Economic Outlook – 28 January 2018

US

• Fourth quarter US GDP rose 2.6% on an annualised basis following the third quarter’s 3.2% rate of growth. An important measure of core demand, real final sales to private domestic purchasers, climbed to 4.6% on an annualised basis. One of the most impressive aspects of the GDP report was consumer spending, which rose 3.8% for the quarter, led higher by stronger spending on durable goods. Business investment and government spending were both stronger in Q4 relative to Q3. Domestic demand led to growth in imports outstripping growth in exports, which subtracted from headline growth as did a downshift in the pace of inventory building.
• The Leading Economic Index pointed toward further robust US GDP growth readings in the coming quarters. The index rose 0.6% in December to a 9.9% three-month annualised pace. The index was led higher in part by the ISM new orders component. Average hours worked in the manufacturing sector was the only negative factor in the index. The forward momentum was also apparent in the durable goods report, which showed that core capital goods orders were up at a 12.0% three-month annualised pace even after the slight 0.3% decline in December. The stronger demand for core capital goods supports the forecast for business equipment investment to grow an additional 8.0 % in the first quarter of this year.
• US housing market data showed some softening in December with new and existing home sales pulling back for the month. New home sales fell 9.3% for the month, while existing home sales declined 3.6%. The sales declines came on the heels of strong November readings. For existing home sales, tight supply remains one of the biggest factors holding back the overall pace of growth. Existing home supply fell to the lowest level since the National Association of Realtors began the measure in 1999. Even with December’s declines, new home sales are up 2.6% relative to December 2016 and existing home sales are up 1.1%. Residential investment is expected to expand 6.1% this year after the modest 1.7% pace of 2017.
• Treasury Secretary Mnuchin had most headlines, stating that “a weaker dollar is good,” – a reversal of US Treasury mantra. A broad US dollar selloff followed, despite attempts by Ross and Trump to repair the damage. Mnuchin’s comments were criticised by ECB President Draghi who referred to an international agreement last October not to talk down currencies.
• US commerce secretary Wilbur Ross said this week that a decision to place tariffs on imported solar panels of up to 50.0%, phasing out over four years, and on washing machines of up to 30.0%, phasing out over the same term, is not the start of a trade war but rather a response to unfair trade competition as other nations skirt global trading rules. The tariffs fall in the middle of the range of potential remedies available to the administration, and were greeted with a sigh of relief by business groups, who feared they would be stiffer.
• US president Donald Trump addressed an international audience of businesspeople and government officials on Friday at the annual World Economic Forum in Davos, Switzerland. Trump emphasised that “America First” does not mean America alone but that there cannot be free and open trade if some countries exploit the system. “Only by insisting on fair and reciprocal trade can we create a system that works not just for the United States but for all nations.”
• US stocks continued their winning streak in the new year, with the major indexes notching their fourth consecutive weekly gain and moving to new record highs. The large-cap indexes performed much better than the mid- and small-cap benchmarks, however. Within the S&P 500 Index, health care-lifted by some early week biotechnology mergers and consumer discretionary stocks led the gains, while energy, utilities, and consumer staples stocks lagged.
• The most important event this week is the Fed meeting on Wednesday evening, when the Fed is not expected to make any move. Also, major changes to the statement are not expected (notice there will be no press conference and no projections), as markets are already beginning to price in the three hikes the Fed is signalling.
• The US the jobs report for January is also due this week, and it is expected to show that employment has continued to rise. Focus remains on average hourly earnings, as the missing wage pressure despite the tight labour market is still one of the big puzzles. If the growth in average hourly earnings surprises on the upside, it will add fuel to the reflation theme in the financial markets.
• Donald Trump’s State of the Union speech is on Tuesday, and it needs to be followed especially with respect to infrastructure and protectionist trade policy following his tax reform.

UK

• UK GDP growth increased to 0.5% in Q4, from 0.4% in Q3. The consensus expectation for Q4 was +0.4%. The annual growth rate in Q4 was 1.5%, down from 1.7% in Q3. The consensus expectation was 1.4%. According to the preliminary estimate, GDP growth in 2017 was 1.8%, down from 1.9% in 2016. According to the ONS, GDP growth was pulled higher by services, which added 0.45 percentage points (p.p.) to GDP growth in the quarter, up from 0.29 p.p. in Q3.
• The business services and finance sector continued to be the main driver of growth in Q4. However, despite improved services growth in Q4, the growth trend over the past year is down.
• According to the ONS, the weakness is particularly notable in domestic consumer-facing type sectors, such as distribution, hotels and catering, and transport, storage and communications. Growth within industrial production (IP) weakened from Q3, adding just 0.09 p.p. to growth, down from 0.18 p.p. in Q3. However, the deceleration was due to one-off factors.
• As expected, mining and quarrying was affected by the shutdown of the Forties oil pipeline for a large part of December. This sector contributed negative 0.05 p.p. to GDP growth. Manufacturing was the largest contributor to growth within IP, contributing 0.13 p.p. to overall GDP growth.
• The construction sector saw output falling for the third straight quarter; the rate of decrease actually accelerated, contrary to what sentiment had suggested. The construction sector pulled GDP growth down by 0.06 p.p., after 0.03 p.p. in Q3.
• The most important release this week is the PMI manufacturing index for January, which is due on Thursday. The UK index usually follows the equivalent index for the euro area, which fell in January. However, the UK index fell in December despite the European index rising.

EU

• The ECB monetary policy decision text was an exact copy/paste of the December meeting, implying no change to policy or guidance. While that was in line with consensus, some saw a slight possibility of the ECB opting to cancel the guidance for a possible increase in the asset purchase programme. That left all focus on the press conference. There, the ECB president made a slight upgrade of the description of strong economic momentum, which “strengthens further” the ECB’s confidence in rising inflation. It suggests that the ECB could raise forecasts again when due in March. Add to this that Draghi, in the Q&A, saw some signs of wage rises. Meanwhile, Draghi expects inflation to hover around the current rate in coming months. More interesting and widely expected, Draghi included some verbal intervention, as he believes that recent “exchange rate volatility” increases uncertainty. Finally, the prepared introductory text did not mention the “revisit” of communication as the minutes of the December meeting revealed will happen early in 2018, but he reminded us that the relative influence of policy pillars will change during the year.
• The leadership of Germany’s Social Democratic Party (SPD) narrowly voted last weekend to enter into formal coalition talks with Chancellor Angela Merkel’s Christian Democratic Union. If talks progress toward forming a so-called “grand coalition” of the country’s two largest parties, the agreement will have to be put to a vote of the entire 440,000 membership of the SPD. The process, if successful, could continue until April. Should talks fail, Germany faces the prospect of a snap election.
• In the euro area, the GDP growth figures for Q4 17 are due for release on Tuesday. Growth was strong in the first three quarters of 2017, with the latest print for Q3 at 0.7% quarter-on-quarter. Both survey and activity indicators have pointed towards continued strong growth. Composite PMI averaged 57.2 in Q4 (up from 56.0 in Q3), unemployment has edged below 9% and industrial production has showed further expansion. Thus, Q4 GDP growth is expected to be reported as 0.6% quarter-on-quarter.

China

• Industrial profits in China rose at the slowest pace in a year in December from a year ago, capping a year of strong growth that is expected to yield to a slowdown in 2018 as Beijing presses on with its campaign to reduce credit risks in the economy. Industrial profits increased 10.8% in December from the prior-year period in local currency terms, down from November’s 14.9% gain. For the full year, industrial profits jumped 21.0%, the fastest pace since 2011, driven by cuts in excess capacity, the statistics bureau reported. Economists chalked up last month’s industrial profits slowdown to a nationwide pollution crackdown targeting smokestack industries, as well as to slower growth in inflation as measured by China’s producer price index (PPI). The PPI rose at its slowest pace in 13 months in December. Last year’s rising PPI readings underscored China’s buoyant economy, allowing the country’s industrial companies to report strong profits growth in 2017. Growth in China’s PPI and industrial profits is expected to moderate in the coming months, as officials have pledged to rein in credit growth and take other steps to reduce risks stemming from too much debt. Though China’s recent de-risking measures have helped allay investors’ near-term worries about the country’s outlook, an unexpectedly severe slowdown in China remains a major concern for global investors.
• The focus this week in China is on the PMI data for January and industrial profits. A small decline is expected in PMI manufacturing from Caixin to 51.2 (consensus 51.5), down from 51.5 in December. However, this would still leave it at a robust level. Strong Chinese exports seem to be compensating for a slowdown in the housing market. Strong profit growth supported by higher producer prices is also underpinning activity.

Sources: MFS Investment Management, Danske Bank, Wells Fargo, TD Economics, T. Rowe Price, Handelsbanken Capital Markets, Hong Leong Bank.