Economic Outlook – 26 January 2020

US

• The December existing home sales print rose a solid 3.6% to a 5.54 million-unit pace as the housing market renaissance continues. Lower mortgage rates have brought buyers back into the market, particularly in the South and West, where population and employment growth remain the strongest. The rebound in existing home sales follows a string of positive housing reports and will have sizable pass-through effects, including realtors’ commissions and remodeling spending. Inventories are extremely low, however, which is driving price appreciation higher again (the median single-family home price rose 8.0% year-on-year in December) which is spurring more construction. Housing starts reached a 13-year high in December and builder optimism is holding near 20-year highs. With this backdrop and no discernible uptick in jobless claims, the housing market is clear for further gains.

• Activity in the US service sector improved in January, according to data released by Markit. Its preliminary service sector purchasing managers’ index for January rose to 53.2 from 52.8 in December. The manufacturing PMI declined to 51.7 from 52.4 the prior month.

• France and the US have agreed to await further negotiations being led by the Organization for Economic Cooperation and Development (OECD) over the taxation of digital services provided mainly by Silicon Valley technology giants. The OECD plans to unveil a universal cross border system by the end of the year, which could allow governments to tax companies that have no physical operations in their countries. France was set to move ahead with its own digital tax, while the US was preparing to levy retaliatory tariffs before reaching a short-term truce at the World Economic Forum in Davos, Switzerland last week. The United Kingdom is exploring its own version of the tax, a factor that could complicate post-Brexit US-UK free trade talks. While in Davos, US President Donald Trump repeated that he will tariff US imports of European autos and auto parts if the European Union does not reach a trade agreement with the US. Officials from the US expressed hope that a deal can be reached before the end of the year

• US stocks closed lower for the holiday-shortened week, as more quarterly earnings reports rolled in and investors worried about the coronavirus outbreak in China. The large-cap benchmarks and the technology-heavy Nasdaq Composite Index outperformed and touched new record highs before falling back sharply on Friday. Markets were closed Monday in observance of Martin Luther King Jr. Day. Utilities shares outperformed, helped by a steep decline in longer-term bond yields, which heightens the appeal of utilities’ relatively attractive dividends. Energy shares lagged as oil prices continued the decline they began on January 6. Expectations for a drop-off in global tourism in the wake of the coronavirus appeared to play a role in driving concerns over oil demand. Wynn Resorts and Las Vegas Sands were also particularly weak given the prospect of a decline in visits to their casinos in Macau.

• Fears over the coronavirus outbreak clearly eclipsed economic data in the fixed income markets, as investors sought the safe haven of Treasuries. The yield on the benchmark 10-year Treasury note plunged to its lowest level in about three months on Friday.

• Next week will feature bigger headlines, with a Fed meeting and fourth quarter GDP data. There won’t be any fireworks from the FOMC, which is widely expected to leave rates unchanged. The narrative of a strong consumer and resurgent housing sector, alongside weak business investment, remains intact since December’s statement.

• GDP will be released on Thursday and the fourth quarter economic growth is forecast to post a respectable 2.1% annualised gain on the surface. However, the details are likely to show the US economy ended 2019 on a soft note. Consumer spending is tracking low a 2.0%, and business investment is looking flat to slightly negative. Residential investment is one area expected to be quite bright, but it is relatively small. A large drop in imports is the main factor keeping growth above 2.0%, but that is not a positive sign for demand.

UK

• Queen Elizabeth II assented to the Brexit withdrawal bill, the final leg in journey that began three and a half years ago. European Union leaders and the European parliament are expected to rubber stamp the deal this week. Negotiations will then begin on the future relationship between the UK and the EU, with negotiators from the UK suggesting they will not attempt to closely align with existing EU rules, a potential negative for UK exporters. However, business optimism has risen sharply in the wake of December’s general election, with the Confederation of British Industry reporting the biggest jump in optimism since the measure was created in 1958. 

• UK Chancellor of the Exchequer Sajid Javid said in an interview with the Financial Times that the UK would not seek regulatory alignment with European Union rules and intends to be out of the single market and customs union by the end of the year. He said the government would not support big manufacturers that favor alignment with EU rules. Javid’s comments represent a shift in the UK’s negotiating stance. But the change in stance caused dismay in the UK auto industry and in Brussels, where officials were quoted by the FT as saying a divergence from EU rules would be economically damaging. Javid then sought to reassure businesses that there would be no wholesale dumping of EU regulations. He also said that the government would always protect British business interests and maintain high standards.

• British employers offered their staff a median annual pay settlement of 2.2% in the three months to December, down from 2.6% in the three months to November. Experts said the slowdown, based on 23 pay deals between October and December, meant that awards in 2019 rose by an average of 2.5%, the same as 2018, and there were similar signs at the start of this year.

• Britain’s government borrowed less than expected in December but there were signs the economy’s weakness was hurting corporate tax receipts, while a pay-rise for health workers pushed up spending. Borrowing excluding public sector-owned banks in December alone fell slightly compared with a year earlier to 4.765 billion pounds, according to the Office for National Statistics.

• The Bank of England is deciding if to cut rates next week on Tuesday. The BoE is closer to cutting interest rates than at any time in the last three years, as governor Mark Carney chairs his last policy meeting and Britain finally leaves the EU. Growth at the tail end of 2019 slowed to its weakest since 2012, prompting Carney and two other policymakers to speak publicly about the possibility of a rate cut, adding their voices to two others who had already voted for looser policy. But there has been a bounce in business and consumer sentiment since Prime Minister Boris Johnson won re-election on December with a bigger than expected majority. Twinned with a tight labor market, this undermines the case for a cut by Britain’s central bank.

EU

• The Eurozone Flash Composite PMI remained unchanged at 50.9 in January compared to the previous month and below expectations. Meanwhile, the Manufacturing PMI was 47.8 compared to 46.3 the month before – above expectations and an extremely high monthly increase by historical standards. Furthermore, the Services PMI was 52.2 compared to 52.8, below expectations. Despite the positive news from German and eurozone manufacturing, this failed to boost composite activity enough to outweigh the easing services sector. As such, although the geographical and to some extent sectoral composition that drives the region changed somewhat, the aggregate picture remains roughly the same.

• The German Flash Composite PMI was 51.1 in January compared to 50.2 December, the Manufacturing PMI was 45.2 compared to 43.7 and the Services PMI was 54.2 compared to 52.9, with all indices well above expectations. The increase across the board in PMI indices is a welcome start to 2020. Whereas the upturn in the Composite index is rather modest, the increase in manufacturing is very large by historical standards, the 1.5 increase in from the previous month corresponds to the top 25th percentile in the distribution of month-on-month changes since 2005.

• The French Flash Composite PMI was 51.5 in January compared to 52 in November, the Manufacturing PMI was 51 compared to 50.4 and the Services PMI was 51.7 compared to 52.4. Whereas the Composite and Services PMIs were below, Manufacturing was above expectations. The milder uptick in the services sector outweighed the slight increase in the manufacturing sector.

• European stocks finished little changed, recovering from earlier weakness after economic data showed the German economy might be picking up steam, and the World Health Organization stopped short of declaring the coronavirus outbreak in China a global health emergency. The pan-European STOXX Europe 600 Index ended the week up 0.08%, while Germany’s DAX Index rose 2.1%.

• In terms of data release, GDP for Q4 should give more insight into how the weak 2019 ended, while preliminary inflation for January will tell whether the recent increase in core inflation is only noise, or whether it is for real.

China

• At least 11 Chinese cities, above all them the important transportation hub of Wuhan, are on lockdown ahead of Lunar New Year celebrations as officials scramble to contain the spread of a deadly coronavirus. Many public celebrations have been cancelled, and travel is being curtained during one of year’s busiest travel periods. Early estimates suggest the epidemic could shave 0.5% to 1.0% from China’s projected 2020 growth rate of 6.0%. As a result, prices for commodities such as oil have fallen as have most interest rates, amid dampened prospects for a global economic rebound following last year’s trade disruptions. Despite isolated case appearing in multiple countries, including the United States, officials from the World Health Organization have so far stopped short of declaring the outbreak a public health emergency of international concern.

• The sudden appearance of a new coronavirus in Wuhan, a city of 11 million people in central China, shook Chinese markets. Reminiscent of the SARS outbreak in 2003, the Shanghai Composite Index suffered its biggest one-day fall (2.8%) in over eight months on the last day of trading before the Chinese New Year lunar holiday. From Monday’s close through Thursday’s close, the Shanghai Composite Index lost 3.8%, and the CSI 300 large-cap index declined by 4.3%.

• While growth has been improving in China since Q3, the spread of the virus is bound to have a negative effect on the Chinese services sector, as people will travel less than usual and not go out to restaurants, movies, etc. as long as the virus is still spreading. In the short term, the virus has increased uncertainty, not least for the Chinese economy and markets.

• This week, the official data on China’s manufacturing PMI and non-manufacturing PMI are due to be released. Normally most attention is paid to manufacturing but the non-manufacturing PMI may be more in focus this time, as a gauge of any impact of the virus on the services sector.

Sources: T. Rowe Price, MFS Investment Management, Handelsbanken Capital Market, Danske Bank, Wells Fargo, TD Economics, Reuters, M. Cassar Derjavets.