Economic Outlook – 30 September 2018

US

• The FOMC decision was the headline event this week, even though its unanimous 25 bps rate hike was widely expected. What was decidedly more interesting were key changes in the language of the committee’s policy statement, as well as the rollout of its 2021 fed funds rate projections. While the FOMC has been steadily increasing interest rates since late 2015, it has kept language in its statement to say that “monetary policy remains accommodative.” However, that language disappeared this week, meaning the committee is implicitly signalling that the fed funds rate has moved into neutral territory. That said, the neutral fed funds rate estimate is not precise and could take on a broad range.
• The PCE deflator rose 2.2% in August year-over-year, just above the Fed’s 2% target. However, fading fiscal stimulus are an important indicator and passthrough effects of monetary tightening to the broader economy to eventually slow growth and lead the Fed to cut the fed funds rate 25 bps at the end of 2020.
• The headline consumer confidence index rose 3.7 points to 138.4 in September, approaching its all-time high registered in 2000. Although the present situation index continues to run ahead of future expectations, the latter still increased six points, signalling that consumers remain upbeat about the near-term outlook. The income and spending data generally confirm the strong survey data this week. While personal spending growth slowed slightly to 0.3% in August, wages and salaries rose a stronger 0.5%, confirming that a tight labor market is likely propelling wage growth in the near term.
• New home sales rebounded in August, rising 3.5% to a 629,000-unit pace after trending lower in prior months. However, affordability remains a concern, as home prices continue to rise and higher interest rates reinforce upward pressure on mortgage rates, giving little room to see much upside to home sales later this year.
• August durable goods orders were a bit less encouraging for business spending in Q3. While headline orders rose a stronger-than-expected 4.5%, core capital goods orders actually declined 0.5% after removing the volatile aircraft component that accounted for most of the headline beat.
• The US-China trade conflict saga continued to play out in the background, given other more salacious domestic political developments. China scrapped talks with the US as tariffs on $200 billion of Chinese goods came into effect. Meanwhile, President Trump accused China of attempting to interfere in the upcoming midterm elections, given his stance on trade. With the two economic heavyweights on a hard-to-avoid collision course, this dispute might become a key risk to growth.
• The major indexes ended mixed for a second consecutive week, with the technology – heavy Nasdaq Composite Index recording a solid gain, while most other benchmarks suffered declines. Along with technology stocks, consumer discretionary shares outperformed within the S&P 500 Index, while materials and financials shares declined. Similarly, faster-growing, higher-valuation growth stocks handily outperformed value shares.
• Longer-term Treasury yields decreased slightly for the week – although the benchmark 10-year Treasury note yield briefly touched a four-month high of 3.11% on Tuesday. A drop in yields on Wednesday appeared to be due in part to dovish comments on inflation from Fed Chairman Jerome Powell following the central bank policy meeting. The lack of any changes in the “dot-plot” survey of individual policymakers’ expectations for future interest rates may have also played a role.
• The most important release this week is the jobs report for September on Friday. Non-farm payrolls are estimated to rise around the current trend of 190,000. As employment has risen for so long, the most important part of the jobs report is the average hourly earnings, as they have risen faster than the recent trend over the past four months and the annual growth rate is at 2.9% year-on-year, which is a cycle high. It seems like the tighter labour market is beginning to put upward pressure on wage growth.
• SM manufacturing is due out on Monday. Overall, ISM manufacturing has been too high compared to reality for a couple of years and is a poor indicator at the moment.

UK

• British companies cut their investment in the second quarter of 2018, when Brexit was less than a year away, and the country’s balance of payments shortfall grew more than expected. The Office for National Statistics confirmed a previous estimate that Britain’s overall economy grew by a quarterly 0.4% in the April-June period. But it lowered the annual growth rate in the second quarter to 1.2% from a previous estimate of 1.3%. It also cut the quarterly growth rate in the first three months of the year, when the country was hit by heavy snow, to 0.1% from 0.2%.
• Bank of England Chief Economist Andy Haldane said on Thursday that the central bank could decide to raise interest rates or to cut them if there was a disorderly, no-deal Brexit. The decision would depend on the balance of factors such as a fall in the value of the pound and the reduction in supply- such as less investment and fewer migrant workers – which would push up inflation, against the hit to demand, he said. “It is genuinely two-sided which way we might act and how we will act will depend upon that balance of demand, supply and the exchange rate, just as it did pre-referendum,” Haldane said during a question-and-answer event at the Institute for Government think tank in London.
• The most important event next week is the Conservative Party Conference beginning on Sunday and lasting until Wednesday. It is going to be very interesting due to the internal disagreements on how to proceed with the Brexit negotiations (not least after the Salzburg-meeting ended terribly and because many of the hard Brexiteers speak explicitly about their wish to replace Theresa May with one of their own. While there are certainly enough hard Brexiteers to trigger a leadership contest (requires the signature of 48 Conservative MPs), the challenge for them is that it requires 158 MPs to vote for no confidence in PM Theresa May, a number which seems more unlikely. The pro-Brexit MPs are very attention seeking but there are many more moderate MPs who are supportive of May and have a softer stance on Brexit.
• Flash consumer price inflation in the eurozone rose in line with expectations, to 2.1% year-on-year, in September, from 2.0% year-on-year in August. Thus, inflation has remained at, or just over, 2.0% for four months in a row. But base effects stemming from energy prices will probably pull headline inflation down toward the end of the year. It was increases in energy and food in particular that pulled up, while core inflation unexpectedly fell to 0.9% year-on-year in September, from 1.0% previously, despite Eurostat’s data showing unchanged annual inflation for service items and non-energy industrial goods. The decline was therefore probably a close call. With core inflation back at its lowest in three months, there is not much to indicate that a faster climb in underlying inflation is about to materialise.
• The European Commission’s Economic Sentiment Indicators for the eurozone, an aggregate measure of consumer and business confidence, fell in September for the ninth-consecutive month and hit its lowest level in more than a year. Eurozone manufacturing slowed as Europe’s export boom reversed course and amid uncertainty about the future of trade deals.
• After rising for much of the week, European stocks lost ground after Italy’s coalition government agreed to a wider-than-expected 2019 budget deficit goal of 2.4%, triple what the previous government had planned. The decision essentially puts the country on a collision course with the European Union (EU), which had urged Italy to rein in its spending. The deal will likely prompt all three major credit ratings agencies to downgrade Italy and put it on negative watch, which could add to the selling pressure on Italian assets.
• There are no market movers in the euro area this week.

China

• China’s main stock indexes rose for the second week as proposals from competing index providers to include more yuan-denominated shares into global portfolios offset the latest round of US tariffs taking effect. For the week, the benchmark Shanghai Composite Index added 0.9% while the large-cap CSI300 Index rose 0.8%. Mainland Chinese markets are closed the first week of October for the National Day holiday.
• In response to the recent US President Trump’s move on tariffs, China said it would impose tariffs on US imports worth about $60 billion. The latest round of US tariffs (which are set to increase to 25% on January 1) come on top of $50 billion worth of Chinese goods that the US has already tariffed this year and raised expectations that the White House is prepared to press on with yet another round of tariffs. Should Trump make good on all his tariff threats, it could bring the total dollar amount of Chinese goods tariffed by the US to over $500 billion. In contrast to hopes of a resolution just a few a weeks ago, many policy specialists now expect that the US – China relationship will grow more tense in 2019 given a lack of good faith concessions on either side that would foster a resolution, according to Deal.
• Key focus in China will be on the upcoming PMI data. PMIs have held up fairly well compared to other indicators.

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