Economic Outlook – 6 May 2018

US

• The US personal income and spending report showed an encouraging spending rebound in March. Consumer spending rose 0.4% during the month on both a real and nominal basis. The 0.4% rise came on the heels of a weaker February gain, with nominal spending flat and real spending declining 0.2%. Consumer spending took a breather in Q1 from last week’s GDP report, which showed only a 1.1% acceleration in Q1 PCE. The solid print in March suggests spending had solid momentum going into the second quarter. Moreover, fundamentals point to more consumption in Q2. The strong job market has supported income growth, though March’s increase was a bit slower.
• Many US homebuyers are facing a dearth of available inventory in their price range. Pending home sales for March showed a smaller-than-expected rise of 0.4%, and the number of signed contracts remained below their year-ago level for the third straight month. Residential construction spending also declined in March, contributing to the 1.7% decline in overall outlays. January and February’s outlays were revised higher and spending remains up year to date, suggesting construction activity is still gaining momentum despite the disappointing report in March.
• The ISM manufacturing survey slipped again in April but remains close to its February high and still points to solid expansion in coming months. Responses reiterated concerns that limited labor supply and supply chain disruptions are restraining production. Delivery times have lengthened and backlogs rose to a 14-year high. This contributed to higher prices paid for many industries, which will likely push up consumer prices as costs are passed along or eat at profit margins. Headline factory orders rose in March, representing a surge in commercial aircraft orders.
• Core capital goods orders and shipments were down on the month. Business equipment has boosted top-line GDP in each of the past six quarters, but the softening in core orders suggests the fastest quarterly growth rates may be behind us.
• Non-manufacturing prices paid also increased in April to its strongest reading since 2012, excluding hurricane-induced spikes. The non-manufacturing ISM composite also eased in April but remains elevated, pointing to continued growth in the services and construction sectors.
• The Fed left interest rates unchanged on Thursday as widely expected, policy statement yielded no major surprises with the Fed sticking to its usual policy stance, signalling ‘further gradual increases” moving forward. The Fed noted a softer first quarter and that inflation has moved closer to its 2% target (the PCE core has increased 1.9% year-on-year in March) but made references to its ‘symmetric’ inflation targets to downplay a seemingly hawkish tone, implying that any deviation of inflation to the upside might not necessarily warrant a policy move i.e. allowing inflation to overshoot above its 2% target. Initial jobless claims were steady while continuous claims fell to an all-time low.
• The US Treasury Department will increase the size of debt auctions in coming months in order to fund a growing US fiscal deficit. In addition to the larger auctions, the Treasury will introduce a 2-month Treasury bill. The Treasury has historically issued, 1, 3, 6 month and 1-year bills on a weekly basis. Secretary of the Treasury Steven Mnuchin said he is unconcerned about the bond market absorbing the additional bond supply. The US government borrowed a record $488 billion in the first quarter of 2018.
• The US unemployment fell to 3.9% in April from 4.1% in March, the lowest since December 2000. Non-farm payrolls rose a smaller-than-expected 164,000, but February and March payrolls were revised up by a net 30,000. Wage growth remains tepid as average hourly earnings advanced by only 0.1% in April despite what appears to be a tight labor market. Nothing in the data should prompt the US Federal Reserve to deviate from the gradual path of interest rate hikes.
• A high-level delegation of US trade negotiators left Beijing on Friday after two days of talks without tangible results. China’s official news agency said that both parties reached agreement in some areas but that there remained significant disagreement over certain issues. The US contingent did not comment on the talks. Among the most thorny issues is a demand by the US that China halt subsidies to favoured industries that are part of the government’s Made in China 2025 initiative. Both sides agreed on the need for more dialogue to ease tensions, according to the Xinhua news agency.
• A high-level delegation of US trade negotiators left Beijing on Friday after two days of talks without tangible results. China’s official news agency said that both parties reached agreement in some areas but that there remained significant disagreement over certain issues. The US contingent did not comment on the talks. Among the most thorny issues is a demand by the US that China halt subsidies to favoured industries that are part of the government’s Made in China 2025 initiative. Both sides agreed on the need for more dialogue to ease tensions, according to the Xinhua news agency.
• US longer-term bond yields remained roughly stable for the week, although the yield on the 10-year Treasury note approached 3.0% again on Wednesday after having crossed the symbolic threshold the previous week. Stable cash flows into the sector and a lighter new issuance calendar helped municipal bonds start off the week on a positive note. Demand remained evident across all maturities but appeared to focus more on shorter and intermediate maturities. Deals continue to be oversubscribed, leading to an uptick in secondary market trading.
• In the US, the most important release is the CPI core numbers for April due out on Thursday. The consensus estimate for the monthly increase yet again is 0.2% month-on-month, which translates to 2.2% year-on-year up from 2.1% in March.
• This week there are also several speeches by FOMC members but they are expected to change much, as the Fed seems to be on autopilot right now and the June hike is fully priced in.

UK

• In the UK, the Monetary Policy Committee (MPC) of the Bank of England (BoE) will meet on Thursday 10 May. The second Inflation Report of 2018, with updated forecasts and a new assessment by the MPC, will also be published on that day alongside minutes from the monetary policy meeting. At the November meeting last year, the MPC voted seven to two in favour of increasing the bank rate by 25 basis points, to 0.5%. The reason behind the rise was a tighter labour market and therefore a less pronounced trade-off between the real economy and inflation, according to the MPC. At its February meeting, in a unanimous decision, the BoE kept the policy rate unchanged at 0.5%, but indicated that the interest rate might have to be raised earlier and to a greater degree than market expectations indicated at the time. At its March meeting, the BoE also kept the policy rate unchanged, but the vote was seven to two, with the minority wanting to lift the policy rate by 25 basis points at that meeting. The likelihood of a May rate hike has, according to the market pricing, dropped from almost 90% in March to below 9 % now. The reason is a string of weaker-than-expected data.
• The UK PMI services index increased to 52.8 in April from 51.7 in March. The consensus expectation was for a more pronounced rebound to 53.5. The PMI composite increased to 53.2 in April from 52.4 (revised from 52.5) in March, while the consensus expectation was 53.7. The services sentiment was pulled up by incoming new business and business activity in April, but the rate of growth was the second weakest since September 2016 according to the survey. This was rather disappointing, as a healthier rebound had been expected after weather-related weakness in Q1. At the same time inflationary pressures moderated and employment growth weakened. A number of survey respondents noted that subdued consumer willingness-to-spend had held back business activity growth in April and there were also reports that concerns about the domestic economic outlook had acted as a brake on spending by corporate clients. Higher salary payments continued to push up cost burdens. However, the overall rate of input price inflation eased since March and remained softer than at any time in 2017, according to the survey. Moreover, the latest rise in average prices charged by service sector firms was the joint-slowest since July 2017.
• UK prime minister Theresa May was dealt a setback this week as a proposed “customs partnership” with the European Union was rejected by her Brexit cabinet. The proposed solution would have removed the need for customs checks at the border with the UK collecting tariffs set by the EU on goods coming into the UK. If they goods didn’t leave the UK and UK tariffs on them were lower, companies could claim back the difference. Leaving the EU’s customs union is problematic for the UK given that goods can cross the border with the Republic of Ireland several times during the production process. Opposition to a customs partnership is so strong that pro-Brexit MPs appear willing to put the matter to a confidence vote.
• The most important UK event is the Bank of England meeting on Thursday. After BoE governor Mark Carney’s dovish comments and weaker-than-expected economic indicators, the hike is likely to be postponed to the August meeting, which would give the committee more time to see whether the weakness is temporary or not.
• Before the BoE meeting, the production and construction data for March will be released, which will give more insight into whether the weaker-than-expected Q1 GDP growth print of 0.1% quarter-on-quarter may be revised up.
• Manufacturing PMI from Markit increased slightly to 51.1 in April from 51.0 in March, versus expectations of a slight decline to 50.9. The official manufacturing PMI index fell slightly to 51.4 in April from 51.5 in March, which was a smaller fall than that expected by the consensus. The overall picture is that both indices stabilised in April following unsynchronised swings in the preceding months. As has been the case with most Chinese macroeconomic indicators over recent months, the PMIs (especially the official PMI) are very likely to have been distorted by the New Year holiday. The official PMI plunged in February but rebounded just as much in March. The April reading is unlikely to have been distorted by the timing of the holidays, and it is therefore reassuring that the index was stable at a fairly high level.

EU

• Eurozone flash annual consumer price inflation slowed a notch more than expected to 1.2% year-on-year in April, from previously 1.4%. While food and energy price inflation rose, service inflation decreased markedly to 1.0% year-on-year in April (previously 1.5% year-on-year). This meant that annual core HICP inflation fell to a meagre 0.7% (previously 1.0%). This mainly reflects an Easter effect stemming from a steep increase in April last year, which will likely reverse in May. Accordingly, the base effect is expected to push up inflation further in the following two months. This will likely strengthen signs that inflation is continuing to rise, albeit at a gradual and bumpy pace.
• As expected, real GDP growth decreased in the first quarter of 2018 to 0.4% quarter-on-quarter, from previously 0.7% quarter-on-quarter. This is the slowest growth in one and a half years. A slowdown was possible as signalled by the weak hard data on retail sales and industrial production in the first two months of the year. Meanwhile, sentiment data has declined sharply, but stabilised at a still robust level in March after flying unsustainably high over the turn of the year. Hence the first quarter growth should likely be seen as a pull-back from a strong finish to 2017, but temporary factors such as poor weather and financial market jitters combined with protectionist worries likely also explained some of the slowdown. Looking ahead, growth is expected to improve in the second quarter, but the slowdown probably underscores the fact that growth has peaked and will likely moderate over the next three years.
• On May 16, the final euro area April HICP figures will be released. Core inflation surprised on the downside in April, falling back to 0.7%. The decrease was partly driven by one-off factors related to the timing of Easter. The final release details will give insights into the exact drivers of the decline and whether to expect a rebound in core inflation in May.

China

• Analysts closely watch China’s PMIs for clues about the strength of global demand. But several subindexes in the various gauges signalled heightened uncertainty for exports, an important driver for China’s economy. The official PMI showed a drop in new export orders in April, a decline that was mirrored in the Caixin/Markit PMI, which revealed that export orders shrank last month for the first time since November 2016. Moreover, confidence regarding next year fell to a four-month low in April, with some firms citing concerns over future market conditions and the strength of global demand, Caixin/Markit reported.
• China’s intermediate-term outlook is solid and that Beijing’s commitment to deleveraging the economy poses a greater growth risk than tariffs. Earlier this year, China’s premier announced an annual economic growth target of about 6.5% for this year, unchanged from 2017.
• The most important data will be the trade balance, inflation and credit/money growth. Numbers are expected to confirm that export growth is levelling off and that credit and money growth is still quite soft. On inflation, CPI is set to decline slightly to 1.9% in April from 2.1% in March, while PPI inflation will be broadly unchanged just above 3.0%. In general, lower commodity price inflation has led to a decline in producer price inflation over the past six months and consumer price pressures are also subdued.

Sources: Wells Fargo, T. Rowe Price, Handelsbanken Capital Markets, Danske Bank, MFS Investments, HongLeong Bank.