Economic Outlook – 4 March 2018

US

• US factory sector data released this week showed another divergence between the “hard” and “soft” data. On the hard data front, private equipment spending looks to be cooling after increasing at a double-digit pace in the third and fourth quarters of 2017. Durable goods orders fell 3.7% in January, with much of the decline concentrated in the volatile non-defence aircraft component. Orders excluding aircraft and defence fell 0.2% in January on the heels of a 0.6% decline in December. The trend in core capital goods orders has weakened noticeably from the impressive run in the fall; core capital goods orders are up at a 3.7% three-month average annualized pace, compared to over 18.0% as recently as November.
• Survey data on US manufacturing, however, continued to reach new heights. The headline print of 60.8 for the ISM manufacturing index was the highest since 2004 and the latest affirmation of broadening business confidence. The prices paid component of the index continued climbing (signaling building price pressures in the pipeline) and the employment component jumped to 59.7 after a sharp fall to 54.2 in January. Hard data for orders are likely to converge with the survey data. In times of such pronounced survey strength, however, the gap between hard and soft data is usually narrowed by business surveys getting reined in, rather than the hard orders data, which feed directly into GDP calculations.
• The Conference Board’s Consumer Confidence Index climbed to 130.8 in February, touching the highest level since late-2000. Both the present situation and future expectations indices rose in the month, with more upbeat sentiment about the availability of jobs and expected income growth. February’s stock market volatility seemed to have little effect on consumer sentiment. A separate release from the Department of Commerce showed strong disposable income growth in January as the tax cuts began to take effect. Consumption growth started the year off on a bit of a soft note, but rising confidence and solid income growth bode well for consumption growth over the remainder of the year.
• New home sales slipped in January, falling 7.8% despite market expectations for a 3.5% gain. The winter months can have notoriously volatile seasonal adjustment factors for home building, however, and some upward revisions going back to October helped offset some of the January weakness. Pending home sales also exhibited weakness in January. Construction outlay data were a bit better, as private residential spending rose 0.3% and 0.6% in the single-family space.
• Fed Chair Powell first testimony to the Congress obviously took centre stage this week. His positive comments about the US economy spurred expectations the Fed could be in for more aggressive interest rate increases this year although there was no such explicit statements from him. Powell mentioned that the economy has strengthened since December; labour market is showing continuing strength; inflation is moving up to target; and recent rise in bond yields and market corrections will unlikely weigh heavily on growth and inflation outlook. His view on policy remains one to juggle between “avoiding an overheated economy” and lifting inflation to 2.0%. Despite the seemingly more hawkish speaks to the House, Powell’s remarks to the Senate appeared more soothing, commenting that the US economy is not running hot and that the Fed is expected to maintain its gradual policy tightening pace. Given the more hawkish speaks, there is a higher chance that the Fed could raise rates more than twice this year, but much would still depend on upcoming economic data.
• Market losses extended further on Thursday on fears of trade wars following Donald Trump’s announcement of a 25.0% import tariff on steel and 10.0% on aluminium. While nothing has been signed yet, should these tariffs be introduced, they will lead to higher input prices for many manufacturing and construction industries which rely heavily on steel and aluminium inputs and ultimately result in higher prices for US consumers, thus posing an up-side risk to the Fed’s inflation outlook.
• US stocks recorded sharp losses for the week. Information technology and consumer staples shares held up best in the S&P 500 Index, while industrials and business services shares fared worst. A decline in industrials giant Caterpillar weighed especially on the narrowly focused Dow Jones Industrial Average, while the smaller-cap benchmarks and the technology-heavy Nasdaq Composite Index fared best. The week started out on a strong note, although on light trading volumes. There did not seem to a single catalyst behind the gains, but rather an overall sense that the factors that drove the market higher in recent months (including global economic strength, strong earnings growth, and enthusiasm over tax cuts) would help stocks recover from recent volatility.
• Interestingly, the threat of a trade war seemed to have a more durable effect on the bond market. After declining for much of the week, the yield on the 10-year Treasury note bounced following the president’s tweets, seemingly due to fears that heightened prices for steel and aluminium (and perhaps more goods to come) would feed through into higher inflation. Municipals under-performed US Treasuries as buyers remained cautious.
• In the US, the most important release this week is the jobs report for February with most focus on average hourly earnings (AHE), as employment growth remains solid and there are no signs that this trend has discontinued. The monthly increase in AHE was strong in both December and January so there is a likelihood that it disappointed in February, as the series is volatile.
• There are upcoming speeches from Fed members this week as well with William Dudley’s two speeches likely to be the most important given his seniority.

EU

• In the Eurozone, sentiments turned less optimistic and inflation extended its moderation trend. Eurozone data appeared to be flattening and is turning south, potentially affecting ECB’s policy normalisation effort.
• European stocks ended the week lower amid subdued trading volumes, lacklustre economic news, and fears about a brewing trade war following President Donald Trump’s announcement of tariffs on steel and aluminium. Both the pan-European STOXX 600 and the German DAX 30 fell just over 2.0%. The UK’s blue chip FTSE 100 fared slightly better but still posted a decline of just over 1.0%. FTSE 100 shares were weak following UK Prime Minister Theresa May’s rejection of the European Union Brexit treaty draft.
• The markets have been largely ignoring the weekend elections in Italy and Germany. According to many sources, the outcome for today’s (n.d.r. Sunday 4 March 2018) Italian general election is uncertain and could result in a hung parliament and the formation of a fragile coalition or a rerun of the election. None of the major political parties has presented clear ideas on how to boost growth through reform. Italy’s benchmark FTSE MIB ended the week about 2.0% lower, mirroring the losses of other major European indexes. Italian bonds rallied. The yield on 10-year Italian government bonds had fallen to around 1.9% by last Friday’s close, down for the week. After the vote is concluded over the weekend, Germany’s centre-left Social Democratic Party will reveal whether it will form a coalition with Chancellor Angela Merkel and her centre-right Christian Democratic Union/Christian Social Union alliance. German bund yields fell for the week.
• The March ECB meeting is due to be held on Thursday. No changes to the policy rates are expected and it is unlikely that the ECB will outline a decision on extension/termination of the QE programme before June. However, it is possible there will be changes to the forward guidance in March. Specifically, the ECB is expected to remove the easing bias in the forward guidance, meaning it will drop the paragraph about increasing the APP in size and/or duration if economic conditions turn less favourable.

UK

• In her speech, Prime Minister Theresa May urged the European Union on Friday to show more flexibility in talks on a future relationship after Brexit, saying Britain realised it could not get all it wanted but believed an ambitious trade deal was still possible. In a much-anticipated speech, May set out ambitions for a tailor-made free trade deal that would include financial services and said Britain would aim for associate membership of EU regulators covering chemicals, medicines and aerospace. May appealed to the EU to work together to solve some of the more difficult Brexit problems, including over Ireland, where some fear the return of a “hard border” with the British province of Northern Ireland after Brexit.
• Growth in Britain’s struggling construction industry picked up slightly in February, led by the commercial sector, but uncertainty linked to Brexit continued to weigh on order books. The IHS Markit/CIPS UK Construction PMI rose to 51.4 from 50.2 in January, at the top end of forecasts in a Reuters poll of economists that had pointed to a reading of 50.5. Construction output suffered its biggest drop in more than five years during the final three months of 2017, according to official figures last month, marking the third consecutive quarter of decline.
• In the UK, the most important release this week is the PMI service index due out on Monday. Both the service confidence indicator from the EU and the Lloyds Business Barometer signal an increase. The index is likely to rise to 53.8 from 53.0. Despite an increase, it does not alter the picture that UK growth remains moderate.

China

• The official manufacturing PMI index fell a full index point from 51.3 in January to 50.3 in February. On the contrary, manufacturing PMI from Markit increased slightly from 51.5 to 51.6. Both indicators might be distorted by the timing of the New Year holidays, but Markit usually seems to better adjust for the New Year than the official statistical bureau. The increase in Markit’s index is only marginal, and the trend for both PMIs seems to be downward. That would be in line with the view that overall economic growth should slow gradually ahead. The construction boom is very likely over due to the many measures taken by the authorities to avoid speculation and dampen the lively housing markets. The authorities are also eager to diminish overall credit growth and, in particular, shadow banking activity, and that, along with the measures to combat air pollution, will inevitably weigh on economic growth ahead.
• The data come as Beijing gears up for a key economic policy meeting, during which China is expected to unveil its annual gross domestic product (GDP) growth target, name a new central bank governor, and possibly announce more forceful measures to deleverage the economy. One ongoing challenge for China has been to free policymakers from the medium-term target of doubling real per capita incomes/GDP between 2010 and 2020, which has tethered policymaking to repeated rounds of credit-led stimulus every time the economy falters. China has modestly lowered its growth target over time and will likely downplay its significance after 2020. But with China’s growth exceeding the pace needed to meet its 2020 goal, the policy priority has shifted toward financial stability.
• Key data releases in China this week will be FX reserves, trade balance and inflation. FX reserves on Wednesday are expected to be broadly flat around the level in January of USD 3.16 trillion. Trade data on Thursday is likely to be distorted by the Chinese New Year and should be taken with caution. Chinese inflation numbers on Friday is likely to show a further drop in PPI inflation to 4.0% year-on-year from 4.3% year-on-year in January. It is driven mostly by industrial commodity prices, where inflation has come down slightly. CPI inflation is set to rise above 2.0% year-on-year from 1.5% year-on-year but this is related in part to higher prices around the Chinese New Year in February.
• Focus will also be on the National People’s Congress, which is due to start on Monday and typically lasts for 10 to 14 days. It is likely to approve the proposal from the Central Committee of the Communist Party to remove the two-term limit for the President and Vice-President, paving the way for Xi Jinping to stay in power beyond 2023.

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