Economic Outlook – 29 July 2018

US

• US real GDP grew at a 4.1% pace during the second quarter and first quarter growth was also slightly stronger than first reported. The stronger GDP figures do not come as much of a surprise. This past quarter’s GDP data were even more difficult to predict than usual. The second quarter data include benchmark revisions, which incorporate new methodologies and data sources. The base year was also moved from 2009 to 2012. The net result was fairly tame, however. Real GDP growth has averaged a 2.3% pace from the end of 2012 to the first quarter of 2018, the same as had been reported previously.
• The net result is an investment-led expansion. Real business fixed investment rose at a 9.4% annual rate during the first half of the year, while consumer spending grew at just a 2.2% pace. The strength in business fixed investment should provide the economy more resilience, by boosting productivity growth, reducing inflationary pressures and increasing the economy’s long-run potential growth rate.
• Durable goods orders ended the second quarter on a strong note. While the headline number came in below expectations, the underlying data were strong. Overall new orders rose 1.0% in June. That gain, however, was held back by an 11.6% drop in defence orders, which followed gains of 16.7% in May and 9.0% in April. Orders for commercial aircraft and motor vehicles both rose. Orders for non-defence capital goods, excluding aircraft, which lead the business fixed investment component of real GDP and rose 0.6% in June and at a 10.9% pace during the second quarter.
• The housing market is likely to continue to face headwinds on both the supply and demand side ahead. A tightening labor market and rising incomes should continue to buoy buyer interest despite rising prices and higher interest rates. But, bigger challenges on the supply side, such as rising material costs and labor shortages, point to no quick turnaround for inventories. With supply likely to remain a limiting factor, gains in housing activity are anticipated to be gradual.
• Amid very low expectations, US president Donald Trump and European Commission president Jean-Claude Juncker met at the White House on Wednesday. The leaders unexpectedly agreed on a framework that will keep the two sides from escalating the ongoing trade battle while negotiating the elimination of tariffs and subsidies on non-auto industrial goods. Additionally, they said they will work toward resolving the steel and aluminium tariffs and the EU’s retaliatory tariffs. It is expected that no new tariffs will be put in place while negotiations are under way. As part of the agreement, the EU agreed to increase purchases of US liquefied natural gas and soybeans. While the proposed pact is only the first step, it is the first sign of a de-escalation on the trade front in months.
• The major benchmarks generated mixed performance for the week, with the large-cap benchmarks outperforming the small-cap indexes and the technology-heavy Nasdaq Composite Index. The busiest week of second-quarter earnings reports saw a modest pickup in trading volumes, particularly on Thursday. Industrials outperformed as trade tensions eased somewhat, and airline stocks rallied on healthy passenger volumes.
• One of the week’s most notable events was Facebook’s dramatic drop in after-hours trading on Wednesday, which eventually resulted in a nearly 19.0% decline in the stock by the time trading closed on Thursday. As many observers noted, the roughly $120 billion drop in the company’s market value was among the largest such losses in market history. The stock fell back only to levels reached in April, however, and Facebook remained the fifth most valuable company in the world.
• Investors appeared to react primarily to growth in Facebook’s revenues in the quarter that was slower than some hoped for (if still in excess of 40.0% on a year-over-year basis), as well as plateauing growth in daily active users in some key markets. The company also warned that rising expenses, partly to deal with privacy concerns, would reduce profit margins in the coming quarters. Despite an upside earnings surprise from Amazon.com, the pressure on Internet and technology firms continued Friday, with Intel and Twitter also suffering large declines.
• News that Japan and other central banks might be preparing to tighten their monetary policies sent longer-term Treasury yields higher at the start of the week. Negative Treasury performance weighed on municipal debt, but municipal bonds outperformed US sovereign bonds, helped by a lighter issuance calendar and adequate demand.

EU

• Following the surprise increase in June, the composite EMU PMI fell back again in July. Thus, it still appears that the recovery has passed its peak and, despite some reassuring signals from the German manufacturing sector, there is also some evidence that the escalating global trade spat is beginning to leave its mark on the economy.
• Flash estimate of Markit’s composite PMI for the Eurozone decreased from 54.9 to 54.3 in July, which was below both market expectations (54.8). The drop was driven by a fall in the service PMI from 55.2 to 54.4, whereas the manufacturing PMI somewhat surprisingly rose from 54.9 to 55.1. On the surface, the latter could suggest that the economy is defying trade war fears with especially the German manufacturing sector showing resilience. However, new orders in Germany showed a weaker inflow, backlogs showed the slowest increase in two years and the gauge for future output slipped to its second lowest level in 20 months. In France, exports of manufacturing goods dropped for the first time in almost two years in July and Markit highlights that the surveys saw worries about trade wars intensify markedly. Also worryingly, the survey reported increasing prices on raw materials as well as shortages and delays in deliveries, which suggests that (the threat of) higher tariffs might already be beginning to disrupt global supply chains.
• European stocks climbed for the week, fuelled by strong corporate earnings results and an apparent thaw in trade-related tensions between the US and the European Union (EU). The pan-European STOXX 600 Index rose by nearly 0.5% to its highest level in more than a month. Germany’s DAX 30 Index notched its highest close since mid-June, reversing its fall earlier in the week that was largely due to trade worries.
• Automakers were some of the most buoyant stocks late in the week following a meeting between European Commission President Juncker and US President Trump. The two apparently agreed to work toward “zero tariffs.” While it is unclear whether automobile tariffs would be under consideration in the working agreement between the two leaders, investors apparently were optimistic. Early in the week, automobile makers, which had been under threat by Trump to become the next tariff target on imports into the US, were notable laggards. Basic resources stocks finished the week higher as trade concerns eased.

UK

• Among the most vexing problems the United Kingdom has had to confront as it prepares its departure from the EU is the issue of the border between Northern Ireland, which is part of the United Kingdom, and the Republic of Ireland, a member of the EU. Presently there is no physical border between the two. In order to maintain an open border, the British government is considering taking the radical step of allowing the EU to impose its market regulations in Northern Ireland while the rest of the UK breaks free. That solution is seen as particularly perilous for Theresa May’s government, which, to maintain its tenuous grip on power, relies on the support of the Northern Ireland’s Democratic Unionist Party, which opposes remaining under the EU’s purview. An alternative plan, in which the UK would collect customs duties on the EU’s behalf, has been rejected by EU negotiators. The EU’s idea for a way around the impasse is for Britain to remain a member of the customs union, but this idea is anathema to Brexiteers.
• In the past year, UK living standards rose at their slowest pace since 2012. The post-crisis recovery in incomes reversed for the poorest 30.0% of families, according to the Resolution Foundation, a large London-based independent think tank. Welfare cuts were part of the reason poorer families saw their incomes decline by 0.3%. The foundation estimated the loss to poorer families at as much as £150 (about $200) a year, as higher wages and lower taxes were not enough to offset cuts to tax credits and child benefits.

China

• China’s unwillingness to approve the merger of the US tech company Qualcomm with Dutch chip maker NXP Semiconductors has set the stage for an escalation of trade tensions with the US. Eight other international regulatory bodies had approved the transaction, with China the lone holdout despite heavy lobbying in favor of the deal by top US officials. China, for its part, said the question of whether or not to approve the deal by Qualcomm’s self-imposed deadline was an antitrust matter and not linked to US-China trade frictions. The deal’s approval had been expected in light of the recent decision by the US to ease penalties on China’s ZTE Corporation.
• China’s yuan posted its seventh weekly loss on Friday in its longest losing streak since 2015 as the deepening trade rift with the US kept downward pressure on the currency. For the week, the yuan weakened 0.6% against the US dollar in onshore trading, which is regulated by Chinese authorities. The yuan also notched its seventh weekly decline in the unregulated offshore market, Bloomberg reported.
• The yuan’s weakness, which should make Chinese exports cheaper in world markets, has raised speculation that Beijing is allowing the currency to weaken as a way to soften the economic blow from US tariffs. Earlier in July, US Treasury Secretary Steven Mnuchin told Reuters that the Trump administration would “very carefully review whether (China) has manipulated the currency.”

Sources: Wells Fargo, TD Economics, T. Rowe Price, TD Economics.