This week we focus in on the state of developed markets. First up is a look at the March PMI results for the US, then we look at some key economic data for the Group of 7 (G7). The graphs show rebounding inflation, very gradual improvement in employment figures, and normalizing GDP growth. Finally we check in on some of the monetary policy decisions over the past week, with an emphasis on the developed market vs emerging market monetary policy outlook.
1. US PMI results
The US recorded a flat reading on the manufacturing PMI with the index at 61.2 vs 61.4, meanwhile the non-manufacturing PMI slipped to 57.3 from 59.7. The standouts on the manufacturing side were many - new orders fell -4.7, production rose +2.7, prices rose +3.0, and backlog of orders and exports both fell -6.5. On the non-manufacturing side business activity dropped -7.2, backlogs were up +4.0, exports rose and imports fell and people thought they had a bit more inventory than they should. So overall the results for both indexes were mixed. The readings were still in positive territory but the direction of a few key sub-indexes give reason to be nervous. But then this recovery was never going to be linear.
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2. G7 Inflation
Most of the G7 are yet to release their March inflation figures, but the February results were as follows: Canada 2.2% France 1.7% Germany 2.1% Italy 2.4% Japan 0% UK 4.4% US 2.1% bringing out a G7 average of 2%. The 2% G7 average compares to a low of -1.4% following the great recession and commodity price bubble and subsequent crash. But the interesting part is that the base-effect (i.e. rebound) is no longer the source of the 2+ readings, it's being driven mostly by rising commodity prices as well as a little bit of a boost from the economic recovery. But for the most part it is cost push inflation, and as the ECB noted, some of this is getting through into inflation expectations i.e. the 'second round effects'. Inflation is gradually becoming a developed market problem - not just emerging markets (and it remains to be seen whether a moderation of commodity prices would have a material impact).
3. G7 Unemployment
Unemployment rates on the other hand have been very slow to normalize, and this remains a challenge for some of the major economies. Within the G7 the February figures were: Canada 7.8% France 9.6% Germany 6.3% Italy 8.4% Japan 4.6% UK 8% (Jan) US 8.9% and the G7 average of 7.7%. Interestingly the big exporters Japan and Germany have done alright, while the rest are struggling with relatively more consumer oriented economies (and we all know how strong the consumer part of developed economies is at the moment!). So the employment situation is probably going to remain a challenge for these economies in the near term, it will be a slow recovery on the jobs front as part of the unemployment is structural - people will need to adjust, to find the new industries or even move - and this is why the spare capacity argument may not be as valid as usual because some 'spare capacity' may not actually be there any more.
4. G7 GDP Growth
Onto the hot topic of economic growth, with the EU just finalizing its Q4 figures this week the G7 results (real GDP growth on a year on year basis) were as follows: Canada 3.2% France 1.5% Germany 4% Italy 1.5% Japan 2.5% UK 1.5% US 2.8% and the G7 average at 2.6%. So all of the G7 economies have rebounded strongly from the deep trough of the great recession, but the trajectory looks like settling back to a lower pace for most, probably no double-dips (unless they really take their medicine on fiscal and private balance sheet repair - especially those with particularly unsustainable government debt and budget situations). But unless there is significant economic transformation (which usually takes some time and pain to implement) the growth rate will drop back a bit due to the structural nature and severity of the recession.
5. Monetary Policy Review
The two big stories of the week in this space were the People's Bank of China raising its 1-year lending rate by 25bps to 6.31% and the European Central Bank lifting the refinancing rate 25bps to 1.25%. The China move was probably most interesting from the perspective that it is likely nearing the end of its tightening cycle with inflation likely to peak in H1, and with the room to move on the RRR and rate being increasingly limited. Meanwhile the ECB's move may well herald the beginning of the tightening cycle for developed markets (or at least a wave of policy normalization). If this is right then the outlook for DM vs EM equities will have to reverse from DM being relatively attractive on most measures against EM, to vice versa. Indeed the flows situation has seen more funds going into US stocks and out of emerging market stocks over the past couple of quarters. These indeed are interesting times.
So we saw some mixed signals in the US PMI results, overall the readings were still at expansionary levels, and the nervousness around some of the details just reflects the non-linear nature of the recovery. Looking into some of the key economic metrics of the key developed markets of the G7 economies there were some interesting signs. Inflation looks to be broadly rising in developed markets, and potentially even becoming a problem not just of emerging markets. The labor market situation is unlikely to improve at a rapid pace given the structural nature of things, but there is signs of gradual improvement underway already. On the economic growth front the initial bounce back is almost certainly set to be followed by a period of below trend growth due to the structural nature of the recession and the severity of the crisis. But on monetary policy, going back to the inflation situation, it may be time for a passing of the tightening torch to developed markets. And these are some of the key issues to think (worry) about for global asset allocators.