Economic Outlook – 26 August 2018

US

• US existing homes sales declined 0.7% to 5.34 million units in July. Single-family sales fared slightly better and only experienced a 0.2% drop, while condos and co-ops fell 4.8%. Total resales have now declined on a monthly basis in each of the past four months and are trending 1.5% below year-ago levels. The parade of disappointing housing data continued with new home sales, which also came in below consensus and fell 1.7% in July. The monthly decline followed a 2.4% drop in June.
• Several factors appear to be limiting home sales. Existing homes only lasted an average of 27 days on the market, slightly less than the 30-day average registered in July 2017. 55% of the existing homes sold were also on the market for less than a month. Tight inventories are more of a concern. On a year-over-year basis, total inventories of existing homes remained essentially flat; however, this followed 37 consecutive months of declines. Home prices also remain high. The National Association of Realtors reported that the median home price for an existing single family home eased somewhat to $272,300, but this followed prices hitting a record high of $276,500 in June.
• Top-line durable goods orders slipped 1.7% in July. However, much of the monthly drop was in the transportation sector, as both civilian and military aircraft orders fell more than 34%. Excluding the volatile transportation component, there was fairly broad-based strength, as orders increased 0.2%, and non-defence capital goods orders excluding aircraft rose 1.4%. Orders in other categories are still positive and unfilled orders of non-defence aircraft elevated.
• Fed Chair Powell gave a speech in Jackson Hole on Friday. He emphasised his view that the economy has “strengthened substantially” and there is “little risk of overheating.” This makes a September rate hike all the more likely, as the minutes of the latest FOMC meeting released earlier last week revealed that participants’ views of the economic outlook had also strengthened despite the noted potential downside risks of trade and the housing sector. This also firms up the stance that the Fed should hike rates two more times this year in September and December, with two additional quarter-point hikes in 2019.
• Last Wednesday, the US stock market set a record for the longest-ever bull market (9 years, 5 months, 13 days). The S&P 500 Index rose to its first intraday record in nearly seven months on Tuesday, tying the length of the longest bull run seen from 1990 to 2000. The latest leg of the S&P bull run can be attributed to strong US economic growth and renewed strength in quarterly corporate earnings.
• The US and Mexico resumed North American Free Trade Agreement talks and indicated that they are closer to resolving some of the issues that have stalled the negotiations, which are focused on revising the rules of origin for autos. Both countries are looking to sort out bilateral trade issues, hopefully in the next few days, before Canada rejoins the conversations. Canada, however, reiterated that it would need to be satisfied with the new auto rules. If all three countries cannot come to an agreement before Mexican president Enrique Peña Nieto leaves office in December, things could become more complicated, as new Mexican president Andrés Manuel López Obrador would want a say in the deal.
• President Trump made statements expressing his hope that Federal Reserve Chair Jerome Powell would keep interest rates low, and he accused both China and Europe of manipulating their currencies toward lower levels to boost their exports to the US. Low-level trade talks between the US and China took place in Washington D.C., but little progress toward an agreement on trade was reported. Trump’s rhetoric on the Fed and currency manipulation helped drive the US dollar lower for much of last week.
• US Treasury yields decreased modestly over last week. Trump’s hawkish talk about wanting Fed policymakers to keep interest rates low may have helped boost demand for Treasuries. New issuance of municipal bonds was light, helping to support that market. There is a lack of conviction in the market about the direction of Treasury yields amid the late-summer doldrums.
• In the US, the most important event this week will be PCE core inflation numbers for July. Based on CPI, PCE is expected to rise +0.2% month-on-month, which translates into 2.0% year-on-year, up from 1.9%. This means that inflation numbers will hit the Fed’s 2.0% target. The steady increase in PCE data supports the expectations of a total of four US rate hikes in 2018, with the last two hikes likely to come in September and December.

UK

• British banks approved fewer mortgages last month, despite a boost from existing homeowners seeking to lock in cheaper interest rates ahead of the Bank of England’s rate rise in August. The number of mortgages approved for new house purchases dropped by 4.3% on the year to 39,584 on a seasonally adjusted basis, figures from trade association UK Finance showed, and net mortgage lending was the weakest since February.
• British retail sales growth picked up unexpectedly in August, but major store chains anticipate sharp falls in employment in the months ahead. The Confederation of British Industry’s (CBI) monthly retail sales gauge rose to +29 in August from +20 in June. A Reuters poll of economists had pointed to a fall to +13. Despite a strong August, the CBI said retailers were downbeat about the outlook.
• The British pound fell against the dollar, and the FTSE 100 Index was flat as the government released contingency plans for a “no deal” Brexit, which would take effect if the UK and European Union (EU) fail to agree to an exit deal before the March 2019 date for the UK’s departure. The release of the plans has been seen as a signal that the UK is serious about walking away from talks with the EU if it doesn’t get a satisfactory deal to leave the union.
• There are no market movers in the UK this week.

EU

• In the EMU, the Composite PMI continued on a more stable path on the back of the decline through H1 2019. The PMI index increased slightly to 54.4 from previously 54.3, almost in line with expectations. Hence, the PMI still trends fairly flattish but the Manufacturing PMI decreased to the lowest level since 2016 (at 54.6), probably still burdened by protectionist worries. Meanwhile, there was little comfort from the Service PMI, which only increased slightly to 54.4. The service sector is expected to gain further optimism, and this supports the view that domestic demand will be the prime driver behind the expectation of slightly higher GDP growth in H2 this year.
• The pan-European Stoxx Europe 600 index rose slightly, snapping three weeks of declines, and the euro gained ground against the US dollar despite ongoing trade tensions and political worries.
• The Italian bond market remained the centre of risk aversion, however, amid fears that the country’s populist coalition government would increase spending as it negotiates its first budget. The yield on the 10-year Italian note climbed to 3.09% as worries rose that increased spending could cause Italy to miss its fiscal targets and create tension with the European Commission, which monitors compliance with eurozone economic policies.
• In the euro area, the HICP figures for August are due for release on Friday. In July, headline inflation reached 2.14% year-on-year, the highest level since 2012 and just above the ECB’s target. The August print is expected to decrease slightly to 2.08% YoY as the positive contribution from energy prices has peaked.
• European core inflation remains muted at 1.07% year-on-year in July; a level it has been fluctuating around since the beginning of 2017. The August figure is expected to edge up marginally to 1.12% year-on-year in line with the recent trend of gradually rising underlying inflation pressures, not least driven by accelerating negotiated wage growth (1.8% year-on-year in Q1 2018).

China

• The United States and China ended their two-day, midlevel trade talks with no progress in sight, reducing the prospects of a deal soon. China seemed unwilling to further address either the Trump administration’s concerns about the bilateral trade deficit, which the US finds too steep, or Beijing’s efforts to get US companies to transfer technology to Chinese partners. A senior US official said that China must address issues raised by the US to get a positive result from these engagements. No discussions took place regarding follow-up talks or any accomplishments. Amid the talks, the US went ahead and imposed tariffs on an additional $16 billion in Chinese goods, raising the total to $50 billion; China immediately responded with similar tariffs on US goods.
• China’s currency remained in focus as officials from both countries eyed the yuan’s recent weakness with growing concern. The yuan fell for the eleventh-straight week, extending a record-long slide, and is down almost 9.0% since the end of March as trade relations with the US have worsened.
• In an interview with Reuters last Monday, President Trump said that China was “absolutely” manipulating its currency; the latest in a string of unsubstantiated accusations that China was deliberately weakening the yuan for economic gain. Trump’s remarks drew a pointed response the following day from a Chinese central bank official, who said that the yuan’s level is determined by the market and that China would not use its exchange rate as a weapon.
• There are no market movers in China this week.

Sources: Wells Fargo, T. Rowe Price, Reuters, Handelsbanken Capital Markets, MFS Investment Management.