Macro Weekly – A good economy, but many complications

by: Han de Jong

  • The global economy is humming along nicely
  • US business confidence rises to highest level since the 1980s
  • Many uncertainties in the background
180907-Macro-Weekly-1.pdf (123 KB)

The US economy continues to perform well. The ISM business confidence index for the manufacturing sector rose to 61.3 in August, up from 58.1 in July. The August reading was the highest since May 2004 when the index reached 61.4. Apart from the 2014 reading, the last time US businesses were more optimistic according to this measure was in 1983. The index for the non-manufacturing sector also rose strongly in August: 58.5 following 55.7 in July. It must be said, the rival Markit PMI indices for business confidence were weaker in August, extending their decline of the previous three months. The ISM is our preferred measure as it has a very long history and a higher correlation with US GDP than the Markit PMI.

Most other US indicators confirm that things are going well in the US economy although there are also some areas that are less robust. Vehicle sales, for example, fell again in August, reaching their lowest level in a year’s time. But, on balance, there is every reason to expect the US economy to continue to grow at an above-trend pace.

Poor factory orders in Germany in July

Recent days have seen few interesting European macro data. German factory orders data for July were a major disappointment. Having fallen 3.9% mom in June, orders were expected to bounce. They didn’t, they fell a further 0.9% mom, keeping the yoy rate in negative territory (-0.9% yoy). The weakness was concentrated in orders from abroad. Domestic orders were actually up. Orders from other eurozone countries did a little better than orders from countries outside the eurozone (-2.7%, versus -4.0%). Orders for capital goods were particularly weak:-2.4% mom. There was strong divergence between domestic orders for capital goods, +4.1%, and foreign orders: -6.5%. This sharp drop in foreign capital goods orders was preceded by a drop of 5.4% in June.

The weakness of foreign orders, particularly in the capital goods sector, is hard to square with the signs of robust capital investment by companies globally. In Japan, for example, strong corporate profits and the labour shortage have prompted Japanese companies to expand capital investment in recent years. Japanese capital investment was up 12.8% yoy in Q2, excluding software, the rise was 14.0%. US capital spending is also rising strongly. According to the most recent data, new orders for capital goods (non-defence, ex-air) rose 1.6% mom in July and 8.8% yoy. Shipments of such goods rose 1.0% mom and 7.7% yoy. As one of the key producers of capital goods, it would be odd that Germany would not participate in this strength.

The weakness of the German orders data is also hard to square with the large rise in the Ifo-index I could report last week. So I am inclined to assume that the weak orders data is a bit of an aberration and will be corrected when the August data is released.

Uncertainties in the background

While the global economy is performing reasonably well, there are many developments that could have a negative impact going forward. We have written about many of those in recent months. At the time of writing, the US had not yet announced whether or not it is going to impose import tariffs of an additional USD 200 bn worth of imports from China. But a further escalation of the trade conflict looks likely. This raises the question when the tit-for-tat will have a clear impact on economic activity. We don’t think we are there yet. And we are still hopeful that damage will ultimately be limited as various policymakers come to their senses.

Another factor that could affect the economy is US politics. The Democrats could take control of the House in November. That would sharply reduce President Trump’s room for manoeuvre in the area of fiscal policy. And it would increase the chance of Trump being impeached. In this context, perhaps Bob Woodward’s new book on the Trump presidency and White House, “Fear”, may contain further revelations. I think an impeachment process would create a lot of uncertainty and would not be taken well by financial markets.

Europe has its own issues: Brexit, the Italian budget, the collapse of French president Macron’s approval rating, to name but a few. Somehow, European problems work themselves out over time. The latest indications about the Italian budget suggest that the government will present a budget that will get the seal of approval from the European Commission.

Most attention has recently been focussed on emerging markets. Turmoil on financial markets in Turkey and Argentina has spread too many other countries. This is contagion. Our view has been, and still is, that very disruptive contagion remains unlikely as the fundamentals of most emerging economies is now much better that it has been when contagion did a lot of damage in the past. I must admit, that seeing pressure also hit countries and currencies that have sound fundamentals is unnerving. I think it is still reasonable to assume that this will not develop into a major crisis. The key risk I see here is how market participants react to further US Fed tightening.