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09 December 2013
Standard Life Investments’ Global Strategy team provide regular analysis of the key economic data that has been influencing financial markets.
Available on a weekly basis, the Macro Digest takes a detailed look at the global economic issues that have been impacting our investment strategy. The regional approach aims to provide an easy-to-navigate guide to the most recent developments in the global economy.
UK – A happy Chancellor
The Autumn Statement has several functions: partly political theatre as it allows the Chancellor to set the scene until the spring Budget, partly an opportunity to update official forecasts and projections, and partly tax and spending announcements – after all, the election is under 18 months away!
Public sector finances are improving, but very slowly. The Office of Budget Responsibility (OBR) forecasts borrowing of £111 billion this year, declining to £96 billion in 2014/15 and £79 billion in 2015-16 - still over 5% of GDP a year. In terms of tax and spending announcements, this mini-Budget was fiscally neutral, raising £15 billion and distributing £13 billion over five years. The politics of envy played a part (the larger bank levy, capital gains tax on non-resident owners of UK homes) while electoral politics helped orientate the distribution (scrapping the planned 2014 petrol tax hike, reducing household energy surcharges, keeping train fares flat in real terms). All in all, Mr Osborne stood firm in his path of fiscal austerity. His target is a balanced budget by 2018-19, which will require a further net tightening of some 6% of GDP, mainly through spending restraint. The ratio of general government consumption to GDP will fall from a record 23% in 2009 to 16% in 2018, the lowest since records began in 1948. The role of the state is being dramatically altered in terms of direct spending, not of course in terms of intervention or regulation.
Moving onto the official OBR economic forecasts, these have caught up with the consensus, suggesting GDP growth of 2.4% in 2014 and 2.2% pa in 2015. Thereafter, growth is estimated to be 2-3% per annum (pa) out to 2018, allowing unemployment to fall to 5.6%. Turning to inflation, the OBR forecasts will remain above the 2% pa target until 2016. Looking at the details of the OBR report, consumer spending is expected to be the strong sector (expanding 1.9% pa in 2014), albeit financed out of savings as real income growth remains weak, and supported by housing wealth (up 12% in 2014-15 combined). In contrast, business investment and net trade are not expected to contribute much.
The economic data certainly supports the upward revisions by the OBR, at least into the winter. One high spot was car sales. These rose for the 21st consecutive month in November, running about 10% higher than a year earlier. After the increase in the manufacturing Chartered Institute of Purchasing and Supply (CIPS) survey, there was similar improvement in construction and services. The former rose from 59.4 to 62.6, its highest in over six years, led, unsurprisingly, by the house building sector. According to the Home Builders Federation, the number of planning approvals granted for new homes has risen by over one third in the last year. Separately, the CIPS service sector survey was released. This edged down from 62.5 to 60.0 in October, still the 6th highest level in the past 15 years. New business at 63.1 and employment at 54.2 were positive components.
The three sectoral reports can be aggregated together into a composite index (taking account of sector weights) which edged down from 61.4 to 60.6 in October. It must be emphasised that dispersion indices such as this do not correlate well with actual output - many aspects relate more to confidence than hard data. Nevertheless, CIPS data at this sort of level would tie in with GDP in Q4 growing between 0.5-1.0% from Q3, suggesting the same order of growth as in recent quarters and for the time being justifying the forecasts of GDP above 2% pa in 2014.
There are risks ahead, however, which cannot be ignored. Bank of England analysis indicated that households reduced their long term savings by £23bn in the past year. There has been growing evidence that the upturn in consumption has been driven by the decline in the savings ratio. To justify this, households will need to see stronger employment and wages growth, not simply a positive wealth effect from rising house and share prices.
US – When good news is good news
November’s employment report continued the recent string of positive data releases as nonfarm payrolls beat market expectations for the second month in a row, rising 203,000 after a 200,000 increase in October. This left the 12 month moving average for employment gains at 195,000, exactly where it has been (give or take a few thousand) for around three years now. Employment growth in goods-producing industries was particularly strong, with construction jobs increasing by 17,000 and manufacturing jobs rising by 27,000. The healthy upward trend in manufacturing employment is consistent with the elevated level of the Institute of Supply Management manufacturing index, which reached its highest level since 2011.
The household survey data also continued its long-standing trend. Looking through the distortions from October’s government shutdown, the unemployment rate fell to 7% in November, which was 0.2 percentage points (pp) below where it was in September and 0.8pp lower than at the same time in 2012. If the present trend decline were to continue, the unemployment rate will hit the Federal Reserve’s (Fed) increasingly obsolete 6.5% threshold by the middle of 2014, around a year earlier than their current forward guidance. Although the participation rate did partially rebound in November, it too was lower in September – no signs of an encouraged worker effect yet. Meanwhile, at 58.6%, the employment-to-population ratio is actually lower than it was a year ago.
Consumption trends are also looking better. Real personal spending rose 0.3% in October, the biggest increase since March, providing yet more evidence that the government shutdown and debt ceiling impasse had no discernible negative impact on private sector activity in the month. The solid growth was driven by healthy increases in durable and non-durable goods consumption, while spending in the services sector edged only a little higher. The leap in new vehicle sales to an annualised rate of 16.4 million in November suggests that consumer spending is likely to grow more strongly in Q4 than it did in Q3. We do not think that too much should be read into the drop in real disposable income. Income data can be volatile from month-to-month and the decline in October followed strong increases in August and September. And while the personal savings rate fell back below 5% it remains well within its post-crisis range.
Continuing with the positive theme, the second estimate for GDP showed that the economy grew at a well above trend annualised pace of 3.6% in the third quarter. The only disappointing aspect of this result is that 1.6pp of that growth came from inventory accumulation. The question of how much payback there will be in Q4 depends on whether the increase in inventories was planned or unplanned. If it was planned in anticipation of a strengthening in domestic demand that does actually comes through, growth in the quarter could remain above 2%. However, if demand does not strengthen, inventories will need to fall back significantly and the quarter could be quite weak. At the moment, the collective message coming from both the hard and soft data is that domestic demand is indeed strengthening, and so the first interpretation looks the more credible.
If we are right, members of the Federal Open Market Committee will be feeling somewhat relieved. As we outlined a couple of weeks ago, many were getting close to the point where they were prepared to support tapering regardless of whether the data improved or not. But there is little doubt that they would rather begin tapering in an improving economic environment. The run of upside data surprises has raised speculation that the Fed could announce a modest reduction in the pace of asset purchases as soon as its December meeting. Though we expect a vigorous debate and would not rule out a move this month, we still think that a policy shift is more likely in January or March. That will take the decision beyond the next round of fiscal negotiations, giving the Committee more time to prepare the ground and decide on the best way to anchor its forward guidance.
Europe – The ECB is ready to act
Communications from central banks are becoming ever more important as investors try to price in future changes. Hence, the latest announcements from the ECB were analysed with interest after the bank unexpectedly cut interest rates in November. Its December announcement held no surprises: interest rates were unchanged and the bank confirmed its forward guidance, expecting ‘key rates to remain at present levels or lower for an extended period of time’. More interesting were the ECB forecasts. These indicated that the central bank would need to keep easy policy for some time to come. The staff suggest only a very weak expansion of inflation: 1.1% in 2014 and 1.3% in 2015, versus the central target of 2.0% per annum (pa). The economic expansion is stuttering and, after a 0.4% fall in 2013, the bank expects only 1.1% GDP growth in 2014 and then 1.5% pa in 2015. The Bundesbank separately announced its forecasts for the German economy, expecting GDP growth of 0.5% in 2013, 1.7% in 2014 and 2.0% pa in 2015, with inflation at 1.6%, 1.3% and 1.5% pa respectively. That puts the rest of the Euro-zone into context!
Comments from Draghi suggested that the ECB is ready and able to act, although he gave more hints than hard details. It appears that negative deposit rates have been discussed as have further LTROs, probably focused on specific sectors. This is not a surprise. The ECB is very aware of the dangers of Europe falling into Japan-style deflation. It also appears to expect the Asset Quality Review and subsequent strengthening of bank balance sheets should allow better credit creation in due course. Separately, governing council member Nowotny did indicate that more support for industry in general, and SMEs in particular, could be expected. Also looking ahead, the ECB is planning eventually to start publishing minutes of its meetings.
One of the reasons why the ECB acted was the sluggish nature of the European economy, This was confirmed by the latest estimate of GDP in Q3. Growth across the Euro-zone remained very modest, only up 0.1% from Q2, led by investment (0.4%) and consumer spending (0.1%). Conversely, the drag from net trade lowered GDP by 0.3%, with imports significantly exceeding exports growth.
The early signs are that Euro-zone economic growth was weak at the start of Q4. Euro-zone retail sales edged down 0.2% in October, leaving them 0.1% lower than a year earlier. German factory orders had risen 3.1% in September but fell back 2.2% in October. Overseas orders in general, and capital goods orders in particular, were the prime cause, a reflection of the moderate expansion in the US and Asia at present. France continues to lag the other major European economies. Its exports eased 0.3% in October (-2.0% pa) while imports fell 2.5% that month (-2.7% pa). The overall trade deficit is improving, but still running at €60bn a year.
The purchasing manager indices (PMI) should always be treated with considerable caution; they can be affected by sentiment, domestic politics or stock market movements as much as by hard data such as new orders. Nevertheless, certain aspects do tie in with other reports from across the Euro-zone. A prime example is the distinction between a stronger Germany, a modestly more confident Spain and weakness in business activity in France and Italy. In November, the German composite PMI index reached 55.4, led by positive new business numbers, while Spain edged up to 50.8. However, the laggards amongst the major European economies saw the composite index ease to 48.8 in Italy and 48.0 in France, their lowest for some months. It must be warned, however, that the relative weakness of the French PMI report does not tie in with the recently more upbeat INSEE survey.
Asia-Pacific - This time it's different...
Having been the subject of 13 economic stimulus packages since 2000, there were few reasons to believe that the Japanese economy would get much of a boost for the ¥5.5 trillion package agreed by the Japanese Cabinet last week. While in total the latest measures are somewhat larger than the previous average of ¥4.5 trillion, they fall a long way short of the ¥10.3 billion splurge earlier in 2013. Not that these details have dampened the Abe administration’s enthusiasm - the Cabinet Office forecasts that the package will deliver an approximately 1% increase in real GDP and create approximately 250,000 jobs. This compares to the more subdued expectations elsewhere, with concerns about whether the package will actually be sufficient to offset the hit to growth from April 2014’s consumption tax hike, estimated at 0.7% upwards.
The cause of the market scepticism lies in the composition of the package. A total of ¥3.1 trillion has been set aside for reconstruction and disaster prevention efforts, a boon for the construction and infrastructure sectors but representing a more dubious impact on the wider economy/productivity. The effectiveness of the government’s measures on private demand, including efforts to promote consumption, innovation and capital investment, are more tenuous. Many have been tried before with limited success and – despite a breakout year for GDP growth in 2013 - it is still unclear how much Japan’s economy and society has really changed.
Following the recent flurry of reform announcements in China, it was notable that the actual data was a little less impressive last week. The HSBC China Services Purchasing Managers Index (PMI) fell to 52.5 in November and the official non-manufacturing PMI dropped to 56.0, marginally lower than October’s levels of 52.6 and 56.3. There was more positive trade news, with exports in November rebounding to a seven-month high of 12.7% year-on-year (y/y), versus 5.6% y/y in October. Imports were somewhat weaker at 5.4% y/y, a five-month low, suggesting the recovery of China’s domestic demand remained slow. Nevertheless, it seems the lift from the reform measures, better news from the labour market, restrained inflation (easing to 3.0% per annum in November) have restored confidence that China will hit the government’s 7.5% growth target and that this may even be extended into 2014.
Of course, promises of structural reforms are only going to keep the wolves from the door for so long; implementation of these measures will be key. On that note, the People’s Bank of China has released an important document laying out the guidelines of the Shanghai Free Trade Zone. Details include allowing residents to open ‘free-trade accounts’ for local and foreign currency transactions, steps to improve capital convertibility, further interest rate liberalisation and the simplification of foreign exchange controls. In totality, the measures suggest that Shanghai is set to become a testing ground for the next stage of internationalisation of the renminbi – a currency which is now the second-most used currency in global trade finance according to a recent report from the Society for Worldwide Interbank Financial Telecommunication (SWIFT).
The fate of the structural reforms will be closely watched in Australia too, where the recent China slowdown and a strong Australian dollar has been choking off domestic activity. Last week’s Q3 GDP growth figure came in at 2.3% quarter-on-quarter, versus 2.9% in Q2. This level was deemed by Treasurer Joe Hockey to be insufficient to generate enough jobs. Unfortunately, the Royal Bank of Australia appears relatively powerless to alter the current course. A direct attack on the currency through an interest rate cut below the current 2.5% level would likely fuel an already frothy housing market. A more likely solution is that the central bank joins hands with the Australian Prudential Regulation Authority to introduce macro-prudential tools, such as lowering maximum loan-to-valuation ratios on mortgages or counter-cyclical capital buffers. Last week’s October trade data served as a reminder that the current squeeze at home might yet be eased by an improvement in overseas demand. Exports to China were up 4.0% month-on-month, a new high. However, such optimism was tempered by announcements that several car manufacturers were thinking of cutting output, citing the currency and local costs as major factors.
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