US
US Nonfarm payrolls increased by a lower-than-expected 160,000 jobs in April. Despite the slowdown, the labor market continues to tighten and wages have accelerated. The productivity slump that has weighed on potential growth during this cycle continued in the first quarter, with nonfarm productivity declining at a 1.0% annualised pace.
Purchasing managers’ indices continued to highlight the divide between the service and factory sectors in the US economy. Both the ISM manufacturing and non-manufacturing indices remained in expansionary territory.
US growth disappointment in Q1 was temporary. Increased savings to be turned into consumption in coming quarters and lift growth. Despite less hiring, companies boosted work hours last month—up 1.5% annualised from the first quarter. Assuming modest further gains in work hours this quarter, real GDP looks to increase 2.3% annualised in Q2, even if productivity remains weak.
Positive feedback loop as increased demand supports investments and hiring. Wage inflation to pick up in the second half of the year. Unemployment rate to decline but at a slower pace. Fed hiking cycle to start in September despite low core inflation.
UK
The UK Purchasing Managers Indexes for all sectors were released. In April, the PMI for the manufacturing sector fell below the 50-threshold that separates growth from contraction within the sector. The employment index within manufacturing fell, as did the new orders index and export orders.
According to the latest polls, the British electorate will vote narrowly against Brexit on 23 June. But if Britain does leave, the consequences for the economy in the rest of the EU are likely to be moderate: EU countries will likely continue to allow the UK access to the single market, since it is an important trading partner. However, the political consequences would be more significant since Brexit would alter the balance of power within the EU. Moreover, the first departure from the EU, which up to now has only added members, could renew doubts over the long-term stability of the EU and indeed monetary union. Therefore, it is not only the pound and British asset prices, but also the euro and peripheral countries’ bonds which would come under pressure.
If the British voters decide to leave the EU, investors will withdraw funds from the UK. EUR/USD and the bonds of its member countries should actually profit. But the opposite is more likely. After all, the euro zone is not a safe haven but a blockaded harbour. After a Brexit the governments would be less willing than ever to tackle the unsolved causes of the sovereign debt crisis through more integration.
EU
The euro area recovery remains on track mainly due to improved domestic demand. Foreign demand is set to strengthen whereas growth in private consumption should have peaked in Q1. Potential GDP growth in the euro area is very low, implying the output gap will close quickly and the unemployment rate will continue towards its structural level.
The euro area has exited deflation and inflation is set to increase sharply late this year mainly due to a higher oil price compared to end-2014, when it dropped considerably. The ECB will fully implement its QE purchases, but QE exit strategies are expected to be a theme at end-2015. The first ECB policy rate hike is expected by analysts in mid-2017 as core inflation should start increasing.
China
A moderate recovery in H2 is expected supported by monetary and fiscal easing. Structurally China’s growth continues to slow. The housing market remains the biggest downside risk but there are signs of stabilisation.
People’s Bank of China is expected to ease further but it will not go all in. Managing financial risks still has high priority. China is not expected to join the global currency war by allowing its currency to depreciate markedly to support growth. China’s currency is expected to be included in the SDR (Special Drawing Rights) this autumn but a “big bang” liberalisation of the capital account ahead of the decision is unlikely.
Sources: Danske Bank, Handelsbanken, Wells Fargo, BMO Capital, Commerzbank.
