Economic Outlook – 3 December 2017

US

• October’s new home sales report suggests that the market was very competitive and there is little relief ahead. The pace of new sales accelerated to the fastest of the current cycle, as products were sold even before construction. Some of the uptick may be traced to seasonal factors. The largest gains were in the Northeast and Midwest, which are smaller and susceptible to large seasonal swings. Still, not seasonally adjusted gains were also strong in all four regions. Attesting to the strong demand, homes where construction had not yet started accounted for the entire rise in new homes sold and almost all of the increase in for-sale inventory on the market. At October’s pace of new home sales, there were just 4.9 months of inventory, down from 5.2 in September. The inventory of completed homes was unchanged. Such fundamentals should keep developers in good spirits this winter.
• The Conference Board provided the most recent evidence that consumer confidence remains high, with its headline index registering a 17 year high in October. Confidence stemmed from a combination of the strong labor market and financial gains improving consumers’ assessment of the present situation, as well as rising expectations about the future. There has been a marked uptick in the expectations index in recent months. Apparently, any partisan bickering has not deterred consumers’ optimistic outlook for tax cuts. The rising stock market and home values are also likely boosting their outlooks. Consumers’ buying plans for major appliances increased to 52 from 48.8, which should give retailers reasons for cheer this holiday shopping season.
• October’s report on personal income and spending suggested consumers should have the means to act on surging confidence. Disposable personal income increased another 0.5% points in October, building on September’s 0.4% increase. Inflation trimmed some of October’s rise, but the 0.3% increase in real disposable income was a welcome lift from essentially flat growth since May. The consumption expenditures side of the report was more a comedown story from September’s 0.9% hurricane-induced lift. Spending in October increased a more modest 0.3% or 0.1% in real terms. The saving rate increased a bit in October to 3.2% from a cycle-low of 3.0%.
• Economic data released this week also supported investor sentiment, with third quarter real GDP revised up to an impressive 3.3% as business investment accelerated (even more than previously estimated), with firms ramping up expenditures on equipment notably. This marks the strongest two consecutive quarters of growth for the American economy in three years. Momentum in business investment is expected to continue, with shale oil production likely to be a key contributor.
• Incoming Fed Chairman Jerome Powell stated that “conditions are supportive” of a December rate hike at his confirmation hearing on Tuesday. Mirroring this view were Yellen and Kaplan in their speeches this week, in contrast to Kashkari who would like to see firmer evidence of inflationary pressures building before proceeding with a hike. At this point, markets are fully pricing in a December hike. Making this scenario increasingly likely is progress on the tax reform front, which will require faster monetary policy normalisation in order to temper the potential inflationary pressures.
• Markets have been buoyed this week on optimism that the US Senate would pass its version of a tax reform bill that would slash corporate tax rates. A late procedural impediment prevented the measure from coming to a vote on Thursday, but a vote is possible on Friday. If passed, the bill would go to a House of Representatives–Senate conference committee to reconcile differences between the two bills. Republican leaders are pushing to have a bill ready for President Donald Trump’s signature before year-end.
• The US Commerce Department self-initiated antidumping and countervailing duties investigations against imported Chinese aluminium sheet. The move is seen as significant because it represents the first time in 32 years that the government has undertaken an investigation on its own without being prompted by complaints from industry, a signal that the Trump administration will seek to enforce trade rules more vigorously than his recent predecessors.
• US stocks were mostly higher in a week notable for the dispersion of returns among the major indexes. The narrowly focused Dow Jones Industrial Average notched its best weekly gain for the year, while the technology-heavy Nasdaq Composite Index recorded a loss; although it joined the other indexes in reaching an intraday record high on Tuesday before falling back later in the week. The financials sector outperformed as an increase in longer-term Treasury yields boosted the outlook for bank lending margins. The rising yields hurt real estate shares, however, by making their relatively high dividend payments less attractive in comparison. Energy stocks were strong after crude prices rallied following an agreement between OPEC, Russia, and other major oil exporters to keep current production limits in place through 2018.
• The jobs report for November is due for release next Friday. Several indicators (particularly PMI employment index) point towards a solid jobs report although it delivered several figures below what could be expected based on other indicators this year. A catching up effect for November driven by the service sector is likely. Hence, non-farm payrolls is expected to rise to 195,000 in November with services being the main contributor.

UK

• The United Kingdom and the European Union have reportedly agreed on a framework for calculating the amount the UK will need to pay the EU to cover obligations committed to in the past. Estimates of what the final figure will be vary widely, with the BBC putting it in the €40 billion to €55 billion range. The UK is attempting to show EU officials that it has made sufficient progress toward the settlement of key issues that ongoing talks can be broadened to include a discussion of the future trade relationship between the two sides. The Irish border remains the main sticking point.
• Bank of England (BoE) Governor Mark Carney warned that £26 trillion of derivative contracts cleared through London could be at risk if Brexit negotiations fail to agree to a legally accepted solution that continues to allow UK banks their “passporting” rights; essentially, the ability to perform cross-border contracts.
• Carney’s alarm highlights his concern that derivative contracts and other financial contracts may, in the short term, endanger the continuity of cross-border financial flows and services between financial services providers in the EU and the UK. To mitigate these risks, Carney called for a Brexit transition period of at least 18 to 24 months. A long transition deal is more likely to be worked out between the UK and the EU given that the EU has a strong incentive to ensure that the financial clearing process is not affected by uncertainty. Following stress tests of UK banks, the BoE announced that it would raise a special buffer half a percentage point, to 1.0%, to lock in capital that banks are currently holding voluntarily. While the major banks passed the stress test, the BoE special buffer requires banks to set aside more capital that they can draw from during severe downturns.
• The UK PMI headline index increased to 58.2 from 56.6 in October (revised from 56.3). The November reading beat the consensus expectation of 56.5. According to the survey, sentiment was pulled higher by all subcomponents, including new orders, output and employment. Also the future expectations index improved a little, but remained below its historical average.
• According to survey respondents, manufacturing production had expanded at the fastest pace since September 2016 and to one of the highest levels during the past four years. Companies linked this to stronger inflows of new orders, reflecting solid domestic demand and steeper gains in new export business. There were also reports that the historically weak sterling exchange rate continued to boost export competitiveness, although mentions of this were less prevalent than earlier in the year. The expansion remained broad-based by sub-sector. Strong and accelerated growth of production and new orders was registered across the consumer, intermediate and investment goods industries. On the price front, rates of inflation in input costs and output charges remained elevated. The year-on-year growth rate in actual manufacturing production was some 3.0% at the end of Q3. Based on past form, the PMI development suggests manufacturing output growth could strengthen further in the short term.
• The most important release next week is the PMI service index on Tuesday. Both Lloyd’s Business Barometer and the UK service confidence indicator from the EU suggest a fall, so a correction down to 54.5 in November is to be expected, although both indicators actually suggest a bigger fall.

EU

• Unemployment and consumer price data was released the past week. Overall the data supports a robust impression of the Eurozone economy with lower unemployment and still low inflation. The unemployment rate unexpectedly decreased to 8.8% in October from 8.9% in September. An unchanged rate was expected after more modest signals from Spain, Germany and France in October. But the rate continued down and recent labour market indicators have improved, with PMI employment trending higher and household unemployment expectations lower. Additionally, numbers released showed that the fall in unemployed persons in Germany increased in November. So the downward trend in unemployment remains intact.
• In Germany, heavy pressure placed on the Social Democratic Party by German president Frank-Walter Steinmeier has greatly increased the chances that Chancellor Angela Merkel will be able to form a stable government without having to conduct another election. Earlier efforts to form a government with the Free Democratic Party and the Greens failed last week.
• In the EU, the main release next week is the euro area third GDP estimate for Q3 on Tuesday. The second estimate showed solid growth of 0.6% quarter-on-quarter in Q3 and no significant revisions are expected to the GDP figure in the third estimate. However, the third estimate will also contain the main aggregates. Consumption is expected to continue driving growth in the euro area, but judging from the country figures already released, solid growth in investments and exports are likely, as exports should not yet have been hurt by the euro appreciation during Q2 and early Q3.

China

• In China, the manufacturing PMI from Markit/Caixin fell more than expected from 51.0 in October to 50.8 in November, the lowest in five months. That contrasts with the official manufacturing PMI, which increased to 51.8 from 51.6 against expectations of a decline to 51.4. Markit’s PMI tends to be more reliable since it is less skewed toward big and often state-owned companies.
• Economic data out of China are currently not pointing in the same direction, as there is almost stable GDP growth, quite upbeat ‘soft’ indicators (such as the PMIs) and a decline in growth of most monthly activity indicators (such as fixed investments and production). Usually, the survey-based ‘soft’ indicators for China tend to lag and not lead actual activity. Furthermore, business sentiment is likely elevated by companies’ profits being buoyed due to higher (commodity) prices following the authorities’ measures against polluting industries and overcapacity industries.
• The main releases in China next week are FX reserves and the trade balance. FX reserves should increase a bit from the October level as a weaker USD during November has increased the value of non-USD FX reserves when measured in USD.

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