Something for everybody

by: Han de Jong

Last week’s crop of economic data provided something for everybody, optimists and pessimists alike. I see no reason to change our above-consensus view on the economic outlook. The fiscal drag is gradually easing in many countries, financial conditions are supportive of economic growth and low inflation is bolstering spending power. As a result, confidence is gradually returning. This may unlock pent-up demand in the global economy in the quarters ahead. As always, risks and uncertainties remain. It has been surprisingly quiet on the US budget and debt ceiling front. A repeat of the deadlock experienced a couple of weeks ago remains a possibility. In addition, concern over US Federal Reserve tapering is always close to the surface. In Europe, preparations for the Asset Quality Review are in full swing. It will be months before we will see any results, but this review clearly has the potential to produce unpleasant surprises. At this stage, my impression is that many details of the Review have not been finalised yet. I hear people talking about having to value assets on the basis of ‘prudent IFRS’. But what this is exactly, is unclear. On balance, however, we think that the risks will not disrupt our main scenario. If we are right that the global economy will pick up steam as time progresses, risks will diminish.

Sentiment rises in Europe

The European Commission’s index of economic sentiment (ESI) for the eurozone, which combines consumer confidence and business confidence, continued its rise in November, its seventh consecutive monthly improvement. This is supportive of our and other optimists’ view that economic growth in the region is strengthening and will continue to do so. However, a divergence is developing between this indicator and the purchasing managers’ index for the region, the ‘composite PMI’. This index’s preliminary reading for November, released over a week ago, dropped for a second consecutive month. In all fairness, the PMI appears to be leading the ESI a little. On the other hand, the PMI has a history of less than 10 years, while the ESI goes back almost 30 years. In addition, the PMI sometimes undergoes significant revision. This Wednesday will see if that is the case for the November reading. One element of the ESI report that deserves particular attention is the fact that the ESI for France fell, although it had risen in previous months. French data is generally distinguishing itself as weak. Many commentators believe that President Hollande’s policies are not very helpful and they are waiting for a U-turn, similar to what socialist President Mitterrand did in the 1980s.


The ECB’s report of monetary developments in October was not very encouraging. M3 growth has fallen back to 1.4%, the lowest level since 2011 and down from 3.9% a year earlier. Loan growth to the private sector, adjusted for banks’ asset sales and securitisations sank deeper into red figures: -1.7% yoy, versus -1.6% in September and -1.5% in August. There is no doubt that these numbers make uncomfortable reading, but perhaps two qualifications are in order. First, while M1 growth is also weakening (6.6% yoy in October against 6.7% in September), inflation is falling faster. Therefore, ‘real M1 growth’ is actually accelerating. That is important because real M1 shows a considerably higher correlation with growth in the economy than M3. Second, bank lending indicators are never the first ones to turn when economic momentum increases. Bank lending growth is a ‘net’ concept, the result of redemptions and write downs on the one hand and new loans on the other. As investment spending has fallen significantly, redemptions and write downs are likely to remain bigger than new loans even when new loans start increasing.

Unemployment fell from 12.2% to 12.1% in the eurozone in October. It was the first monthly decline since early 2011. Hopefully this is a sign that unemployment has peaked. While it is always difficult to time when the labour market changes direction, an end to deteriorating conditions is consistent with our underlying view. I must caution against an overly optimistic interpretation, however. Unemployment statistics suggested that a peak had been reached a couple of months ago, but the data was later revised. In addition, unemployment is unlikely to start falling again before the second half of next year in any case. Still, at least for now, we should be cautiously positive.

Eurostat reported a modest rise in inflation in November: 0.9% yoy, versus 0.7% in October. Core inflation edged up from 0.8% to 1.0%. This level of price rise remains uncomfortably low for the ECB, but the uptick probably reduces the central bank’s desire to take further action in the short term.

Decent confidence, but weak orders in the US

Several confidence indices in the US also produced positive readings last week. The Chicago PMI fell from 65.9 in October to 63.0, but this was a modest reversal from the rise in October (September’s reading had been 55.7). 63.0 was also above economists’ expectations and it remains historically a very high reading. The two main monthly gauges for consumer confidence provided conflicting messages last week. The Conference Board’s index fell in November, while the University of Michigan’s index rose and surprised on the upside. I am inclined to put more weight on the Michigan index as it tends to lead the Conference Board’s measure, but, more importantly, it provides a preliminary reading half way through the month. The final reading then, provides information about how the second half of the month compares to the first. The strong final reading of the University of Michigan’s index for November thus suggests that confidence picked up quite noticeably in the course of the month. This supports the view that the deadlock over the debt ceiling had hurt confidence earlier. That dip may not be particularly relevant for spending plans.

Other positive data released last week included jobless claims, which continued their steady decline, consistent with a further improvement in labour market conditions. Building permits were also encouraging as they showed strong increases in September and October, suggesting that the housing market is managing to cope with the rise in mortgage rates that took place over the summer.

US durable goods orders for October were a disappointment. Orders fell 2.0% mom after a rise of 4.1% in September. More to the point, non-defence capital goods orders excluding aircraft fell 1.2% mom, following a decline of 1.4% in September. Our main scenario of a gradual move to trend growth and above requires a more significant contribution from corporate investment. We remain hopeful that investment spending will pick up when the fiscal uncertainties are out of the way and companies realise that demand growth is picking up while their cash positions are strong on average and credit is cheap and available.


Improvement in Japan

It remains fascinating to follow how successful (or not) Abenomics is. Last week’s data confirmed the ‘so far, so good’ school of thought. Unemployment was unchanged at 4.0% in October, but employment continued to grow, climbing by 143K in the month, reaching its highest level since March 2009. The jobs-to-applicant ratio continued to rise as well, suggesting tightening labour market conditions. The response by wages has so far disappointed. In order to leave deflation solidly behind, wages need to embark on a rising trend. So far, that has not happened and the Japanese Prime Minister has called on companies to award higher wage increases. Nomura announced that it will do that, raising wages on average by 2% early next year, favouring younger employees.

Japanese business confidence continued its steady rise in November while industrial production and orders data was strong. Inflation accelerated further. Headline inflation rose to 1.1%, but perhaps more importantly, core inflation amounted to 0.3% yoy in October, the first positive reading since 2008 and actually the highest reading since 1998! As indirect tax increases are looming, the BoJ cannot lean back. This week’s minutes of the BoJ’s November policy meeting shows a somewhat divided committee. On balance, it looks like the BoJ will be prepared to step up its aggressiveness should the economy suffer a significant setback when the sales tax is raised in April.