Economic Outlook – 4 February 2018

US

• The ISM manufacturing survey ticked down 0.2 points to 59.1, but new orders remained exceptionally strong and the backlog of unfilled orders increased. While the index declined slightly, it does not signal a slowing in manufacturing activity or the economy since the ISM survey is a diffusion index and measures the breadth of strength in the factor sector, not the magnitude of that strength. The current reading is consistent with solid growth in manufacturing and real GDP growth in the 4 % range. Along those lines, the closely watched Atlanta Fed GDPNow forecast for first quarter GDP growth jumped from 4.2% to 5.4%.
• Consumer confidence rose 2.3 points in January, with all of the gain coming from the expectations series. The rise in expectations likely reflects the surge in the stock market earlier in the month as well as growing optimism about tax reform. The present situation index fell slightly but remains near historic highs.
• Rising consumer confidence helps explain the persistent drop in the saving rate. Consumers have become much more optimistic about their employment prospects and are willing to spend a larger proportion of their take-home pay. Attitudes are also likely being bolstered by the run-up in the stock market and rising home prices. S&P CoreLogic Case-Shiller home prices rose slightly more than expected and were up 6.2% year-on-year in November.
• The Federal Reserve’s January FOMC meeting ended with little fanfare. The Fed kept the federal funds rate unchanged and made few meaningful changes to their policy statement. The financial markets are looking for the Fed’s new leadership to take a slightly more hawkish tone and will get the first good look into the Fed’s mindset when the Fed’s new chair, Jerome Powell, delivers his Semi-Annual Testimony to Congress later this month.
• The January employment report came in well ahead of expectations. Nonfarm employment rose by 200,000 in January. Hiring rose solidly in construction and manufacturing. The factory sector appears to be benefitting from stronger global economic growth and the weaker dollar. The unemployment rate was unchanged at 4.1%, but average hourly earnings jumped up to a 2.9% year-on-year gain. The increase adds to concerns the economy might grow too fast for its own good in 2018, which sent bond yields higher immediately after the report was released.
• On the inflation side, market-based measures of inflation expectations have also moved up. The five-year forward inflation rate (an indicator of expectations for inflation five-to-ten years from now) has moved up over 20 basis points since the start of the year. Tax cuts are expected to push economic growth further above its trend rate and also increase the supply of Treasury securities, even as the economy approaches full employment.
• Meeting in Montreal, negotiators from the United States, Canada and Mexico concluded a sixth round of talks this week. The mood was modestly more upbeat than after prior rounds, with all three nations reporting movement, though US trade representative Robert Lighthizer said progress was very slow. Envoys from Canada and Mexico rejected a key US demand that the NAFTA signatories rework the corporate arbitration system now in place. The US maintains that the investor-state dispute settlement (ISDS) erodes national sovereignty.
• US stocks recorded their first weekly loss of 2018, with the large-cap S&P 500 Index suffering its worst weekly drop in two years. Energy stocks led the declines due to a plunge on Friday following lower-than-expected earnings results from Chevron and ExxonMobil. Health care shares were also especially weak after tumbling Tuesday on news that Amazon.com, Berkshire Hathaway, and JPMorgan Chase were planning to cooperate in establishing a health care system for their US employees. Financials fared better, helped by rising bond yields, which augur well for improved lending margins.
• In the US, there is no economic data releases of particular interest this week. Instead the focus is on the many Fed speeches after this week’s meeting. Based on the meeting statement, it seems that the FOMC has become more confident in the economic outlook (three hikes this year) and not necessarily more hawkish. The speech by Dudley is the most interesting one, as he is right now the second most important voice at the Fed, as Trump still needs to nominate a Fed vice chair (Powell being the most important one).

EU

• EU gross domestic product figures released last week show that the European economy grew faster than the US last year. The Eurozone economy expanded by 0.6% in Q4, the 19th straight quarter of expansion. For the full year, the Eurozone economy grew 2.5%, while the preliminary reading from the US was 2.3%. Despite the region’s strong growth, inflation remains well below the European Central Bank’s target of near 2.0%. Preliminary data indicate that consumer prices slipped to a 1.3% annualised growth rate in January while CPI prices held steady at 1.0%. Recent euro strength versus the dollar could further complicate the ECB’s efforts to boost inflation.
• A broad-based retreat pushed European equities lower for the week as key regional indexes, including Germany’s DAX 30, France’s CAC 40, and the pan-European STOXX Europe 600, posted losses. The UK’s blue chip FTSE 100 Index lost almost 3.0% for the week, its worst performance since November. A rise in bond yields, which tend to make stocks look relatively riskier, was one of the underlying reasons for the equity sell-off. Corporate earnings were generally solid, and many investors seemed to believe that stock markets were repricing given a strong January performance.
• No big market movers are released in the euro area in the coming week, but new developments in the German coalition talks are under observation, as parties have set themselves a deadline of 4 February to wrap up the coalition negotiations. If that goal is met, the SPD plans to hold a nationwide member ballot on the final coalition agreement, which could take up to three weeks to organise. This could still be a big hurdle for the government formation process in Germany, as many SPD members remain skeptical about another grand coalition with Angela Merkel and the outcome will crucially depend on how many of its flagship policies the SPD can include in the final agreement.

UK

• The UK Manufacturing PMI fell to 55.3 in January from 56.2 in December (revised from 56.3) and missed the consensus expectation of a small increase to 56.5. Sentiment was burdened by new orders and output, as output growth eased to a six-month low, according to the survey. The growth in new orders was the slowest in seven months. New orders were pulled down by domestic orders, while export orders improved slightly. The order intake was somewhat stronger in investment goods than in consumer and intermediate goods. However, despite the weakness in new orders and output, expectations of future output improved in January and are currently back where they were in 2015 and are higher than the historical average. The employment index improved in December, but it is still lower than it was in October and November. Price pressures picked up markedly in January, according to the survey, with purchase prices rising at the fastest rate in 11 months. Increased demand for inputs reportedly led to improved supplier pricing power and shortages of raw materials, thereby resulting in a marked acceleration in input cost inflation. Part of the increase in costs was passed along to clients in the form of higher selling prices, and January saw the steepest increase in output charges since April of last year.
• The most important event this week is the Bank of England meeting on Thursday including an updated Inflation Report and a press conference. While economic data have been more or less in line with expectations since the last Inflation Report in November, the market movements are interesting. On one hand, the oil price is now higher than projected, which should lift the inflation projection in the short-term, while on the other, stronger sterling means lower inflation (but slightly further out). Overall the net effect is likely around zero. Also markets have priced in around 80.0% probability of a hike in August and it will be interesting to hear whether the BoE thinks this is appropriate or not. The appetite for making a big signal shift at this meeting is low and that the BoE might take a wait-and-see approach, not least now that the Brexit transition talks have begun. Hence the vote to keep monetary policy unchanged was unanimous.
• The most important data release is the PMI service index for January due out on Monday. Both the Lloyds Business Barometer and the service confidence indicator from the EU survey suggest the service index may have risen marginally. An increase to 54.6 from 54.2 is likely. Service sector growth remains positive but still not as high as previously in the cycle.

China

• China’s official manufacturing gauge hit an eight-month low in January, a possible early warning sign of weakening growth momentum following unexpectedly strong growth in 2017. China’s official manufacturing Purchasing Managers’ Index (PMI) came in at 51.3 in January, down slightly from December’s reading and analysts’ consensus forecast. A private survey, the Caixin/Markit manufacturing PMI, came in at 51.5 in January, unchanged from December’s level. PMI readings above 50 signal expansionary conditions, while those below 50 indicate contraction. China’s official manufacturing PMI released by the government surveys mostly larger, state-owned enterprises, while the Caixin/Markit PMI polls smaller, export-driven companies. Economists scrutinise both PMI gauges each month for clues about economic activity in China, the world’s biggest exporter, and the strength of global demand. Meanwhile, China’s official non-manufacturing PMI beat expectations and rose for the third straight month to its highest since September, reflecting the country’s transition to a services- and consumption-led economy from one driven by manufacturing.
• The weakness in January’s official PMI could be an indication of a growth slowdown engineered by China, which is trying to clamp down on industries that pollute and excessive borrowing. Growth in China is expected to “moderate gradually” in 2018, the International Monetary Fund forecast in its latest world economic outlook. Slower growth is possible for the Chinese economy in 2018 as the country reckons with years of rapid credit growth and starts to crack down on shadow lending. Encouragingly, the absence of a forward-looking growth target at last October’s Communist Party Congress signals that Beijing is placing less importance on headline GDP growth and focusing more on income growth and other measures.In terms of economic data release, Chinese FX reserves have likely increased in January to USD 3.17 trillion (consensus) due to valuation effects as the USD has weakened substantially. This raises the value of non-USD reserves in the calculation.
• Chinese trade data to confirm robust growth in exports while import growth is moderating a bit due to the slowdown in the housing market. There are some downside risks to export growth as it was very strong in recent months and base effects work to pull the year-on-year rate lower. The data is more volatile than usual in January/February due to the Chinese New Year.
• Chinese PPI inflation is expected to fall slightly to 4.5% year-on-year in January from 4.9% in December – mainly due to a lower inflation impact from commodity prices, which tend to be the main driver for PPI. CPI inflation is expected to stay around the current level of 1.8% year-on-year, still comfortably below the 3% target (which in practice serves more as a ceiling).

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