Economic Outlook – 7 January 2018

US

• The ISM manufacturing index for December remained in solid expansion territory, coming in at a mild 59.7 to extend a five-month streak above 58. The last time the index posted such a run was in 2004, then 1987 prior to that. Activity rose across most sub-categories, particularly new orders, which surged to its 13-year high point. That suggests solid momentum to start 2018. Factories already appear to be having trouble keeping up with orders, as evidenced by the elevated readings for both supplier deliveries and order backlogs. That also allowed for some much needed pricing power, as prices paid rose 3.5 points to 69. International demand was also a large contributor to the increase in orders, as improving economic conditions abroad continue to buoy exports. Better economic fundamentals abroad combined with continued business optimism domestically have set the stage for a strong start to the New Year for manufacturers.
• Construction outlays continued to increase in November, notching the fourth-straight month of total spending growth. Strength stemmed from a multitude of sectors. Public spending continued to build on the rise fuelled by storm repairs, but it remains down on a year-to-date basis. Residential outlays were strong in November, specifically for single-family homes and remodels and repairs. Multifamily building was down on the month but positive year to date. Strength going forward is likely to come from the single-family market, as multifamily has largely topped out this cycle. Total construction spending was up at a strong 8.8% three-month average annualised growth rate, which bodes well for Q4 GDP growth.
• US jobs report was lukewarm relative to consensus expectations. There were 148,000 net new jobs created in the last month of 2017, and revisions to previous months put the average gain over the past three months at 203,700 jobs. That is the highest three-month average posted since September 2016 and suggests solid momentum to start 2018. The US labor market added 2.055 million jobs over the year. That marks a deceleration from previous years of the cycle, which is to be expected given how low the unemployment rate has drifted. The national unemployment rate held steady to end 2017 at 4.1%, 0.6 points lower than a year ago. The labor force participation rate was unchanged over the period. Wage gains perked up in December, rising 0.3% on the month. Wage growth remains lacklustre over the year, rising 2.5% from December 2016. The low unemployment rate should put more upward pressure on wages in 2018.
• The Dow Jones Industrial Average, S&P 500 and Nasdaq Composite reached fresh highs, owing to rising profit expectations and strong fundamentals. Energy stocks were lifted as WTI hit $62 for the first time since 2014, a result of strong global demand that has fuelled a production boom and helped drain oil surpluses.
• Wednesday brought the release of minutes from the Federal Reserve’s December 12-13 policy meeting, which seemed to reassure both stock and bond investors. The minutes revealed that views on rate policy were not unanimous, as the two dissenters from the vote to raise rates were concerned that the hike could slow economic growth and further impede an acceleration of inflation. Additional developments, such as the flattening of the Treasury yield curve and the economic impact of the tax bill signed into law in December, were also points of consideration during the discussion. The release of the minutes appeared to put a cap on the 10-year Treasury note yield, which had spiked the previous day.
• US tax reform was also a topic discussed by the FOMC in December. The pace of monetary policy normalisation could increase to offset any inflationary pressures that materialise from the plan. This prospect sent the U.S. dollar higher temporarily while the ten-year benchmark bond yield rose. Still, the Committee expressed concern over low inflation that has remained despite persistent labor market tightening.
• CPI figures for December are due for release on Friday. The current trend growth in core CPI is around 0.2% month-on-month and this was the level of growth in December is likely (implying 1.7% year-on-year in December versus 1.7% year-on-year in November). Headline inflation is expected to come in at a ‘small’ 0.2% month-on-month too, as gasoline prices were more or less unchanged in December (in seasonally adjusted terms), despite higher oil prices in December. This would imply that the annual headline inflation rate was 2.1% year-on-year (versus 2.2% year-on-year in November).
• The coming week also brings several speeches by FOMC members and particular attention should be paid to any further comments about the likelihood of another hike as soon as March and a possible shift to price level targeting.

EU

• The Markets in Financial Instruments Directive II (MiFID II) rolled out fairly smoothly on 3 January, according to press reports. The largest regulatory reform to impact European markets in more than a decade is estimated to have cost the financial services industry €2.5 billion to implement so far. Among the highest-profile changes brought on by the reforms is the unbundling of research costs from brokerage commissions. In general, the new rules are meant to increase transparency and competition.
• Inflation at the headline level fell to 1.4% in December in the Eurozone, well below the European Central Bank’s target of close to 2.0%. Core inflation held steady at 0.9%. The decline in inflation comes at a time when the ECB is dialling back its monetary accommodation via asset purchases. A continued decline in inflation could call into question the ECB’s ability to fully wind down that program by the end of this year, as markets had expected.
• ECB Governing Council member and rate-setter Ewald Nowotny told a German newspaper that the ECB might end its stimulus program this year if the Eurozone economy continues to grow strongly, according to Reuters. One of the goals of the stimulus program is to revive the Eurozone inflation rate, but data at the end of the week showed that the euro-area inflation rate had slowed to 1.4% in December from 1.5% in November. In addition, the pace of inflation in Italy slowed in December to 1.0%, its lowest level in 2017. Some observers reflect that it might be difficult to end the stimulus program if the inflation rate remains weak.
• Government bond yields across most countries were little changed for the week, despite the publication of figures suggesting that Eurozone manufacturing is buoyant. The Eurozone Manufacturing PMI was 60.6 in December, the highest level since the survey began in 1997, driven by broad-based growth across the region.
• The ECB minutes from the December meeting are the highlight in the euro area this week. The meeting carried new staff projections and no batch of measures such as those at the October meeting. Hence, nuances in the assessment of the new staff projections should be of interest (including 2020), in particular on inflation. Following the decisions taken at the October meeting, the ECB has had no need to change its position just yet.
• Additionally, euro area confidence indicators and November data from both German industrial production and factory orders are due this week.

UK

• UK services PMI increased to 54.2 in December from 53.8 in November. The consensus expectation for December was 54.0. Sentiment was lifted by current business activity, while incoming business and employment dragged it down. According to the survey, service providers noted that Brexit-related uncertainty continued to hold back clients’ willingness to spend at the end of 2017. New business volumes increased at a solid pace, but reports from survey respondents suggested that subdued business investment and cost consciousness among clients were factors that weighed on sales growth. Backlogs of work fell for the second time over the past three months. The rate of job creation slipped to a nine-month low, and it was suggested that efforts to reduce operating costs had acted as a brake on employment growth. At the same time, service providers indicated another marked increase in their average prices charged, which was linked to strong cost pressures. Survey respondents signalled the fastest rise in operating expenses for three months.
• In the UK, there are no market movers this coming week.

China

• A trio of Chinese manufacturing indicators for December signalled that the country’s economic activity stayed strong as 2017 ended, though analysts still expect a slowdown in 2018 as Beijing steps up measures to curb financial risks.
• China’s official manufacturing purchasing managers index (PMI) declined slightly to 51.6 in December from November’s pace, in line with economists’ estimates. The non-manufacturing PMI rose to 55.0, exceeding the prior month’s rate and economists’ forecasts. A third gauge, the private Caixin manufacturing purchasing managers index, rose to a surprisingly strong 51.5 reading in December, a four-month high. (Numbers above 50 indicate expansionary conditions, while those below indicate deteriorating conditions.) China’s official PMI surveys mainly large companies and state-owned enterprises, whereas the Caixin survey focuses on small- to mid-size businesses that are generally more export-oriented.
• The latest indicators show that China’s economy finished 2017 on a strong note. But the government’s pledge to de-risk the economy by reining in rampant credit growth since the 2008 global financial crisis is expected to lead to markedly slower growth in the coming years.
• The subject of China’s economic growth rate has become “somewhat of an obsession” for foreign investors given its status as the engine of global growth. However, the absence of a forward-looking growth target at China’s Communist Party Congress meeting in October was a noteworthy omission, signalling that Chinese leaders are placing less importance on headline GDP growth. On the contrary, growth in income levels may be an even more important number for China’s leaders given that Beijing has consistently raised minimum wages each year. China’s median income rate now ranks among the highest in the Asia Pacific region, offering further evidence of the government’s emphasis on a high level of income growth.
• The main releases in China this week are CPI and PPI inflation. CPI inflation is expected to rise to 1.9% year-on-year in December, from 1.7% year-on-year in November. This is still comfortably below the 3.0% target. PPI inflation is set to decline to 4.8% year-on-year, from 5.8% year-on-year in November. This reflects commodity price increases having moderated somewhat over the past six months. It is still a decent rise in producer prices, though, and supports Chinese profit growth.
• Credit and money supply data may also be released next week, which would show how much the tightening campaign towards shadow banking and financial leverage is dampening credit growth. However, so far, the impact on the economy of the credit tightening has been lower than expected.

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