investment in the US current account in Q4, gladly financing the deficit.
• Existing home sales bounced back from January’s 3.2% drop with a 3.0% gain in February. The rise in home sales was largely driven by warm weather in the West and South, allowing for more home buying activity in the month. Weather in the Northeast and Midwest was a different story, with snowstorms causing declines in home sales. New home sales decreased slightly in February from a 622,000-unit pace to a 618,000-unit pace. January’s 7.8% drop was revised to a 4.7% decline. Housing demand is strong behind job and income growth, but supply shortages are limiting the pace of growth to moderate. The lack of inventory is particularly pointed in lower-priced homes, keeping first-time buyers on the sidelines. The low inventory has driven prices up rapidly and is causing homes to be on the market for a shorter amount of time.
• Durable goods orders rose 3.1% in February, much stronger than the consensus 1.6% estimate following a weak prior two months. Core capital goods orders were particularly strong this month, doubling market expectations and rising 1.8%, ex-aircraft and defence. Manufacturing output increased a solid 1.2% in February, which foreshadowed the strength in core orders. The gap between the sky-high soft survey data and the hard data such as spending and orders was narrowed in February, but remains wider than historical norms.
• US president Donald Trump announced tariffs on about $60 billion in imports from China and also imposed restrictions on technology transfers and acquisitions in response to unfair trade practices, such as the theft of intellectual property. The tariffs are meant to roughly offset estimates of the value of lost earnings to US companies as a result of forced technology transfers and joint ventures in order to gain access to China’s markets. In response to the US actions, China announced it will add tariffs of $3 billion on imports from the US and called for a dialogue to address trade conflicts. China has also threatened to retaliate against the levies by halting purchases of certain agricultural products from states that President Trump won in the 2016 general election, a move aimed at hurting the president politically. Not all the news on the trade front was adversarial this week, though. In a NAFTA breakthrough, the US dropped its demand that 50% of the content of vehicles assembled in Canada or Mexico originate in the US, a major concession that makes a renegotiation of the agreement somewhat more likely.
• US stocks suffered steep losses for the week against a remarkably turbulent geopolitical backdrop. The large-cap Standard & Poor’s 500 Index eclipsed its sharp drop in early February and recorded its worst weekly loss since the start of 2016. The technology-heavy Nasdaq Composite performed even worse, weighed down in part by a steep drop in Facebook shares following revelations about undisclosed use of customer data. Likewise, technology shares fared especially poorly in the S&P 500 Index, along with financials and health care stocks. Conversely, energy stocks managed to escape the week’s downdraft, thanks to a rally in oil prices to seven-week highs following reports of a drawdown in crude inventories. The declines took most of the indexes back into negative territory for the year to date.
• The yield on the 10-year Treasury note moved back to multiyear highs on Wednesday but declined on Thursday, as investors sought perceived safe havens in response to trade worries. Municipal bond returns were flat for the week. While the primary driver of activity, new issuance, continued to be extremely light, cash flows into the sector forced investors to look for longer-term issues in the secondary market, leading to a flattening of the yield curve.
• US PCE core inflation for February is due for release on Thursday. CPI core came in at 0.2% month-on-month in February and, therefore, PCE core inflation is expected to come in at 0.15% month-on-month, which translates into 1.5% year-on-year, unchanged from January. Normally, there is some noise in the data, so not much should be read into the stronger-than-expected numbers from December and January.
• Personal spending numbers for February are also due this week. Retail sales fell for the third month in a row in February, which is surprising as consumer confidence is extremely high. This points to a slowdown in consumer spending in Q1 but overall there is a positive consensus on private consumption due to the high degree of optimism among others.

UK

• The Bank of England kept its benchmark interest rate steady at 0.5%, noting that wage growth is firming up in response to a tightening labour market. BoE projected that inflations are expected to moderate but to remain above the 2% target. Data released earlier have shown that headline inflation has cooled more than expected whereas unemployment rate has dropped with wage growth picking up. BOE mentioned that policy tightening will be carried out at a gradual pace and to a limited extend, setting the pace to a hike in the coming May meeting.
• According to the BoE, the prospects for global GDP growth remain strong and financial conditions continue to be accommodative, with little persistent effects from the recent financial market volatility. According to the BoE, the latest activity indicators suggest that the underlying pace of GDP growth in the first quarter of 2018 remained similar to that in the final quarter of 2017. Overall, the bank staff’s usual models suggested that underlying GDP would grow by around 0.4% in Q1 2018, in line with the estimate in the February Inflation Report. However, after incorporating an initial judgement on the impact of the weather-related distortions, the BoE’s estimate of headline GDP growth was revised down to 0.3% for Q1 2018. CPI inflation fell from 3.0% in January to 2.7% in February, which was 0.2 percentage points below the estimate of the BoE. However, that news had partly reflected changes to the CPI component weights by the ONS, which had weighed on inflation. The BoE still expected inflation to ease further in the short term but to remain above the target. The BoE said that pay growth continued to pick up, in line with expectations at the time of the February report, and that the firming of shorter-term measures of wage growth in recent quarters and a range of survey indicators suggested pay growth would rise further in response to the tightening labour market. This had provided the MPC members with increasing confidence that growth in wages and unit labour costs would pick up to target-consistent rates.
• In the UK, the most interesting release is the service index (measuring actual growth in the service sector) in January.

EU

• In March, the Markit Composite index in the Eurozone decreased more than expected to 55.3 from previously 57.1. The surprising decline was more pronounced than in February, and it brought the activity barometer down to the lowest level in 14 months. This suggests that the slowdown is more of a fundamental nature and not just a reaction to the financial market jitters earlier in the year. The moderation might very well be influenced by increasing worries about protectionist trade tendencies as well as an effect of the stubbornly strong EUR. This compares well with weakness being greatest within the manufacturing PMI and, in particular, the new orders index took a hit for the third month in a row. National level PMI showed an even more marked decrease in Germany. Even though the Composite PMI index has fallen for two straight months, the high starting point in January implies that the average for the first quarter is almost in line with the healthy reading from fourth quarter 2017, indicating unchanged robust GDP growth. However, the weaker momentum suggests that second quarter growth might very well prove weaker.
• European Union leaders met in Brussels last week to discuss, among other things, the transition deal that will govern the United Kingdom’s relationship with the EU for nearly two years after Britain leaves at the end of March 2019 and to pave the way for free trade talks. Most major issues have been resolved, but not how to regulate the movement of people and products across the border between Northern Ireland and the Republic of Ireland.
• European stocks dipped to lows not seen since early 2017. Investor sentiment remained fragile as tensions between US and China heightened. While the US temporarily exempted European Union nations from looming steel and aluminium tariffs, it apparently was not enough to quell concerns from investors about a potential trade war between the world’s two biggest economies. Stocks plummeted for three consecutive days at the end of week due to lacklustre economic data as well as the announcement of US import tariffs. The pan-European index STOXX 600, Germany’s export-heavy index DAX 30, the UK blue chip FTSE 100, and France’s CAC 40 all gave up between 1% and 4% for the week. Basic resource, technology, and bank stocks were some of the weakest segments.
• In the euro area, HICP figures for March are due for release this Wednesday. Since November 2017, there have been declining headline inflation, falling from 1.5% year-on-year to 1.1% year-on-year in February. Mainly temporary energy and food price base effects have driven the decline. However, the effect is likely to wear off in March, causing headline inflation to bounce back to 1.5% year-on-year. Headline inflation is expected to remain at 1.4% to 1.5% in coming months.

China

• China’s benchmark stock indexes slumped Friday and recorded their worst weekly performance in six weeks amid fears of an escalating trade war with the US. The Shanghai Composite Index and the blue chip CSI 300 Index shed 3.6% and 2.9%, respectively, with each benchmark notching its lowest close since early February. The steep declines prompted intervention by China’s government-backed investment funds, which habitually step in to prop up domestic stock markets on days of big losses. Mainland stock markets slumped after Beijing unveiled plans to impose tariffs on up to $3 billion of US imports, a day after President Trump imposed tariffs on $60 billion of Chinese-made products and tighter restrictions on acquisitions and technology transfers.
• China PMI manufacturing is due this week. A decline in Caixin PMI manufacturing from 51.6 to 51.0 is possible since the Chinese financial tightening is likely to start feeding through to a weaker domestic economy. At the same time, the euro area is slowing a bit, which may feed into Chinese exports. The scenario of a moderate slowdown is currently underpinned by some softening of metal prices, which generally tends to be a good real-time indicator for Chinese PMI.

Sources: Wells Fargo, T. Rowe Price, Handelsbanken Capital Markets, Hong Leong Bank, Danske Bank, MFS Investments.