Signs of moderation in the economic backdrop – weekly update 3 September

A look back over macroeconomic and market events for the week ending 31 August 2018. There were signs of moderation in the economic backdrop, though absolute numbers remain robust. The focus this week will likely be on Friday for the latest non-farm payroll numbers in the US.

Global PMIs suggested some further moderation

Global PMIs suggested some further moderation in business activity, but remain firmly in expansionary territory. Generally it was services that remained resilient, hiding some softening from the manufacturing side.

In Europe, the Composite PMI rose marginally from 54.3 to 54.4, just below expectations of 54.5 and dragged lower by Manufacturing (where the PMI reading fell from 55.1 to 54.6, against forecasts for a slight increase to 55.2). In the details, there were signs of growing uncertainty heading in to the latter half of the year with outlook measures softer and manufacturing optimism nearing the lowest level in three years.

In the US, the Composite PMI from the market slipped from 55.7 to 55.0, pulled lower by both Services and Manufacturing measures which fell more than expected. In the details, order book growth was reported as cooling after very strong growth in the first half of the year, while employment growth was the slowest in more than a year as firms became more cautious in their hiring strategies. This moderation in activity has been well-signposted from the dipping momentum in the first half of the year, and is something we have kept in mind as part of our investment strategy, so there are no surprises here. The readings still comfortably point to continued expansion, though perhaps not at the breakneck speeds seen earlier in the year, and this should be enough to sustain economic fundamentals, absent any trade war-related issues.

Inflation data didn’t provide any shocks

Inflation data didn’t provide any shocks, rising as expected in the US and slightly softening in the Eurozone. The Eurozone reading provided the most food for thought, with the headline CPI number dipping from 2.1% to 2.0% year on year (yoy) against street expectations for no change. The core measure, which strips out energy and food slipped 0.1% to 1.0% (again, with no change expected). While this might ease some of the hawkish pressure on the European Central Bank, the shortfall is marginal.

By contrast, the Personal Consumption Expenditure (PCE) measure in the US, which is the Federal Reserve’s (Fed) preferred measure, advanced another 0.1% to 2.3% yoy with core rising from 1.9% to 2.0%. These are the fastest rates since 2012, underlining the ongoing strength in the US economy, though there is little wage pressure in evidence. It is therefore difficult to see inflation accelerating significantly from here, and with inflation remaining around the Fed’s symmetrical target, these latest numbers are unlikely to impact the Fed’s policy of gradual monetary policy tightening.

US second-quarter GDP was unexpectedly revised up

US second-quarter GDP was unexpectedly revised up from 4.1% to 4.2% annualised, beating expectations for a moderation to 4.0%. Upgrades to net exports and business investment were the main drivers, however there are reasons to believe that the second quarter may represent a near-term high point with growing headwinds for the rest of the year.

Net trade has been boosted largely due to accelerated soybean and other exports ahead of the imposition of retaliatory tariffs, while business investment (which was revised from 7.4% to 8.5% annualised growth) could be imperilled by ongoing trade tensions as well as the fading economic momentum and diminishing tax effect. While consumption is robust, it is difficult to see this picking up meaningfully until real wage growth also accelerates.

Last week’s other events

• Eurozone construction output picked up from 2.0% to 2.6% yoy, but confidence numbers dipped. Industrial business confidence slipped from 5.8 to 5.5 whilst services confidence fell from 15.3 to 14.7 and consumer confidence continued to deteriorate, falling from -0.5 to -1.9 (-0.7 was expected)
• In the UK, Net Consumer Credit growth slowed from £1.5 billion to £0.8 billion in July (£1.5 billion was forecast), and Consumer Confidence (from GfK) improved from -10 to -7 (no change was expected). The Lloyds Business Barometer showed a fall from 29 to 23
• US Durable Goods Orders slumped more than expected in July, from 0.7% to -1.7% month on month (mom), worse than the -1.0% expected. Other activity indicators also softened, with the Chicago Fed National Activity Index dropping from 0.48 to 0.13 (0.45 expected) and the Dallas Fed Manufacturing Activity Index falling from 32.3 to 30.9 (30.0 expected), however, the Richmond Fed’s Manufacturing Index recorded a gain from 20 to 24 (17 was expected). Consumer Confidence was also more robust, rising from 127.9 to 133.4 (126.6 was expected), and Personal Spending came in unchanged at 0.4% mom as expected, with Personal Income dipping from 0.4% to 0.3% mom (no change was forecast)
• Japanese inflation rose from 0.7% to 0.9% yoy, but was slightly short of the 1.0% forecast. Consumer Confidence slipped from 43.5 to 43.3, whilst the related factor of Retail Trade growth slipped from 1.7% to 1.5% yoy (1.2% was expected). Industrial Production rebounded, growing at 2.3% yoy in July from -0.9% in June, but was below forecasts of 2.7%
• In China, official Composite PMI advanced from 53.6 to 53.8, with outperformance from both Manufacturing (51.3 from 51.2, 51.0 expected) and Non-Manufacturing (54.2 from 54.0, 53.7 expected) components

The markets

Equity markets were relatively stable, with emerging markets having a short-term bounce, as core sovereign bonds were relatively unmoved. Sterling regained some strength after recent weakness.

Equities

Emerging markets staged a bit of a rebound over the fortnight, with the MSCI Emerging Markets index gaining 3.5%. The Japanese TOPIX was the best of the major developed regions, returning 2.3% with the S&P 500 in the US a little behind at 1.9%. Continental Europe was only just positive for the period, advancing just 0.9% whilst UK was the only major region to post a loss, falling -1.1% (both on MSCI measures).

Bonds

The 10-year US Treasury yield was unchanged over the fortnight – in fact, taking closing prices Friday-Friday (17th-31st) the yield was down just 0.01 of a basis point (bp) (that is, 0.0001%). The equivalent German bund yields rose just 2 bps to finish at 0.33%, following a sharp rally at the end of the two weeks. 10-year gilt yields finished at 1.43%, an impressive 19 bps higher, but in reality it was a mostly phantasmal move as the benchmark bond changed during the period and contributed the majority of this artificial move.

Commodities

Oil regained some of its swagger, strengthening to US$77.42 per barrel and the upper end of its recent range, while gold moved back above the US$1,200 mark to finish at US$1,203 per ounce. Following an initial rally, copper swooned towards the end of the fortnight to close at US$2.65 per lb.

Currencies

Sterling was notably stronger over the fortnight, up over 1.6% against the US dollar and making reasonable gains against the euro and yen. Sterling closed on Friday at US$1.30, €1.12 and ¥144.

The week ahead

US non-farm payrolls on Friday will be the focus for the week with markets expecting 194,000 jobs added for August, from 170,000 last month. The all-important average hourly earnings number is expected to come in unchanged at 2.7%. We also have the rest of the global PMIs out, including US ISM numbers, as well as the readings from the UK, Japan and China (Caixin measure). We will also have the final estimate of the second-quarter GDP for the Eurozone on Friday. The daily breakdown is as follows:

Monday: Overnight Japan and China (Caixin) report Manufacturing PMI numbers, with UK Manufacturing PMI out later in the morning (53.9 from 54.0 expected).

Tuesday: A minute after midnight, the British Retail Consortium will update the latest Like-for-Like Sales, with UK Construction PMI (54.9 from 55.8 expected) reported later in the morning. In the afternoon, US Manufacturing PMI from the Institute for Supply Management is expected to show a slowdown from 55.8 to 54.9 with the details also likely to draw some attention.

Wednesday: Overnight Japan and China will update their Services PMI numbers and the combined Composite reading. Later in the morning, UK Services PMI is expected to come in at 53.9 from 53.5, and then the Eurozone will report Retail Sales shortly after (1.3% from 1.2% yoy expected).

Thursday: It’s a fairly quiet morning, and then in the afternoon the US will report ISM Non-Manufacturing PMI (forecast to have increased from 55.7 to 56.6) as well as some initial labour market data ahead of the main NFP release on Friday.

Friday: The morning will give us the final estimate for second-quarter GDP in the Eurozone, then non-farm payrolls dominate the afternoon. The main headline numbers are covered above, while details such as underemployment and labour force participation could also be worth watching.