Economic Outlook – 27 May 2018

US

• New US home sales declined 1.5% in April, dropping to an annual pace of 662,000 units. This was better than the consensus estimate of a 2.1% decline. However, March new home sales were revised downward to a 2.0% monthly gain from a first reported 4.0% rise. New home sales are now 8.4% higher year-to-date than this time last year. Sales of new homes that have not yet been started jumped 40,000 units in April, the largest jump in five months, to 221,000 units. This increase in sales of homes not yet started points to strength in housing starts in the months ahead. New home sales are off to a solid start in 2018 behind consistently strong demand due to solid job and income growth.
• Existing US home sales also dropped in April, slipping 2.5% to a 5.46 million unit annual pace. The pace of existing home sales came in lower than the 5.55 million unit annual pace expected by the consensus. The entirety of the drop came from a slowdown in single-family homes, which were down 3.0% on the month, while condos and co-ops picked up by 1.6%. The typical home for sale was on the market for just 26 days before being sold in April, down from 29 days a year ago. Homes are selling quickly, which is capping inventory growth. Prices also continue to rise along with mortgage rates, which could dampen demand and price potential buyers out of the market.
• US durable goods orders retraced in April following consecutive months of gains. Orders fell 1.7% on the month, which was worse than consensus. Transportation orders fell 6.1% as aircraft orders declined a whopping 29%. Transportation spending has been a key driver of fixed investment, and backlogs in the sector are rising, which bodes well for future transportation spending. Core capital goods orders, which exclude defence and aircraft orders, rose a solid 0.9% on the month.
• US consumer sentiment fell once again in May according to the University of Michigan. However, high overall levels of consumer sentiment since the presidential election are consistent with improving economic growth and consumer spending figures. Current economic conditions were responsible for the entirety of the drop in May, driven by rising gasoline prices. Consumers expecting gas prices to rise over the next year jumped 15 points. Consumers are also concerned about household finances as the run-up of asset prices could be reaching their peak in their view.
• A sudden shift in tone from North Korean officials in recent weeks prompted US president Donald Trump to cancel a summit with North Korean Leader Kim Jong Un, Trump said in a letter to Kim. The meeting had been scheduled for 12 June in Singapore. US secretary of state Mike Pompeo said that summit preparation talks had broken down, making a successful outcome for the summit unlikely. Differing interpretations over the term “denuclearisation” were at the core of the recent uptick in friction between the two sides. In his letter, Trump left open the option of future talks should the North Korean leader have a change of heart. For its part, North Korea indicated it is open to resolving differences and willing to meet at any time.
• President Trump signed a bill into law Thursday that rolls back some of the regulatory burden placed on small- and medium-sized banks in the wake of the global financial crisis. The law raises the threshold on systemically important banks to $250 billion in assets from $50 billion previously while easing mortgage loan reporting requirements for the majority of banks, among other measures.
• Minutes of May’s meeting of the Federal Open Market Committee show that the US Federal Reserve is likely to maintain its pace of gradual policy tightening. Another quarter-point hike at the 13 June meeting is widely expected by markets, which are trying to determine whether the Fed will hike a total of three times or four times in 2018. The odds of a fourth hike decreased after the release of the May minutes.
• Last week there was a plunge in oil prices and energy shares. On Monday, oil prices reached their highest level since late 2014 on speculation that the US would impose new sanctions on Venezuela after the country’s leadership solidified its control in allegedly corrupt elections over the weekend. Venezuela has the largest proven oil reserves in the world, although its production has been constrained by the country’s economic collapse.
• The major indexes were flat to slightly higher in light trading ahead of the Memorial Day weekend. The small-cap Russell 2000 Index lagged, reversing a recent stretch of outperformance that brought the benchmark to record highs. Energy shares performed worst within the S&P 500 Index, while utilities stocks recorded solid gains as longer-term bond yields fell, making their relatively high dividend yields more attractive in comparison.
• The dovish tone of the Fed minutes and growing demand for perceived “safe-haven” assets amid geopolitical uncertainty helped push longer-term Treasury yields substantially lower for the week. Municipal bond issuance remained muted during the week, but the few deals that priced were well received.
• The most important release in the US is the jobs report for May on Friday. Once again, the most interesting part is the average hourly earnings. Wages are expected to rise +0.2% month-on-month in May in line with the recent trend, implying an unchanged annual growth rate of 2.6% year-on-year. Even if wage growth surprises on the upside, one should not expect the Fed to accelerate its hiking cycle, as it has said it tolerates inflation overshooting the 2.0% target temporarily and the upper limit seems to be three additional hikes this year.
• ISM manufacturing for May is due out this week. Based on the regional PMIs and Markit PMI manufacturing, it probably rose and it may have rebounded from 57.3 to 58.0. This does not change the consensus view that the US manufacturing indices should move lower in 3-6M.

UK

• British annual producer price inflation has been overestimated by an average of 0.3 percentage points every month since December due to errors related to rubber and plastic products, the Office for National Statistics said on Friday. The ONS said it was revising down April producer output price inflation to 2.4% from 2.7% and making similar changes to the rate of producer price inflation for December through March.
• Prime Minister Theresa May wants to extend the transition on customs and trade to 2023 (and not just to the end of 2020) in order to buy some time to find a more permanent solution. A White Paper on the government’s position is due out in June. Also, the House of Commons is going to discuss the House of Lord’s amendments to the EU withdrawal bill, which is also going to be a war between the soft and hard Brexiteers.
• The number of mortgages approved for house purchase by major British banks rose to a three-month high in April but was still nearly 10.0% lower than a year earlier, industry figures showed on Friday. Trade body UK Finance said 38,049 mortgages were approved for house purchase on a seasonally adjusted basis in April, recovering from March’s three-month low of 37,606 but 9.4% lower than in April 2017.
• On Friday, the PMI manufacturing index for May is due out. The UK index is more volatile (bigger swings) than the equivalent index for the euro area and since it fell in May, the UK index may very well follow. The fall is expected to be smaller.

EU

• Europe’s General Data Protection Regulation (GDPR) came into force last week. The measure applies to any firm doing business in the European Union and outlines privacy rights and data collection responsibilities. The fines for breaking the rules are astronomical, up to 4.0% of a firm’s annual worldwide revenue or €20 million, whichever is higher.
• The Eurozone flash PMI disappointed in May when it unexpectedly fell for another month to 54.1, from previously 55.1. Hence, after showing signs of stabilising in April, the sentiment slowdown gained speed again in May. This is the lowest sentiment reading in 18 months and it causes further questions on whether the economic weakness in the first quarter was temporary and dampens the potential for a rebound in activity in the second quarter. Hence, given that the June PMI maintains the May level, it suggests that annual GDP growth decreases a notch further in second quarter (see figure). Even though PMI seemed too high at the turn of the year and has now adjusted down to actual growth, the further fall causes questions as to whether the first quarter GDP slowdown was merely of transient nature.
• Nearly three months after going to the polls in early March, an alliance led by a law professor has been given a mandate by Italy’s president to form a government. The coalition, made up of two out of the establishment parties with very different agendas, has put forth Giuseppe Conte as the prime minister designate. Markets await news on the makeup of the cabinet, which they believe will indicate how far the government is willing to push against the status quo. Italian yields have risen sharply in recent sessions as the 5-Star Movement and The League fleshed out their program. Investors are concerned that the combination of a rollback of pension reforms, tax cuts and increased social spending could dramatically increase Italy’s budget deficit.
• Geopolitical uncertainty and soft economic data led to European market volatility during the week, as investors wrestled with the ever-changing developments regarding an historic meeting between the U.S. and North Korea, as well as growing concerns about political issues in Italy, Spain, and the UK. The pan-European STOXX 600 Index posted a weekly loss, breaking its longest string of gains since mid-2014. The index had a notable late-week dip after President Trump called off the planned summit with North Korea’s Kim Jong-un. Stocks recovered somewhat after a measured response from Kim Jong-un that may have mollified some skittish investors.
• In the Euro Area, the HICP figures for May are due for release on Thursday. After increasing to 1.3% year-on-year in March, headline inflation declined to 1.2% year-on-year in April. A large increase is expected to 1.6% in May, driven largely by energy price inflation. Headline inflation is also expected to remain at this level temporarily, before falling back down to around 1.4% to 1.5% at the end of the year.

China

• While stopping short of agreeing to the US demand that China slash its trade surplus by $200 billion, negotiators from the US and China agreed to a framework in which China will increase purchases of US products, particularly agricultural and energy-related products, strengthen intellectual property protections and improve market access to US companies. Already last week, China has cut its passenger car tariff from 25% to 15% and ordered state-owned enterprises to increase purchases of US goods. However, many details are yet to be worked out. The US also agreed to the outlines of a deal that would save Chinese mobile phone giant ZTE. The US will allow the firm to import American-made components if it makes significant changes in its management and board of directors, as well as pay possible fines. That proposed deal is getting pushback from Capitol Hill because it would not sufficiently punish ZTE for evading US trade sanctions on North Korea and Iran.
• China’s benchmark stock indexes posted their biggest weekly drops in a month, capping a week marked by geopolitical volatility after President Trump pulled out of the summit with North Korea’s leader and Sino-US trade tensions remained on low boil. By Friday’s close in Shanghai, the blue chip CSI300 Index and the Shanghai Composite Index had given up 2.2% and 1.6%, respectively, marking the worst weekly decline for each since late April.
• Capital restrictions are once again being loosened in China, with domestic stock and bond markets being opened up for foreigners. This is part of China’s strategy to integrate its financial markets with the rest of the world, and ultimately to make the CNY a new global reserve currency. Opening up does not necessarily imply net capital inflows and give a stronger currency; this leads in the direction of a slightly weaker CNY versus the USD in the short run amid general USD strength.
• China PMI data will be released this week. A small decline in both the official PMI manufacturing as well as the Caixin PMI manufacturing is in order. This is based on weaker momentum in industrial metal prices, which tend to be a good short-term indicator for Chinese activity as China consumes 50% of global metals. Chinese tightening measures are expected to lead to a soft landing this year.

Sources: Wells Fargo, T. Rowe Price, Handelsbanken Capital Markets, MFS Investments, Reuters, CaixaBank.