Economic Outlook – 28 May 2023

Demand in the manufacturing sector is also showing signs of stabilizing. Durable goods orders surprised to the upside in April, increasing 1.1% over the month. While defense orders drove much of the headline increase, nondefense capital goods orders excluding aircraft—a leading indicator for business investment spending—were solid, rising 1.4%. Nondefense capital goods shipments, which are used to calculate business spending in the GDP accounts, slipped 1.8% in April. The weak outturn puts equipment investment on shaky footing at the start of the second quarter Real personal spending rose a stronger-than-expected 0.5% in April. The feat was impressive against a 0.4% increase in consumer prices that same month, as tracked by the PCE deflator. On the flip side, real disposable income growth was flat in April, suggesting that income is losing some momentum. Consumers continued to tap excess savings built up during the pandemic, but the stockpile has dwindled. Looking ahead, consumer spending will likely reach an inflection point later this year as tighter borrowing conditions, scant savings and loosening labor demand meaningfully weaken purchasing power With the US Department of the Treasury’s forecast for an X-date of 1 June fast approaching, both the White House and Speaker of the House Kevin McCarthy (R-CA) say a deal is close, though details over reduced spending in the coming two fiscal years remain to be ironed out. Spending cuts ranging from between 0.1% and 0.2% of GDP are expected when the negotiations are complete. The outline of the plan being discussed suggest the debt ceiling would be raised by about $4 trillion, which is projected to be enough to push the need for a further rise until after the 2024 elections. If an agreement can be reached by 27 May, a vote in the House of Representatives could take place on 31 May, with the Senate voting the day after. However, the negotiation of a modest level of spending cuts and a larger-than-expected increase in the debt limit could run into opposition from rank and file members of the Republican party in the House which could necessitate Democratic support to reach a majority, something that could endanger McCarthy’s grip on the speaker’s gavel Two credit ratings agencies, Fitch and DBRS Morningstar, placed the United States on review for potential downgrades from AAA amid ongoing haggling over the debt limit. The brinkmanship over the debt ceiling and the failure of US authorities to meaningfully tackle medium-term fiscal challenges will lead to rising budget deficits and a growing debt burden added to downside risks to US creditworthiness, Fitch noted In order to keep pressure on negotiators to raise the debt limit in a timely manner, US officials have been loath to discuss contingency plans in the event that it is not raised prior to the X-date. However, the Wall Street Journal reported Thursday that the US Treasury Department has a backup plan in place to delay payments. But it is still unclear if the government has the ability to prioritize the payment of interest and principal on Treasury bonds, allowing the US to avoid default Wall Street, led by the Securities Industry and Financial Markets Association (SIFMA), an industry trade group, has also been laying the groundwork to keep markets operating smoothly in case of a debt ceiling breech. Under SIFMA’s plan, investors would be able to keep trading all US Treasuries, even those with past-due interest or principal payments Having depleted its general account in order to stave off default, the US Treasury is expected to issue as many as $1 trillion worth of Treasury bills and notes in the six months after the debt limit is raised. Combined with ongoing quantitative easing, liquidity conditions are expected to tighten significantly in the second half of the year, creating a headwind for risk assets  Benchmarks end mixed as investors watch debt ceiling negotiations. The major benchmarks ended mixed as investors watched carefully for signs of progress in negotiations over raising the federal debt ceiling. The technology-heavy Nasdaq Composite outperformed and ended the week up 23.97% for the year-to-date period—a stark contrast to the 0.16% decline of the narrowly focused Dow Jones Industrial Average over the period. Similarly, the Russell 1000 Growth Index ended up 20.75% over the period, while the Russell 1000 Value Index—heavily weighted in the struggling financials sector—was down 1.64%. Markets were scheduled to be closed on Monday, May 29, in observance of Memorial Day. Relatedly, alongside the debt ceiling negotiations, the signal event in the week may have been Thursday’s 24% jump in the shares in chipmaker NVIDIA, which took the company’s market capitalization to roughly USD 963 billion by the end of the week and made it the sixth most highly valued public company in the world. Shares rose after the company beat consensus first-quarter earnings expectations by a wide margin and raised its profit outlook. The large move in such a heavily weighted stock reverberated throughout the major benchmarks—Thursday was among the most remarkable sessions he had witnessed in the last 25 years In terms of data release, consumer confidence is out on Tuesday. Consumer confidence was down in the dumps in April, hitting a six-month low. Consumers continued to be more worried about the future than the present. The future expectations index dropped to its lowest level since last July, while the present situation index increased and is near the highs of the past year. Consumers’ plans to make a major purchase within the next six months declined across almost every surveyed category. Plans to buy a major appliance fell to 41.0%, the lowest since 2011. Interestingly, this pessimism has not been fully reflected in the hard data. In contrast, auto sales have been fairly strong so far in 2023 ISM Manufacturing Index is out on Wednesday. April marked the sixth consecutive month that the ISM manufacturing index has been in contractionary territory (a reading below 50). The new orders subcomponent ticked higher but remained weak at 45.7, and the current production subcomponent was only a bit better at 48.9. The softness in the ISM manufacturing index has been matched at least partially in the hard data: Manufacturing output is down 0.9% over the past year. That said, the index has treaded water in recent months. April’s reading of 47.1 was only slightly below the six-month average of 47.7. The employment subcomponent also remained a relative bright spot, just inching into expansionary territory at 50.2 in April.  

Inflation (CPI) has come through at 1.2% MoM, 8.7% YoY. The fact headline inflation is above 8%, and well above consensus will be a cause for concern to the Monetary Policy Committee and interest rate expectations will be soaring.  Core inflation (stripping out food and fuel) was 0.0% MoM, 6.0% YoY; Input prices were -0.3% MoM, 3.9% YoY, while output prices 0.0% MoM, 5.4% YoY. The Retail Price Index (less used, with a higher weighting of housing – this is what Floating Rate Gilts are tied to) came through at 1.5% MoM, 1.4% YoY. There are no silver linings to all of this Combining the rapid pace of interest rate rises, along with the impact of Quantitative Tightening, would have been having more of an impact by now. At the same time, wages were due to be a good deal more problematic (stickier) than had generally been anticipated, once inflation was below 5%, it would be falling less rapidly than has generally been anticipated. It appears there is a double problem; energy prices are not as deflationary as anticipated, and while energy contributed 1.42 percentage points to the fall in annual inflation as last April’s rise dropped out of the comparison, it still contributed 1.01 percentage points to annual inflation Retail sales figures for April came in broadly as expected. MoM sales (including fuel) registered at 0.5% while YoY sales were -3%. Monthly growth in sales was driven by food and non-food stores, while fuel sales volumes fell despite declining prices. It is widely assumed that sales volumes of fuel may have been partly affected by industrial action There is a yawning gap in the trend between sales by volume and sales by value. Compared with pre-COVID-19 levels in February 2020, total retail sales were 16.5% higher in value terms but 0.8% lower in volume terms, highlighting the inflationary impact on the data. Sales volumes saw a downward trend from June 2021 to September 2022, and have since effectively flatlined. The proportion of online sales was unchanged at 26% in April 2023 and has remained broadly consistent at this level since May 2022.  

The eurozone flash composite PMI was slightly below expectations at 53.3 in May, compared with 54.1 the previous month. The Manufacturing PMI fell more than expected to 44.6, compared with 45.8 earlier, and the Services PMI was better than expected at 55.9, compared with 56.2 the month before.  Economic activity in France lost some of its momentum May as services growth slowed. French manufacturing PMI improved in May, but remained below the 50-threshold level. New orders softened both in manufacturing and services. On the other hand, employment growth was robust, especially in services. In Germany, the divergence between services and manufacturing widened in May as Services PMI increased to a 21-month high and Manufacturing PMI weakened to a 36-month low.  New orders declined in manufacturing, while in services they went up. Hiring activity remained strong in the service sector European Central Bank (ECB) policymakers echoed ECB President Christine Lagarde’s view that interest rates would need to rise further and stay high to curb inflation in the medium term. Bank of Spain Governor Pablo Hernandez de Cos said policy tightening still had “some way to go” and that “interest rates will have to remain in restrictive territory for an extended period of time to achieve our objective in a sustained manner over time.” Banque de France Governor Francois Villeroy de Galhau said: “I expect today that we will be at the terminal rate not later than by summer.” Shares in Europe fell on signs that the economic outlook may be worsening and continued uncertainty over U.S. debt ceiling talks. In local currency terms, the pan-European STOXX Europe 600 Index slid 1.59%. Major stock indexes also weakened. Germany’s DAX declined 1.79%, France’s CAC 40 Index dropped 2.31%, and Italy’s FTSE MIB tumbled 2.93%.   

No major indicators or policy measures were released in China during the week. But mounting evidence that the country’s post-pandemic recovery is losing momentum has raised concerns about the economic outlook. Most recently, industrial output, retail sales, and fixed asset investment all grew at a weaker-than-expected pace in April, while weak credit growth indicators also pointed to sluggish domestic demand Geopolitical risks also dampened risk appetite after Beijing said it would ban Chinese companies from buying products from Micron Technology, citing security risks it uncovered in a review of the U.S. chipmaker’s products. The ban announced on May 21 applies to domestic telecom firms, state-owned banks, and other companies behind China’s information infrastructure. The Chinese ban on Micron was seen as China’s most significant retaliation to date in response to U.S. controls on certain technology exports Chinese banks kept their one- and five-year loan prime rates steady for the ninth straight month, as expected, after the People’s Bank of China (PBOC) left its one-year policy loan rate unchanged earlier in May. However, speculation is growing that the central bank will ease policy to shore up the economy. The yield on China’s 10-year government bond dropped to a six-month low of 2.70% last week, according to Bloomberg, as traders increased their bets on monetary easing by the PBOC in the near term Chinese stocks fell after a batch of disappointing indicators in recent weeks pointed to a flagging economic recovery. The benchmark CSI 300 Index fell 2.4%, its biggest weekly drop since the five days ended March 10 and erasing all its gains this year, according to Bloomberg. In Hong Kong, the benchmark Hang Seng Index fell below the psychologically key 19,000-point level to its lowest close since December in a holiday-shortened trading week.
Sources: T. Rowe Price, MFS Investments, Wells Fargo, Handelsbanken Capital Markets, M. Cassar Derjavets.