Economic Outlook – 3 June 2018

US

• US consumers’ optimism about the economy helped to fuel spending above and beyond income growth in April. US household spending rose 0.6% in April, while personal income rose 0.3%. Stronger spending has also been driven by the recent federal tax changes leading to lower withholding for many households. Income outpaced spending the first two months of the year when changes initially went into effect. Now with the tax savings accumulating (and more mild weather), households have stepped up spending. The saving rate, in turn, has fallen half a point since February, but at 2.8% remains above December’s 2.4% rate.
• Spending has also been lifted in recent months by climbing gasoline prices. Although gas prices typically rise heading into the summer driving season, the average national price of a gallon of gas according to AAA was $2.72 in April, a 13% increase over last year. With gas prices having climbed another 6% in May, real household spending power is coming under pressure despite the recent boost tax changes have provided to disposable income.
• Inflation, measured by the PCE deflator, rose 0.2% in April, keeping it at 2.0% year-over-year. That is only the fourth month in the past six years inflation has been at or above the Fed’s target. Beyond gasoline prices, however, inflation is firming. The core PCE index rose more than expected in April (0.2%), and, at 1.8%, is also closing in on the Fed’s target.
• In May, average hourly earnings growth rose 0.3%, bringing the year over year rate up to 2.7%. Although that is still a bit below the pace registered a few months back, strong hiring continues to support aggregate income growth among households. The income proxy (total hours worked multiplied by average hourly earnings) has improved to a 5.4% annualised pace over the past three months, compared to 3.3% at the start of the year.
• Employers added 223,000 new jobs in May, with gains widespread across industries. The diffusion index (a measure of the net share of industries adding jobs) improved to 67.6 in May and has been trending up over the past year. The supply of labor looks increasingly scarce and will likely place additional upward pressure on compensation costs. The unemployment rate fell to 3.8%, which matches the low of the 1991 to 2001 cycle.
• The White House announced that it would be pushing ahead with tariffs on $50 Billion of Chinese goods and ends the exemption on steel and aluminium tariffs for the EU, Canada and Mexico. These normally close allies pledged to challenge the tariffs through the WTO and NAFTA channels and levy retaliatory tariffs. At around $12.6 billion and $7.7 billion of US products targeted by Canada and the EU respectively, and an estimated $4 billion in trade with Mexico, the amount of affected trade is still quite small. But the wide list of products marked for tariffs, which stretch from agricultural products to motorcycles, are sure to strike a sour cord with the US. Ultimately, the tariffs will make goods more expensive for the American consumer.
• Stocks finished the week modestly higher after quickly recovering from a post-Memorial Day sell-off amid worries about Italian politics and the stability of the euro zone. The small-cap Russell 2000 Index outperformed the broad market, reaching record highs, as did the tech-heavy Nasdaq Composite Index. On the negative side, the blue chip Dow Jones Industrial Average declined. Technology shares performed well, while financial stocks struggled as a sharp decrease in longer-term Treasury yields led to investor worries about bank profitability.
• On Tuesday, demand for safe-haven securities amid political turmoil in Italy triggered a rally in Treasuries, driving the 10-year Treasury note’s yield to its largest one-day decrease since the UK voted to leave the European Union in June 2016. Many attributed the sharpness of the rally to investors being positioned for price declines on Treasuries; the price gains would have likely led to quick reversals of those positions, further fuelling the rally. Treasury yields increased later in the week to finish only modestly below where they started.
• In the US, there are no first tier economic releases this week.

China

• The manufacturing PMI from Markit was unchanged at 51.1 from April to May, marginally weaker than expected by consensus. The official manufacturing PMI increased somewhat from 51.4 to a better-than-expected 51.9. Thus the spread between the two indices widened considerably, making it harder to conclude on the direction for China’s industry in May. Despite us generally preferring Markit’s PMI to the official one, it seems as though momentum was up rather than down in May. This is to some extent explained by the scrapping of the measures to improve air quality over the winter.
• China’s leading stock indexes fell for the week as global risk aversion outweighed the long-awaited inclusion of Chinese A shares into MSCI’s global equity benchmarks. For the week, the benchmark Shanghai Composite Index and the large-cap CSI300 Index dropped 2.1% and 1.2%, respectively. The declines in Chinese stock markets continued into Friday, when 234 Chinese companies officially joined MSCI’s global equity benchmarks, including its flagship Emerging Markets Index.
• Chinese trade figures are due this week. When it comes to trade data, they are very volatile on a monthly basis. The trend is expected to show some levelling off in both import and export growth as has been the case in the past couple of months. On the trade front, the focus will also be on the trade talks from Saturday to Monday with the US Commerce Secretary, who is in Beijing with a 50-person delegation to continue negotiations with China.

UK

• The Markit/CIPS UK Manufacturing Purchasing Managers’ Index suggested that Britain’s economy has not recovered much from a slowdown in early 2018, although manufacturing accounts for only about 10% of overall output. The Bank of England is watching for signs that the near-stagnation of the economy between January and March was temporary and caused by unusually cold weather; rather than the approach of Brexit next year; before it raises interest rates for only the second time in over a decade.
• Britain’s consumers picked up the pace of their borrowing in April, according to data that could reassure the Bank of England that the economy is ready for another interest rate hike after a cold winter slump. Also on Thursday, surveys showed consumers turned a bit more confident this month, possibly reflecting an easing of a Brexit-related squeeze on their spending power, and companies were more upbeat too.
• UK PMI service index for May is due out on Tuesday. PMI growth was just 0.1% quarter-on-quarter in Q1 and the service index in April showed no signs of a rebound. However, the service confidence indicator in May was encouraging, as it indicates service sector growth was stronger in May. Also Lloyds Business Barometer rose in May.

EU

• The flash annual HICP inflation increased significantly in May to 1.9% from the previously subdued 1.2%. The increase was less of a surprise given the upbeat consumer price data released yesterday from Germany and Spain (and to a lesser extent from France this morning). All of the three core countries now have annual inflation rates of 2% or above. On the other hand, Italy still has lower inflation, at 1.1% in May, although it increased from 0.6% previously (HICP). The rise in inflation mainly was due to the annual base effect from lower prices a year ago, but it was topped up by higher energy prices. Annual core HICP inflation thus rose less markedly to 1.1% from the previous 0.7%.
• Following days of uncertainty in Italy, the Five Star Movement and League renewed their coalition deal and received approval for their cabinet from President Sergio Mattarella. Although the initial market reaction was positive, as political uncertainty subsided along with the risk of a new election, more struggles is likely ahead and markets will continue to be very headline driven over the next few weeks and months. Clashes between the Italian government and the EU on the economic ruleset over coming months will be likely, as well as abandonment of fiscal prudence which could trigger more rating action.
• Evolving political developments in Italy and, to a lesser degree, in Spain were the primary drivers in a volatile week for European equities. The pan-European index STOXX 600, plus both Italy’s and Spain’s main benchmark indexes (the FTSE MIB and IBEX 35 respectively) ended the week lower. But investors appeared more confident as the week came to a close, and stocks across most of Europe, buoyed by a positive US monthly jobs report, began to recover some earlier losses.
• It was a volatile week for euro zone government bonds too, with political situations in Italy and Spain triggering swings in the market. Peripheral yields spiked mid-week when the ongoing Italian political situation looked to be heading to new elections. The losses were largely recouped, though, by the end of the week, when the Five Star and League coalition appeared to be back in place. This boost to positive sentiment spread to other peripheral markets with Spanish bonds rallying. Core euro zone yields ended the week broadly flat after dipping mid-week, as investors sought safe-haven assets during the escalation of Italy-related risk.
• In the euro area, there are no market movers in terms of data releases this week.

Sources: Wells Fargo, T. Rowe Price, Handelsbanken Capital Markets, Reuters, TD Economics.