Economic Outlook – 3 September 2017

US

• Payroll growth slowed in August with employers adding 156,000 jobs. It is worth noting that the initial print for August payrolls has historically seen the largest upward revisions between the first and third release. Over the past five years, August payrolls have been revised up by an average of 46,000, suggesting the extent of the slowdown may be overstated. That said, job growth for June and July was also revised lower by a total of 41,000 jobs and indicates that the trend in hiring has genuinely eased. The unemployment rate rose to 4.4% amid a drop in the household measure of employment. The labor force participation rate was unchanged at 62.9%.
• Manufacturers added 36,000 jobs, consistent with the leap in the ISM manufacturing employment component to a six-year high. Gains were also strong in construction (+28,000) and professional & business services (+40,000). Weakness was more evident in lower-wage sectors such as retail (+1,000) and leisure & hospitality (4,000). Despite the favourable composition of job growth, average hourly earnings rose just 0.1% in August, keeping the 12-month change in wages at 2.5%.
• The US economy grew at a 3.0% annual pace in the second quarter, an upward revision from the 2.6% pace reported in July. Spending was robust by both consumers and businesses in Q2, with capital expenditures expanding at an 8.8% rate – the fastest in nearly two years. Corporate profits rose 8.1% year-on-year.
• Consumer confidence is up again. The Conference Board’s measure rose 2.9 points in August from an already elevated reading. August’s gain was mostly driven by more favourable views of current business conditions and the labor market. A larger share of respondents viewed jobs as “plentiful” while fewer viewed jobs as “hard to get.” The difference between these two series, known as the labor differential, suggests that the downward trend in the unemployment rate should resume.
• Personal income rose 0.4% in July, led by a 0.5% rise in wages and salaries. While July’s gain marks a welcome rebound after income was flat in June, income growth still looks tepid compared to the first few months of the year; over the past three months, nominal income has grown at a 3.0% annualised rate.
• While low inflation has benefitted real income and spending gains of late, it remains a headache for the Fed. Both headline and core inflation are up only 1.4% over the past year. That marks the weakest 12-month change in core inflation since December 2015. Unlike then, however, the dollar has been weakening and commodity prices have been largely stable, which has made it harder for the Fed to consider the weakness transitory.
• Hurricane Harvey made landfall in Southeast Texas on August 25, 2017 and has brought heavy rains and unprecedented flooding to the area, with some counties expected to receive more than four feet of rain by the time it tapers off. Forecasters expect rains to cease tomorrow morning, but this could still change. Given the ongoing deluge, the situation remains fluid, with the economic impact estimates presented below subject to change as more information becomes available. At this point, early estimates of damage suggest roughly USD30 billion in property losses, which would make Harvey costlier than Andrew and nearly on par with Ike, but well below that of Sandy and Katrina.
• An estimated 23% of US refinery capacity is offline because of flooding in the wake of the exceptionally slow-moving Hurricane Harvey. Nationally, gasoline prices have risen an average of 17 cents a gallon since Harvey made landfall and now average USD2.45, according to AAA. The storm, which left at least 39 dead and displaced tens of thousands, is expected to be one of the most expensive natural disasters in US history. Parts of the Houston area received in excess of 50 inches of rain, a US record for a single event. Markets have largely taken the news in stride. Prices of municipal securities issued around the Houston region have not been heavily impacted, nor have bonds of companies in the insurance and energy industries.
• The economic impact of the storm can be divided into two phases. The first, taking place right now, is a slump in economic activity related to the shuttering of refineries, ports, oil rigs, and other places of business. This is going to reduce economic activity during the current quarter and depends on the duration of the stoppage and the breadth of businesses affected. The second phase will be the rebuilding phase, which will add to economic activity as homes and businesses are rebuilt and automobiles and other equipment is replaced. In addition to the GDP and payroll impacts, other economic indicators including net exports and industrial production should show some weakness in the coming month or two given the importance of the region as an energy and export hub.
• US President Donald Trump travelled to Missouri this week to make the case for overhauling the US tax code. The president called this a once-in-a-generation opportunity to reshape the increasingly complex US tax system. But, the president offered few specific policy proposals beyond calling for a code that is fairer for lower- and middle-class Americans and for the corporate tax rate to be lowered to 15.0%, a level he said would create jobs and raise wages. Tax reform faces an uphill battle, with an already packed legislative calendar set to become even more crowded as lawmakers begin to address disaster relief for the Texas Gulf Coast.
• Congress has two critical to-dos in September: raise the debt ceiling and pass a resolution to fund the government beyond the end of September. In recent years, these issues often are not settled until the 11th hour, resulting in market volatility. With Republicans dominating Washington, agreements on both items should seemingly be reached more easily. However, the need for Democratic cooperation in the Senate raises the probability of a government shutdown in particular. A brief government shutdown would dent, but not derail, economic growth in the fourth quarter. The risk is a standoff could damage market confidence in Washington Republicans enacting pro-growth policies they expect. A sneak preview of the volatility that could result from this reveals that, in the worst case scenario of a bad standoff and severe market turmoil, the Fed could delay the start of normalisation of its balance sheet in September.
• ISM non-manufacturing in August is due to be released on Wednesday. The service sector has been the main driver of growth for a long time and it is not expected to change. Although the ISM non-manufacturing declined sharply in July, it is still at a level indicating progress in the service sector. Furthermore, the fall last month was too big and that it will have recovered some of the lost ground in August. Hence, the ISM non-manufacturing is likely to come in at 55.0, which is also in line with what the PMI services for August indicates.
• The final core capex orders for July are due out on Tuesday. The first release indicated that the recovery in the manufacturing sector is still intact and there is no reason to believe that the final numbers will change that impression.
• A number of speeches by FOMC members are due next week, the most interesting being Dudley’s (voter, dovish) on Friday. Dudley is seen generally as very influential in terms of rate decisions and he has recently expressed confidence that the tightening of the labour market will eventually push up inflation. He also emphasises the importance of financial conditions in the Fed’s monetary policy decisions and currently financial conditions are very easy.

UK

• UK Manufacturing PMI increased to 56.9 in August from 55.3 in July (revised from 55.1). The August reading was stronger than the consensus expectation of a sideways movement in sentiment (consensus 55.0). The upturn in manufacturing activity in August was reported to be broad-based across sectors, and according to the survey, all five of the PMI components (output, new orders, employment, suppliers’ delivery times and stocks of purchases) increased sentiment in August. Production rose at the steepest pace in seven months, underpinned by faster intakes of new work received. The domestic market was the prime source of new contract wins, while the rate of improvement in new export business eased from July’s highest ever. Purchase price inflation accelerated for the first time in seven months during August. However, the overall rate of increase remained well below the record seen at the start of the year. Business optimism improved to a three-month high in August. Positive sentiment was attributed to rising demand, a stronger global economy and planned investment spending.
• The third and latest round of Brexit negotiations ended on an acrimonious note, with the two sides unable even to agree on whether any progress had been made during the week. British Brexit secretary David Davis said concrete progress had been made while the European Union’s Michel Barnier said no progress had been made. There has been no agreement on key issues such as the Northern Ireland border, citizen’s rights and the size of the Brexit divorce payment. The EU has stated that sufficient progress must be made on those issues before discussion of the United Kingdom’s future trade relationship with the EU can be taken up.
• The main release next week will be the PMI service index for August on Tuesday, which will give more information about how the economy is doing in Q3 given growth was sluggish in the first half of the year. There are some mixed signals from the service sector, as the Lloyds Business Barometer fell sharply in August while the service confidence indicator was more or less unchanged. Although this makes it more difficult to estimate the exact level for PMI services, it seems there is limited upside potential. A decline from 53.8 to 52.7 is likely. This is in line with the consensus expectation that the economy is continuing to grow around a quarter percentage per quarter.

EU

• European equities also reaped the benefits of improving economic data. Despite August’s strong inflation reading in the Eurozone, the ECB is expected to leave its policy stance unchanged at next week’s meeting. The committee’s monetary policy path is complicated by the differing rates of recovery within the Eurozone. Germany and Northern Europe have displayed strong growth, while Southern economies including Greece and Italy are still grappling with slow employment growth and an elevated euro that is proving to be a barrier to export growth.
• German chancellor Angela Merkel has joined French president Emmanuel Macron in calling for the creation of a Eurozone finance minister in order to increase fiscal integration in the single-currency area. However, specifics on what duties would fall to such a minister remain vague. Merkel is in the home stretch of her campaign for a fourth term as chancellor. Germans go to the polls on 24 September.
• In the euro area, the Sentix investor confidence is due for release on Monday. Sentix reached 28.4 in June, which is the highest level in 10 years, but has since declined marginally to 27.7 in August. Sentix seems to be set for a further decline in September. The tension concerning North Korea is still seeing spill overs to the financial markets, while the recent EUR strength might also have weighed on investor confidence.
• On Tuesday, euro area retail sales figures for July are due out. Retail sales have shown monthly growth in every month in the first half of 2017, with the exception of April. Consumer confidence has also been increasing throughout 2017, paving the way for higher retail sales. Although consumer confidence decreased marginally in July, it rebounded in August and remains at a high levels not seen since 2007, a positive growth in retail sales of 0.3% month-on-month in July is possible.
• The September ECB meeting is due to be held on Thursday. Announcements on the meeting are not expected as Mario Draghi has emphasised that discussions on the QE programme will take place in the autumn, and no decision will be made before the meeting in October. That said, there will be a lot of questions and some signals from the ECB about how the QE programme will continue in 2018. Added to this, a lot of focus is likely to be on the EUR appreciation as it poses a rising problem for the ECB. It would not be surprising to hear Draghi mention this as a worry again especially as the stronger EUR is likely to result in a lower inflation projection from the ECB, which is due to be released at the meeting.

China

• In China, trade balance and FX reserves readings are due next week. Trade data is quite volatile, so the focus should be on the trend in the numbers. The past months have shown decent growth in exports while imports have been a bit softer. The latter is likely to reflect some slowing of the domestic economy. A similar picture is possible for the August data. FX reserves are estimated to be broadly unchanged in August at around USD3.08 trillion.

Sources: Wells Fargo, MFS Investment Management, TD Economics, Handelsbanken