Macro Weekly – World economy making up its mind

by: Han de Jong

  • US economic data continues to be strong
  • Fed change of tone
  • German orders provide some relief, in the detail
  • Italian and Brexit risks in Europe
  • PMIs in Asia cannot impress
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US data has been Goldilocks-like recently and the latest data does not suggest any change is imminent. The ISM index of business confidence in the manufacturing sector eased somewhat (from 61.3 in August to 59.8 in September), but remains at a level implying strong growth in the economy. The non-manufacturing gauge rose to 61.6 (up from 58.5), its second highest monthly reading on record, behind a reading of 62.0 in 1997.

The labour market report was not as strong as expected at first sight. According to the non-farm payroll report the US added a net total of 134,000 jobs in September, some 50,000 below expectations, but there were upward revisions to the two previous months totalling +87,000. So I guess job growth was more or less as expected. The unemployment rate fell to 3.7%, the lowest since 1969. This contributed perhaps to some further inflation fears. However, average hourly earnings remain well behaved, rising 0.3% mom while the yoy rate actually eased from 2.9% to 2.8%. This pace of increase was also 2.8% in September 2017 and it was 2.6% in September 2016. The conclusion is that there still is very little, if any evidence of accelerating wage increases that may push up inflation, despite the strength of the economy

Fed change of tone

Senior Fed officials have recently turned more hawkish in speeches and comments. As my colleagues Bill Diviney and Nick Kounis are arguing, this is more a change of tone than a fundamental change of monetary policy. Fed chairman Powell recently said that the economy is very strong. We agree. He also said that there is no reason why that couldn’t continue. Well, that is true as well as Australia shows. That country has enjoyed continued growth for over 25 years, at least on a yoy basis. Given that many US recessions are caused by the Fed itself, perhaps it is promising that Powell is optimistic on the economy. But he also said that rates are still “a long way from neutral at this point, probably”, and that the Fed may go past neutral with its rate hikes.

It looks likely that the Fed is trying to affect market expectations related to future monetary policy. And judging by the bond market’s behaviour, they are successful. While market expectations of future monetary tightening may have been too sanguine, we still think the Fed will ultimately not deliver all hikes they are currently expecting. It is true that economic growth is strong, but we think the economy will cool in the course of next year and that inflation will rise only modestly.

The rise in US bond yields has taken other financial markets by surprise. Higher than expected dollar interest rates are a significant risk to global financial markets and stability and it is no surprise that risky asset have been shaky as a result. But we think this was more or less a one-off adjustment. Yields may obviously rise a little further, but we think the rise will be modest.

German factory orders provide some relief, Dutch business confidence up again

Economic conditions have softened this year in the eurozone. This has been mainly driven by international trade. The German industrial sector has experienced quite a remarkable softening. Industrial orders reached a growth rate of 9.7% yoy in September 2017. But growth has slowed since. The most recent numbers show a 2.1% yoy fall in orders in August, even though the mom growth rate was an impressive 2.0%. The breakdown of the numbers shows that non-eurozone orders were strong, while domestic and eurozone orders fell. What was particularly encouraging was that foreign orders from outside the eurozone for capital goods were up 13.7% mom. This data is volatile, obviously. But it does suggest that investment activity in the rest of the world is continuing apace.

Also encouraging was that Dutch business confidence was up in September, the second monthly rise after five consecutive declines. The Dutch economy is open and highly exposed to international trade.

Italy and Brexit risks

Developments in Italy and around Brexit are a concern to financial markets. Having said that the budget deficit target for 2019 will amount to 2.4% of GDP, the Italian government had to face sharp criticism. The criticism did not only come from politicians in other EU countries, financial markets also had a say. The bond spread widened and the Italian stock market underperformed. The Italian government then suggested they may cut the deficit in the years after 2019. It is early days yet. The budget has not been finalised yet in detail. Ultimately, the European Commission will provide its assessment and possible actions by late November. The discussion has the potential to upset financial markets.

The UK Conservative Party conference was never likely to produce solutions to the Brexit discussion with the EU. So we weren’t expecting much. I can’t say that it was a disappointment, although my expectations were very low. The whole thing is looking messy. We have no way of telling whether or not all these skirmishes are the to-be-expected parts of a negotiating process. You only make the last compromise in the final hour and you don’t make it unless you have to. Either way, the Brexit process also has the potential to upset markets.

Asian PMIs mixed

Like Europe, the Asian economies are not looking too strong either. Recently released business confidence numbers for September paint a remarkably mixed picture. Japan, Hong Kong, Taiwan and Indonesia saw their PMIs fall in September. On the other hand, South Korea and India registered an increase. I was particularly surprised by the South Korean PMI rising from 49.9 in August to 51.3, because the previously reported trade data for September had been very weak. Exports were down 8.2% yoy. This series is volatile, but it was the worst reading in over 2 years.

The PMIs of some other important emerging economies were also mixed. The PMI in Brazil was down from 51.1 to 50.9, a marginal decline. A much bigger drop occurred in Turkey: 42.4 in September, versus 46.4 in August. On the other hand, the manufacturing PMI in Russia picked up from 48.9 to 50.0, undoubtedly on the back of rising oil prices.

All this mixed evidence suggests that the global economy is still making up its mind where to go next.