Kuwait: September 10, 2019
US MANUFACTURING ACTIVITY IN CONTRACTION TERRITORY
The US economy has continued to display mixed signals, with real signs of trouble for manufacturing contrasting a consumer sector still in very good shape. The manufacturing PMI, for example, at 50.3 in August recorded its lowest reading in a decade on deteriorating auto demand and a tariff and trade tension-linked fall in export orders. The equivalent ISM survey was even weaker, pointing to outright contraction in activity. However, consumer spending rose a solid 4.1% y/y in July and confidence remains strong, backed up by a tight labor market. There was also upbeat news from the revised national accounts for 2Q19, which saw private consumption upgraded to an annualized 4.7% q/q from 4.3% before, despite a downgrade to GDP growth from 2.1% to 2.0%. Since consumer spending accounts for 70% of the economy and is still doing well, GDP growth is so far not expected to slow much in Q3, at 1.5-2.0%.
Nevertheless, the challenge facing the Federal Reserve is becoming ever more acute. Having cut rates by 25 bps in July, the bank is under pressure from both the financial markets and President Trump to loosen policy much further over coming months and “get ahead” of a future downturn as well as tackling low inflation, which was unchanged 1.6% y/y in July on the core PCE measure. But minutes of the last Fed meeting show that FOMC members were divided over July’s cut, and given the ambiguous data there is a risk that the Fed could dent its credibility and deploy its limited firepower too soon. Futures markets take a dovish view, now pricing in a mid-September rate cut with certainty, and a near-90% chance of another cut by year-end. Fed policy will be influenced by the ability of the US and China to reach an agreement on the trade war, which despite the announcement of a return to official-level talks over coming weeks, still looks some way off.
EUROPEAN GROWTH FALLS AS ECB MULLS INFLATION TARGET SHIFT
The European economy remains particularly exposed to weaker world growth. Retail sales in the crucial but export-dependent German economy – worth 30% of Eurozone GDP – dropped a larger-than-expected 2.2% m/m in July, while unemployment rose in August, raising fears that external weakness is filtering through to the domestic economy. Indeed, having fallen in Q2, GDP could decline again in Q3, putting Germany officially in recession. Eurozone growth, which slowed to just 0.2% q/q in Q2, could come in at little more than 1% this year overall.
The European Central Bank (ECB) is set to make the shift to looser policy in mid-September, including a cut in the deposit rate from its current -0.4%, stronger forward guidance and a possible restart of the bank’s asset purchase program that it ended last December. But there is debate within the ECB about the efficacy of fresh stimulus, including the financial distortions caused by negative interest rates and the number of available bonds eligible for purchase. While likely to support monetary loosening, Christine Lagarde, who will replace current ECB chief Mario Draghi on November 1st, has called for European governments to do more on fiscal policy to promote growth.
In the UK, the Brexit drama took a further turn when the new PM Boris Johnson, looking to reinforce his negotiating hand with the EU, opted to close parliament for five weeks from mid-September and reduce opposition to his threat to take the UK out of the EU without a deal at the end of October. Parliament however looks set to speed through legislation to block a ‘no deal’ exit, which would force Johnson to ask the EU for a fresh minimum three-month extension. A general election now looks all but inevitable, the result of which may still not be decisive for Brexit if it yields a minority government with a commitment to a second referendum. The uncertainty continues to hurt the UK economy, where construction orders fell the fastest in 10 years in August and the pound hit a 34-year low of $1.21 in August.
JAPANESE GROWTH BEATS EXPECTATIONS
Japan’s economic growth slowed from an annualized 2.2% in 1Q19 to a much better-than-expected 1.8% in 2Q19, as a pick-up in capital spending helped offset some of the ongoing weakness in the external sector. The strong growth rate has raised the stakes for a planned increase in the consumption tax from 8% to 10% in October. Analysts are penciling in a GDP contraction for Q3 if the much-delayed tax hike is imposed, as downward pressures from the external sector are compounded by potentially weaker growth in consumption. Meanwhile, the Bank of Japan made its biggest bond purchase cut since it embarked on its yield-curve control policy back in 2016, after a bond rally pushed bond yields near record lows. It now plans to buy between ¥250 and ¥550 billion of 10-year notes at each operation in September, as opposed to between ¥300 and ¥650 billion in August.