International Economic Week In Review: No Central Theme, Edition

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by: Hale Stewart

Once again, negative Chinese news started the week, with Markit reporting a 48.2 PMI. Production dropped; orders and prices were weak. The service sector expanded, with the PMI rising from 50.2 to 52.4. The composite index was a barely positive 50.1. Manufacturing is the biggest problem for a large number of markets. As the following chart shows, it's been contracting for 11 consecutive months:

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Markit also released Canada's PMI. While it increased 1.8, it was still a contractionary 49.3. There were good points, however. Thanks to a weaker Loonie, exports rebounded. But due to weak oil prices, the Canadian manufacturing sector has been in a contraction for most of the last year:

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Unemployment was unchanged at 7.7%:

The Bank of England kept rates at .5%. Their policy announcement contained two key paragraphs:

Returning inflation to the 2% target requires balancing the protracted drags from sterling's past appreciation and low growth in world export prices against increases in domestic cost growth. Fully offsetting the drag on inflation from external factors over the short run would, in the MPC's judgement, involve too rapid an acceleration in domestic costs, one that would risk being unsustainable and would lead to undesirable volatility in output and employment. Given these considerations, the MPC intends to set monetary policy to ensure that growth is sufficient to absorb remaining spare capacity in a manner that returns inflation to the target in around two years and keeps it there in the absence of further shocks.

In the first sentence, the Bank acknowledges the strong Sterling has done some of the banks work in containing prices. Next, they note the strong currency will, for now, keep inflation contained. In fact, should they raise rates in the current environment, the potential adverse effects will outweigh the benefits. This statement dovetails with Carney's recent speech where we said in no uncertain terms that the BOE would not raise rates anytime soon.

Global growth has fallen back further over the past three months, as emerging economies have generally continued to slow and as the US economy has grown by less than expected. There have also been considerable falls in the prices of risky assets and another significant fall in oil prices. The latter appears largely to reflect news about the supply of oil. Developments in financial markets seem in part to reflect greater weight being placed on the risks to the global outlook stemming from China and other emerging economies. Looking ahead, growth in the United Kingdom's main trading partners should continue to be supported by the boost to real incomes from low commodity prices, and to some degree by monetary and fiscal policy. But emerging market economies are likely to grow more slowly than in recent years and the risks to the MPC's central projections of only modest global growth lie to the downside.

Because central banks have a longer time horizon, events such as the recent sell-off usually don't faze them. But clearly they have taken notice not only of recent volatility but weakening economic news. The jury is still out as to what their overall judgment of these factors is, but the collective impact of exogenous events is strong enough to at least give the board a temporary reason to pause.

All three Markit indexes showed expansion. The PMI increased from 52.1-52.9. Domestic orders increased, but the strong sterling is hurting exports. Construction dropped 2.8 to 55. But underneath the headline numbers was an increase in contractor uncertainty and an overall decrease in new orders. Finally, services increased .1 to 55.6; new business orders were at a 6-month high. However, sentiment was the weakest in three years.

In a speech on Monday, Mario Draghi explained that deflationary concerns were the primary reason for the recent increase in the ECB's QE program:

It was about three years ago that inflation started moving away from the ECB's medium-term inflation aim of below, but close to, 2%. Since October 2013, inflation has been below 1%. Throughout 2015 headline HICP inflation in the euro area was very low or even negative, remaining under the influence of low commodity prices, and euro area annual HICP inflation was estimated at 0.4% in January this year.

In parallel to this trend, we had to continually revise our outlook for inflation: while at the start of 2015, our staff was forecasting inflation to reach 1.5% in 2016 and 1.8% in 2017, in December they projected a rate of only 1% for this year and 1.6% for 2017.

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Therefore we decided to recalibrate our monetary policy stance. We cut the deposit facility rate further to -0.3%, we extended the envisaged end-date for our monthly purchases to the end of March 2017, while maintaining its conditionality on the inflation outlook, and we announced that we will reinvest the principal payments of our purchased assets once they mature, for as long as necessary. …..

Since our meeting in early December, conditions have once more changed. A moderate recovery of the euro area economy is under way, driven mainly by domestic demand. But downside risks have increased again amid heightened uncertainty about emerging market economies' growth prospects, volatility in financial and commodity markets, and geopolitical risks. Inflation dynamics are also tangibly weaker than we expected in December. While the most recent wave of disinflation is mainly due to the renewed sharp fall in oil prices, weaker than anticipated growth in wages together with declining inflation expectations call for careful analysis of the channels by which surprises to realised inflation may influence future price and wage-setting in our economy.

Therefore, at our last meeting in January we judged that it will be necessary to review and possibly reconsider our monetary policy stance at our next monetary policy meeting in early March, when the new staff macroeconomic projections become available.

For the last 5-6 years, most central banks have continually lowered their inflation projections. As noted above, the ECB is part of this trend. Draghi is worried about several intertwining economic threads:

  1. A continued lowering of the public's inflation expectations. This will most likely dampen consumer demand in the long run.
  2. A continued lack of business pricing power, dampening revenue and profit growth.
  3. A general overall weakening of firm's pricing power.

Ultimately, Draghi is most likely terrified of the EU beginning to resemble Japan.

Additional EU releases were positive. The EU manufacturing PMI declined .9, but was a still positive 52.3. All 8 major countries expanded:

Backlogs and new orders increased, although the latter was the weakest in the last four months. The EU service index declined from 54.2 to 53.6. Like the manufacturing index, all countries expanded, with backlogs, new orders and employment rising. Finally, unemployment moved lower by .1% to 10.4% and retail sales increased .3%.

The Bank of Japan's slight bullishness is based on two groups of statistics: increasing business profits leading to a "virtuous cycle" of rising investment while increasing income will lead to higher consumer purchases. As for the former, consider these two charts:

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The top panel shows manufacturing companies' profit growth. Larger companies' earnings increased at a faster pace over the last three years; small and medium companies grew at a slower pace. The lower panel shows non-manufacturing earnings, and here, the pace of growth is faster for all company sizes.

Let's turn to the consumer, focusing on the following chart:

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Employee income increased over the last three years, with the rate of change fluctuating between a little over 0% and 2%. Whether this leads to a "virtuous cycle" is up for debate.

Markit also released its Japanese surveys this week. Manufacturing moved .3% lower to 52.3. But export orders were up and all three sectors reported expansion. The service sector number increased .9 to 52.4. The best part of the report was a solid expansion in new orders.

Finally, the RBA kept rates at 2%, offering the following analysis of the Australian economy:

In Australia, the available information suggests that the expansion in the non-mining parts of the economy strengthened during 2015 even as the contraction in spending in mining investment continued. Surveys of business conditions moved to above average levels, employment growth picked up and the unemployment rate declined in the second half of the year, even though measured GDP growth was below average. The pace of lending to businesses also picked up.

The unemployment rate declined during the second half of 2015 - an obviously solid development. Above, the RBA refers to the NAB business survey, which is positive. However, AIG surveys are weaker. Manufacturing is still expanding, with a 51.5 reading. This is the seventh continuous month of expansion. However, services contracted with a 48.4 reading. 4/5 sub-indexes declined and only 2/9 industries expanded. And construction contracted as well, with a 46.3 reading. Only housing was positive. All four sectors had new orders below 50.

Hale Stewart, XE.com