Economic Outlook – 28 January 2024

Real GDP expanded 3.3% annualized in the fourth quarter, a lot more than the median economist forecast calling for a +2.0% print. Year on year, real GDP expanded 3.1%. Domestic demand grew at a healthy clip in the three months to December, supported by household consumption (+2.8% QoQ annualized) as well as investment in structures (+3.2%) and in intellectual property products (+2.1%). Business investment in residential structures (+1.1%) and in machinery and equipment (+1.0%) expanded as well, albeit at a more tepid pace. Government spending rose 3.3% annualized. Counter to expectations, household spending grew at a faster pace in the goods segment (+3.8%) than in the services segment (+2.4%). Be that as it may, consumption growth was nonetheless solid in both categories. Trade had a positive impact on growth (+0.43 percentage point) as exports growth outpaced imports growth (+6.3% vs. +1.9%). Inventories, for their part, added 0.07 percentage point to the headline GDP figure. The Personal Consumption Expenditure Price Index excluding food and energy climbed an annualized 2.0% in Q4, just as it did in Q3 and the least since 2020Q4. YoY, the index slid from 3.8% to an 11-quarter low of 3.2%. The saving rate, for its part, dropped from 4.2% to 4.0%, further below the 10-year average for this indicator (5.8%)   Nominal personal income increased 0.3% in December, a result in line with the median economist forecast. The wage/salary component of income showed a 0.4% gain, whereas income derived from government transfers edged up 0.1%. Personal current taxes, meanwhile, rose 0.3%. All this translated into a 0.3% increase in disposable income   Nominal personal spending, for its part, rose 0.7%, more than the 0.5% print expected by consensus. Adding to the positive surprise, the previous month’s result was revised upwards, from +0.2% to +0.4%. Outlays on goods jumped 0.9%, while services spending increased 0.6%. As disposable income grew at a weaker pace than spending, the savings rate fell from 4.1% to a 1-year low of 3.7%, a level far below those observed before the pandemic (between 6.5% and 8.5%)   The headline PCE deflator came in at 2.6%, unchanged from the prior month and in line with consensus expectations. The core measure, for its part, cooled from 3.2% to a 33- month low of 2.9%. On a monthly basis, both the headline index and the gauge excluding food and energy rose 0.2%. Core services PCE excluding housing, a measure closely followed by the Fed, advanced 0.3% in December and was tracking a 2.2% gain on a 3-month annualized basis, the lowest print in three years   The Conference Board index of leading economic indicators (LEI) slid 0.1 point in December to a 43-month low of 103.1. This was the 21st consecutive decline for this indicator, marking the longest negative streak since the Great Recession. Four of the ten underlying economic indicators acted as a drag on the headline index. The biggest negative contributions came from ISM new orders (-0.18 pp), the interest rate spread (-0.16 pp), and average consumer expectations (-0.12 pp). Historical analysis shows that an annualized drop of 3.5% in the LEI index over six months, coupled with a six-month diffusion index below 50%, is generally symptomatic of a pending recession. Both conditions were met in December: The LEI index dropped 5.8% annualized over six months and the six-month diffusion index stood at 40%   The S&P Global Flash Composite PMI improved from 50.9 in December to a seven-month high of 52.3 in January, signalling a stronger improvement in private sector operating conditions. The services sub-index increased from 51.4 to a seven-month high of 52.9. The manufacturing tracker, for its part, moved from 47.9 to 50.3, which indicated a marginal expansion of activity in the sector. The figures for the new orders sub-index showed that the manufacturing sector expanded for the first time since October 2023 and that the services sector recorded its sharpest gain in seven months. This improvement was “linked to greater client referrals and emerging reports of customers having worked through their buffer stocks”. Still, new export orders remained subdued in January in both sectors. The employment sub-index stayed in expansion territory, but the workforce increased only marginally. On the inflation front, the PMI report showed that both input and output prices increased at a slower pace. Expectations among firms regarding the 12-month outlook also improved in January, reaching their highest mark since May 2022   Durable goods orders were unchanged in December instead of rising 1.5% as expected by consensus. Orders in the transportation category fell 0.9% as orders for defence aircraft declined 2.9%. Excluding transportation, orders grew 0.6%, overshooting the consensus forecast of 0.2%. The report showed, also, that orders for non-defence capital goods excluding aircraft, a proxy for future capital spending, rose 0.3% MoM after gaining 1.0% in September. On a three-month annualized basis, “core” orders were up 2.9%   Sales of new homes rebounded 8.0% m/m in December to 664K (seasonally adjusted and annualized), topping the 649K print expected by consensus. However, this increase in transactions should not be seen as a sign of strength in the real estate market. The rise in new-home sales is explained, instead, by the resale housing market being completely paralyzed by the current interest rate environment. This increase, combined with a marginal increase in the number of homes available on the market (from 449K to 453K), pulled the inventory-to sales ratio down six ticks to 8.2, which is still above this indicator’s historical average of 6.1. It is worth noting that a growing share of the houses available on the market were completed rather than under construction or awaiting construction. Completed houses represented 19.4% of the total inventory, up from a trough of 7.6% in April 2022 but still below the pre-pandemic proportion (about 25%). Faced with severe labour shortages, homebuilders were unable to meet the explosion in housing demand that occurred during the pandemic. As a result, construction backlogs swelled. The current context, which is less effervescent, is allowing homebuilders to make up for lost time   From the Fed’s perspective, time (and the economic data) remain on their side. With the economy showing no signs of keeling over, and the labor market still relatively tight, policymakers can afford to be patient. Fed officials will want to see at least a few more ‘soft’ readings on inflation and a bit more easing in the labor market before pulling the trigger on rate cuts   Regional indicators of activity all missed to the downside in recent releases from the regional Federal Reserve banks. The Richmond Fed’s manufacturing index fell to -15, which is the lowest the manufacturers’ sentiment in the mid-Atlantic region has been since spring 2020. The Philly Fed’s General Business Activity Index again contracted in January after it had broken into positive territory for the first time in over a year back in December   Stocks recorded another week of gains, bringing the Dow Jones Industrial Average and the S&P 500 Index to new all-time highs and marking the 12th weekly advance out of the last 13 for the latter. The gains were relatively broad, although the small-cap Russell 2000 Index remained nearly 20% below its all-time intraday high. Given the lack of “Fedspeak” during the week—Federal Reserve officials were not making any comments or speeches ahead of the upcoming policy meeting—investors turned most of their focus to a building stream of fourth-quarter earnings reports. Major movers included Tesla, which fell sharply after the company missed both earnings and revenue estimates and warned of slower growth in 2024. Conversely, Netflix recorded solid gains after an upside surprise in subscriber additions   In terms of data release, construction spending is out on Thursday. Construction spending rose a solid 0.4% in November, which translates to an 11.3% annual gain. Overall growth in construction outlays continues to be fueled by private single-family outlays, which have picked up for seven consecutive months. The recent gains in the single-family category reflect lower mortgage rates and relative attractiveness of new construction amid scarce supply and tough affordability conditions in the existing home market. On the downside, multifamily outlays continue to moderate off of the post-pandemic construction boom alongside normalizing apartment demand and declining multifamily starts   ISM Manufacturing is out also on Thursday. High interest rates, moderating goods consumption and weaker global economic growth continue to weigh on the factory sector. The headline ISM manufacturing index, which increased to 47.4 in December, has been hovering below the break-even 50 level for 14 straight months. That noted, the top-line index did notch a gain to end 2023, and several of the underlying details indicate that manufacturing activity may be starting to pick up a bit. New orders declined, but the production and order back-log sub-indexes both rose during December, portending further improvement in overall activity in the months ahead. In addition, the producers who provided comments for December’s survey struck a more optimistic tone, given the prospect for lower interest rates. What’s more, the preliminary reading for the S&P Global US Manufacturing index covering January jumped more than consensus estimates.

Business activity rose more than expected in January, suggesting that the economy could avoid a recession. The preliminary S&P Global/CIPS UK composite PMI rose to 52.5, the highest level in seven months, from 52.1 in December. Even so, shipping disruptions in the Red Sea caused input prices in the manufacturing sector to rise for the first time since last April, which may contribute to a pickup in inflation   British consumers are their most confident since January 2022 as lower inflation helped them to feel better about their finances, a survey showed, welcome news for Prime Minister Rishi Sunak before a national election expected this year. The GfK consumer confidence index rose to -19 in January from -22 in December. A Reuters poll of economists had forecast a slightly smaller improvement to -21. “Despite the cost-of-living crisis still impacting many households across the UK, consumers appear to be encouraged by the positive news about falling inflation,” Joe Staton, client strategy director at GfK said. Sunak, who has suggested he will hold a national election in the second half of 2024, has promised to voters that he will get the economy growing again. While British inflation unexpectedly rose to 4% in December, denting investors’ hopes of quick interest rate cuts by the Bank of England, it is well below its peak of 11.1% in October 2022. The BoE is expected to hold its main Bank Rate at a nearly 16-year high of 5.25% next week after 14 consecutive increases between December 2021 and August 2023 but analysts are expecting a signal that the time for rate cuts might be approaching.

Lagarde did not deliver any promises, leaving the door open for speculation about the timing of rate cuts. Data has not changed much since the December meeting, but delegates have had more time to digest the ongoing disinflation, and several members have opened for rate cuts by summer. The language in the press release was also marginally softer, leaving out the sentence about elevated domestic price pressures (unit labour costs) and mentioning that dampened demand is helping to push down inflation. At the press conference, Lagarde said that there had been consensus around the table that it was premature to discuss rate cuts, but she did not explicitly push back on expectations of cuts before summer. Overall, the data dependent strategy implies that disinflation must become more advanced. Lagarde underlined that this means looking at all sorts of data, and that it would be wrong to focus at particular release dates, including specific wage statistics. Lagarde noticed that almost all measures of underlying inflation declining further in December and the ECB expects disinflation to continue. High wages in combination with low productivity is keeping domestic wage pressures high. However, the ECB sees easing unit labour costs as well as moderating unit profits. Lagarde also noted that short-term inflation expectations have come done markedly while longer-term expectations mostly stand around 2 percent   The PMI flash composite output index was 47.9 in December, up from 47.6 in November and in line with the market expectation of 48.0. The low composite indicator reflects a weak outlook for manufacturing as well as services. The manufacturing index was up more than expected from 44.4 in November to 46.6 in December. The service index fell back 48.4 from 48.8, against expectations of a slight increase. All sub-components related to output and employment remain below historical averages, but seemed to have bottomed out. The composite employment index remains below, but close to, its historical average level, supported by labour market resilience in the service sector   Flash PMI release confirmed the weak momentum in economic activity while it failed to provide clear evidence of continued disinflation. Elevated price indicators highlight remaining challenges and confirm the view that the ECB will be on hold until June   In local currency terms, the pan-European STOXX Europe 600 Index ended 3.11% higher on encouraging corporate results and China’s announcement of additional stimulus measures. Stocks also received a lift after the European Central Bank (ECB) left interest rates unchanged and appeared to signal a more dovish outlook. Most major stock indexes rose, with France’s CAC 40 Index climbing 3.56%, Germany’s DAX advancing 2.45%, and Italy’s FTSE MIB tacking on 0.32%.  

The People’s Bank of China (PBOC) said it would cut its reserve ratio requirement (RRR) by 50 basis points for most banks on February 5, marking the central bank’s first cut in banks’ required reserves this year. PBOC Governor Pan Gongsheng also announced that the central bank will lower interest rates by 25 basis points for refinancing and rediscounting loans to support agriculture and small businesses from January 25. The PBOC cut the RRR twice in 2023, with the last cut in September, and has reduced the RRR by a smaller 25 basis points in the past two years   Chinese regulators removed the draft rules imposed on online video games in late December that were aimed at curbing spending and rewards. The regulations wiped off nearly USD 80 billion in market value from some of China’s largest gaming companies when they were first announced as investors grew concerned about the possibility of another crackdown on the sector   Chinese banks left their one- and five-year loan prime rates unchanged as expected after the PBOC kept its medium-term lending rate on hold the prior week. Many analysts predict that the central bank will continue to roll out pro-growth measures to revive consumer confidence, which has been hit by China’s protracted property downturn and deflationary pressure   Chinese equities advanced after Beijing stepped in with forceful measures to support the economy. The Shanghai Composite Index rose 2.75%, while the blue-chip CSI 300 gained 1.96%. In Hong Kong, the benchmark Hang Seng Index advanced 4.2%, according to FactSet.      
Sources: T. Rowe Price, MFS Investments, Wells Fargo, Handelsbanken Capital Markets, TD Economics, Reuters, M. Cassar Derjavets.