Economic Outlook – 29 October 2017

US

• The modest 0.3% gain in industrial production for September would have likely been larger had it not been for the quarter percentage point drag from Hurricanes Harvey and Irma. Industrial production fell at a 1.5% annualised rate in the third quarter, but according to Fed estimates, this figure would have been an increase of at least 0.5% had it not been for the weather disruptions. Looking into the few remaining months of the year and assessing the outlook for 2018, industrial production is likely to accelerate modestly. The dollar’s early strength in 2017 has largely reversed, which will likely boost investment plans for export-dependent producers. Moreover, energy prices have broadly stabilised, which has lifted mining output once again.
• Durable goods orders rose 2.2% (month-on-month) in September; more than double the expected rate, while new home sales surged an impressive 18.9%. Although the latter can be partially attributed to a rebound in hurricane-hit areas, improvements were recorded in all regions, as activity was likely boosted by significant inventory shortages in the existing home market. The passing of a budget plan in the House, another step forward toward tax reform, added to the upbeat tone and proved particularly beneficial to Treasury yields and the US dollar.
• BEA’s advance GDP estimate, reflected this positive momentum. Growth for the third quarter came in much better than anticipated, with the economy expanding at 3.0% (quarter-on-quarter annualised) despite hurricane impacts. The latter did appear to weigh on a few categories, such as services spending and both residential and non-residential construction, all of which dragged on domestic demand , although inventory restocking helped provide some offset. Net trade also contributed positively to growth, but likely reflected a hurricane-related fall in imports, suggesting some giveback ahead. Still, with rebuilding likely to lift fourth-quarter economic growth via a rebound in domestic demand, another print of around 3% appears to be in the cards. Given estimated trend growth of 2.0%, another quarter of above trend growth is consistent with a continuation of the current interest rate hiking cycle.
• Fed, which has a number of open Board of Governor positions and may soon get a new Chair. Among the front-runners for the top position, former Fed Governor Kevin Warsh and Stanford professor John Taylor are regarded as somewhat of a challenge to the status quo, given their apparent preference for a more rules-based approach to setting interest rates. The current Fed under Chair Yellen views monetary policy rules more as guideposts and argues against a mechanical approach, the shortcomings of which include the failure to capture current cycle dynamics and the difficulty in measuring the input variables.
• Most of the major benchmarks ended the week higher and moved further into record territory. The broad S&P 500 Index recorded a seventh consecutive weekly gain, its best stretch in nearly three years. The technology-heavy Nasdaq Composite Index performed best, helped by a surge in Microsoft, Amazon.com, Alphabet (Google’s parent company), and Intel at the open of trading on Friday following the release of better-than-expected earnings reports the previous evening. The small-cap Russell 2000 Index lagged and recorded a small loss for the week. Technology stocks led the week’s gains, while health care shares fared poorly.
• After a year of dysfunction, congressional Republicans appear to be rallying around efforts to reform the bloated US tax code. On Thursday, the House of Representatives passed the Senate’s budget bill, laying the procedural groundwork for the passage of a tax reform package without any support from the Democratic opposition. An initial bill is set to be released as early as next week, with a vote possible by late November. Details of the measure are still being worked out as constituents balk over the potential loss of tax deductions for state and local taxes, as well as potential changes to the tax treatment of retirement plans such as 401(k)s.
• In the US, PCE and PCE core inflation for September will be released on Monday. Headline CPI rose quite strongly in September due in large part to a strong boost from energy following rising fuel prices and effects from the hurricanes. However, there was almost no increase in core CPI. Hence, PCE core is likely to come in at 0.1% month-on-month in September (unchanged at 1.3%) and headline PCE at 0.3% month-on-month (1.6% year-on-year against 1.4% in August). Note that very soon the first estimate of US GDP growth in Q3 will be released, including (implicitly) an estimate of PCE in October.
• ISM manufacturing is due on Wednesday and many believe is a bit too high and hence look for a decrease to 59.0. Although PMI manufacturing for October has been released, PMI and ISM seemed to have decoupled recently and therefore not much attention should be devoted on PMI to predict ISM.
• The US labour market report for October is due on Friday. Employment growth was negative in September due to hurricanes, an upward revision would not be that unlikely, as some businesses may have reported their payroll information late. Employment growth in October is due to be significantly stronger than underlying trend growth due to catch-up effects from September. It is expected to be 300,000 in October, but note that uncertainty is still high as it is not certain that businesses in the affected areas are running on all engines yet. The fall in the unemployment rate might have been a bit overdone and therefore some reversal back to 4.3% against 4.2% in September are possible.

EU

• All eyes on ECB policy decision this week where ECB decided to halve its monthly asset purchases to €30 billion starting January. While reducing the pace of its asset purchases, ECB decided to extend the duration of its QE programme by another nine months to September 2018, somewhat neutralising its “hawkish” move in trimming the amount of bond purchases. Despite a more positive macro backdrop in the Euro region, President Draghi assured that stimulus withdrawal will be gradual and QE will not end abruptly even after September, a rhetoric which many view as leaving more policy flexibility for the central bank to manoeuvre given prevailing geopolitical uncertainties and downside risks to the global recover.
• The Ifo Business Climate Index hit a record, reflecting confidence that Europe’s economic recovery will extend into the future. The improved sentiment is notable in that it comes against a backdrop of uncertainty surrounding Brexit, Catalan independence and the final makeup of Angela Merkel’s ruling coalition.
• Separatists in Spain’s Catalan region declared independence and passed a resolution to create a Catalan republic, a move that was immediately countered by a Spanish Senate vote to expel Catalonia’s current leadership and subsequently take direct control of the region. Spain’s IBEX index fell about 2% following the duelling political declarations, with the banking sector leading the losses. Earlier in the week, the IBEX strengthened partly due to optimism that the two sides would find a solution before reaching crisis level. Although the rift between the two sides has been widening, European stocks have been generally stable in their response to the escalating crisis.
• The preliminary GDP figures for Q3 are due for release on Tuesday. Quarterly growth is expected to be in the 0.5% range in Q3, falling slightly from Q2 growth, which was estimated at 0.7%. the slightly lower growth in Q3 than Q2 will most likely be determined by activity indicators such as PMIs which have been lower throughout Q3 but remain at high levels and signal robustness for the euro area recovery.
• On Tuesday, the euro area HICP figures for October will also be released. Headline inflation is expected to tick down to 1.4% year-on-year in October from 1.5% in September, due mainly to energy price base effects. Headline inflation developments still seem to be driven largely by energy price inflation. Since the beginning of 2017, energy price inflation has been declining, driving headline inflation from the peak of 2.0% in February to 1.5% in September.

UK

• The leadership of five large British business groups, including the Confederation of British Industry and the British Chamber of Commerce, wrote to Prime Minister Theresa May this week that their members will start moving jobs and investment outside the United Kingdom if a transition deal with the European Union is not agreed soon. UK business investment slowed sharply in the wake of the June 2016 Brexit vote, and has been flat since that time, recent figures show, owing to uncertainty over the UK’s future relationship with the EU.
• The Monetary Policy Committee (MPC) of the Bank of England (BoE) will meet next Thursday to decide monetary policy. Markets are now pricing in a probability of 82.0% that the MPC will vote to raise the bank rate by 25bp, to 0.5%, at next week’s meeting. The reason for the expected rise is surprisingly hawkish signals after the BoE’s September meeting, where the press release stated that “A majority of MPC members judge that, if the economy continues to follow a path consistent with continued erosion of slack and a gradual rise in underlying inflationary pressure then, some withdrawal of monetary stimulus is likely to be appropriate over the coming months in order to return inflation sustainably to target.” The MPC’s turn in a more hawkish direction was explained by an assessment that remaining spare capacity in the economy was being absorbed more rapidly than the MPC expected at the time of the August report. The MPC’s view was therefore that the trade-off between a weak economy and high inflation had become less pronounced.
• UK government bonds sold off during the week after gross domestic product (GDP) figures exceeded market expectations and increased the prospect of an interest rate increase at the Bank of England’s next policy meeting. Economic growth reached 0.4% in the third quarter (1.5% on an annual basis), up from 0.3% during the previous period. The yield on 10-year gilts had risen to over 1.38% by Thursday’s close but fell back Friday to end at 1.34%.
• Bank of England to raise the Bank Rate by 25bp to 0.50% from 0.25% when they meet on Thursday, as core BoE members have become increasingly concerned about the combination of high inflation and low unemployment. No change is expected to the QE programmes; the hike is unlikely to be the beginning of a new cycle but is more likely about taking back its emergency cut in August 2016 just after the Brexit vote.
• UK PMI manufacturing is due out, which is expected to have increased in line with the equivalent index for the euro area. PMI services are expected to remain around the current level of 53.6 but see risks skewed to the downside, as the index is bit higher than suggested by the most recent business confidence indicators. Combined, the PMIs will show growth continues around the pace seen in recent quarters.

China

• At the conclusion of a weeklong congress of China’s Communist Party, Xi Jinping was elected to a second term as president. In addition, members of the congress voted unanimously to revise the party’s constitution to include “Xi Jinping Thought on Socialism with Chinese Characteristics for a New Era.” The only two leaders whose thoughts are enshrined in the party’s constitution are Mao Zedong and his successor Deng Xiaoping. Analysts note that the makeup of the new Politburo Standing Committee suggests that the 64-year-old Xi may serve beyond the completion of the traditional two five-year terms.
• The Chinese official and the private (Caixin) PMI will be released. The two indices normally move in the same direction but in September the official PMI increased sharply whereas the Caixin index dropped a bit. The official PMI is likely to fall in October from 52.4 to 52.0 (consensus 52.2) as there are signs of the housing market slowing in China. This is expected to lead to a moderate slowdown in China over the next 12 months. For the Caixin index, a flat reading is the most likely option.

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