Following the ‘reopening’ of the US Federal government, the pause in the flow of official economic data from the US has come to an end. However, the question now is to what extent the data has been affected by the shutdown and the political bickering and might therefore be distorted. The truth is, nobody really knows for sure. Consequently, US data has to be interpreted carefully and it is unlikely that either financial market participants or policymakers will feel comfortable basing important decisions on the data until we can be sure that it reliably reflects underlying economic developments.
European economic sentiment has improved strongly in recent months, but last week saw a softer German Ifo and a noticeable decline in services-sector business confidence. Here, too, the question is whether there have been some distortions. For example, have the US problems had an impact on activity or sentiment in the eurozone? And to what extent was the strong rise of business confidence over the summer flattered by the somewhat better-than-usual weather?
While the US government shutdown is now behind us and we get more data reported on the economy, we know that the data has been distorted. The shutdown has clearly affected consumer confidence but has also impacted activity levels. With parts of the federal government shut, their suppliers could not deliver, so they were idle as well. The weekly data on initial jobless claims usually provides a relatively reliable and frequent gauge of the labour market. But it is hard to interpret the data now, even more so because computer problems in California and Arizona appear to have lowered the reported claims several weeks ago, but are now pushing them up as processing backlogs are being cleared. The preliminary reading on the Markit PMI for October was weaker than expected and also weaker than its European counterpart. But it is unclear to what extent that is a reflection of underlying developments or whether it correctly indicates a topping out of the industrial cycle.
The headline of the US durable goods report for September looked very good: +3.7% mom. However, this was due to a 58% mom increase in aircraft orders. Orders for so called non-defence capital goods excluding aircraft, which are considered a good gauge for future investment spending, fell 1.1% mom and have fallen 8.4% during the last three months on an annualised basis. At this stage in the cycle, one would expect investment spending to play a bigger role in the recovery. Although the budget debate did not get to a head until mid October, it is entirely possible that the tension had affected the willingness of firms to invest. One thing is clear, though: for the recovery to become more solid we need business investment to make a contribution.
Pushing out our tapering forecast to March
We think that economic fundamentals in the US have strengthened for some time. And we believe investment spending is set to accelerate, adding to overall growth. With fiscal austerity easing further, we therefore think that the business cycle will pick up during the next couple of quarters. But one cannot be altogether confident as it is impossible to know how to read the data. The Federal Reserve may have more and better information on the economy than we do, but even they are facing the same uncertainty. As a result, it seems unlikely to us that the Fed will decide to start tapering at their December FOMC meeting. We have therefore pushed out our forecast for the start of the tapering process to March. One other reason for the Fed to hold off is that the recovery of the housing market appears to have been affected by the rise in borrowing costs since Fed boss Ben Bernanke first mentioned ‘tapering’ in May. According to the report on existing home sales, the median house price fell month-on-month in September while other price indices are showing a clear deceleration. The latter would not be a big problem, but a sustained price fall would be highly unwelcome.
Little data in Europe
Last week’s data calendar in the euro zone was relatively light. The eurozone PMI for the manufacturing sector edged a touch higher in October, moving in the opposite direction from its US equivalent. But the PMI for the services sector fell from 52.2 in September to 50.9 in October, pushing the so called composite PMI down as well, its first decline after six consecutive monthly increases. Germany and France were the culprits as far as the PMI services was concerned. Other countries saw modest gains. The German Ifo also weakened in October, as did the index of Belgian business confidence. This is not a disaster, but the absolute level of this indicator is reflecting nothing more than very modest growth. The ECB’s money and bank lending statistics did not provide much good news either as M3 growth slipped fractionally from 2.3% in August to 2.1% in September.
It is with some amazement that I am watching the euro, already overvalued against the dollar, move higher against the US currency. It would appear that the ECB is not particularly worried. However, the recent further strengthening of the euro must be of some concern. A couple of large internationally operating Dutch companies, for example, reported disappointing Q3 earnings last week due to exchange rate effects. If sustained, the euro’s strength will clearly have a damaging effect on activity in the region. We think that the ECB is most likely to sit on its hands for now. A new rate cut is unlikely at this stage. This may change if a further delay in tapering by the US Fed pushes the euro higher still. Additional monetary easing by the ECB would be unwelcome in Germany, where the Bundesbank last week warned of a 20% overvalutation in house prices. That seems a bit of an overestimation to me. Nonetheless, the combination of reasonable economic growth, high consumer confidence and interest rates that are too low for the German economy against a background where house prices had been more or less stable for the best part of twenty years, is the perfect mix for a bubble to develop. Some might argue that the building bubble on the German housing market shows that a common currency and thus, a uniform level of interest rates within such a diverse group of countries simply cannot work. We think that policymakers can and must use other methods than monetary policy to prevent housing bubbles in individual countries.
UK data was a little mixed last week. The CBI industrial trends survey disappointed, but GDP growth accelerated a little. And according to a survey of the British Bankers’ Association the number of mortgage approvals continues to rise. In the third quarter it reached its highest level since 2008.