Macro Weekly – Diverging trends in confidence in various regions

by: Han de Jong

  • Upward revision to US savings rate creates more upward potential for the economy
  • US economy continues to power ahead
  • Business confidence in the eurozone appears to be bottoming out
  • Asia appears hit by the trade conflict
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Europe and Asia were the growth leaders last year as the US lagged behind somewhat. This year is different. A sudden drop of confidence hit Europe and Asia early in the year. That was not alarming as confidence was at multi-year, in some cases multi-decades highs. But it did signal that actual economic growth was likely to slow. That, indeed occurred. Why confidence eased and growth slowed is not entirely clear, it was probably caused by a combination of factors. On top of that came the trade dispute. It now seems likely that more recent developments of confidence are heavily affected by this conflict, triggered by US president Trump. Asian and European economies are more open and, thus, more dependent on trade. So it is perhaps logical that the trade conflict affects business confidence in these economies more. At the same time, US tax cuts, tax reform and government spending increases support economic activity more this year and next than is the case in other countries.

Spectacular upward revision to the US savings rate (especially for 2017)

The US economy expanded at a 4.1% annualised pace in Q2, after 2.2% in Q1. The support for growth was quite broad, although some argue that exports of soy beans to China were exceptionally strong as Chinese importers were trying to beat tariffs before they came in. What struck me most about the GDP data were the revisions to previous years as regards the personal savings rate. The US personal savings rate for the years 2012 through to 2015 was revised up by an average of 1.5%-point and now averaged 7.5% over that period. The savings rate for 2016 was revised up from 4.9% to 6.7%. The revision to the 2017 data was spectacular. Originally reported as 3.4%, the 2017 personal savings rate is now estimated as having been 6.7%, a revision of 3.3%-points. These revisions are due to higher estimates for personal income as more detailed information become available. Upward revisions are common but the ones just made are large. A much higher savings rate is very important. The picture painted by the previous data was that the consumer was stretching himself, dipping into money that he should really save. If that was correct, one should expect some reversal further down the road. The drop in the savings rate thus indicated a ceiling to consumer spending growth. The drop in the savings rate that had some analysts worried actually never happened according to the revised data. The implication is that the assumed ceiling in consumer spending doesn’t exist. Thus, the growth potential for the US economy has improved.

US business confidence indicators have been a little mixed recently, but they are generally strong. The ISM index for the manufacturing sector fell from 60.2 in June to 58.1 in July, still very strong. The Chicago PMI moved up slightly from an already high 64.1 to an even better 65.5. 157,000 new jobs were created in July, a little less than expected, but data for the previous two months was revised up by a total of 59,000. The unemployment rate fell back from 4.0% to 3.9%. Despite all this, wage pressure remains modest. Average hourly earnings rose 0.3% mom (after 0.1% in June), but the yoy rate was unchanged at 2.7%.

Eurozone business confidence bottoming out

The European Commission’s index of Economic Sentiment eased a little further in July: 112.1, versus 112.3 in June. Nevertheless, this indicator is showing signs of bottoming. The same is true for the German PMI for the manufacturing sector. This indicator had achieved an extremely high level of 63.3 in December 2017 and had fallen six months in a row. But July saw the first rise: 56.9, after 55.9 in June. These readings still suggest solid growth.

The preliminary reading for July inflation showed a further modest rise. Headline inflation amounted to 2.1% yoy following 2.0% in June. Core inflation was also up a touch: 1.1% yoy against 0.9% in June. This will strengthen the ECB in its belief that reducing and, before too long, stopping the asset purchases is the right thing to do. Given the continued slack in the labour market in the eurozone, we are less convinced that inflation will pick up further from here.

Asia the odd one out

As US economic data remains solid and business confidence in the eurozone seems to be bottoming, one would expect similar improvements in Asia. The most recent set of confidence indices, however, don’t suggest Asia is tagging along. In China, the official and the Caixin PMIs were all weaker in July, bot for manufacturing and for services. They weren’t down a lot, but the fact that they were all down was striking. The manufacturing PMIs in Japan, South Korea, Taiwan and Singapore were also all down in July. In Korea and Taiwan the index fell more than a full point. Korea also showed poor data on industrial production for June: -0.6% mom and -0.4% yoy. Japan registered a drop in its industrial output in June of no less than 2.1% mom and 1.2% yoy. Korea reported slightly better exports in July: up 6.2% yoy, versus -0.2% in June. There may be noise in the monthly data, but this all does not show particularly encouraging.

It is not entirely clear why Asian data is weaker than data elsewhere. It is tempting to blame the trade conflict. Not only are Asian economies more dependent on trade than most other economies, they also are most vulnerable to protectionist measures taken by the US. Our view remains that the conflict is a huge nuisance, but that it will not tip the global economy into a recession unless it escalates much further. Having said that, it is clearly having a negative impact on global economic activity as we speak.