Background
The Consumer Confidence Index (CCI) is a monthly release from the Conference Board, a non-profit business group that is highly regarded by investors and the Federal Reserve. CCI is a unique indicator, formed from survey results of more than 5,000 households and designed to gauge the relative financial health, spending power and confidence of the average consumer.
There are three separate headline figures: one for how people feel currently (Index of Consumer Sentiment), one for how they feel the general economy is going (Current Economic Conditions), and the third for how they see things in six months' time (Index of Consumer Expectations).
The Consumer Sentiment Index is a component of the Conference Board’s template of economic indicators. Historically, changes in this index (of the three released) has tracked the leading edge of the business cycle well.
There are other sentiment indicators that can sometimes be confused with the Consumer Sentiment report or used in conjunction with it, such as the University of Michigan Sentiment Report, and some investors will try to average the two reports to get their own sense of consumer sentiment.
What it Means for Investors A strong consumer confidence report, especially at a time when the economy is lagging behind estimates, can move the market by making investors more willing to purchase equities. The idea behind consumer confidence is that a happy consumer - one who feels that his or her standard of living is increasing - is more likely to spend more and make bigger purchases, like a new car or home.
It is a highly subjective survey, and the results should be interpreted as such. People can grab onto a small situation that garners a lot of mainstream press, such as gas prices, and use that as their basis for overall economic conditions, fair or not. There are no real data sets here, and people are not economists, so they cannot be counted on to realize that, for example, because gas prices may only represent 5% of their expenses, they should not sour their entire economic outlook.
Because of its subjective nature and relatively small sample size, most economists will look at moving averages of between three and six months for consumer confidence figures before predicting a major shift in sentiment; some also feel that index level changes of at least five points are necessary before calling for the reversal of an existing trend. In general, however, rising consumer confidence will trend in line with rising retail sales and, personal consumption and expenditures, consumer-driven indicators that relate to spending patterns.
Regional breakdowns of the data are valuable for seeing the breadth of sentiment across the country, which can be a useful factor in the real estate market, along with indicators such as housing starts and existing home sales.
Strengths
One of few indicators that reaches out to average households
Has historically been a good predictor of consumer spending and, therefore, the gross domestic product (consumer spending makes up more than two-thirds of real GDP)
Weaknesses:
A subjective survey with no physical data sets
Small sample size (only 5,000 households)
Survey results may contradict other indicators, such as GDP and the Labor Report
The Closing Line Sentiment indicators can carry a lot of weight - there are so few that are standardized like Consumer Confidence and, in the final analysis, the happiness and spending ability of Joe Consumer is the most important determinant of an expanding economy.
Preseason football, the end of the Summer Olympics and the onset of the political conventions signal that fall is just around the corner. And somehow, miraculously, the economy continues to eke out at some modicum of growth. Second quarter real GDP growth will likely be revised up to around a 3 percent pace and growth during the current quarter should be 1.5 percent.
The second half of 2008 will be very challenging. Questions about the viability of Fannie Mae and Freddie Mac are keeping mortgage rates higher than they should be, putting additional strain on home sales. Slower job and income growth, declining home prices, and the end of tax rebates should produce at least a modest pullback in consumer spending; we expect outright declines in the next two quarters.
Business investment appears set to slow as well. Lending standards for all types of loans continue to tighten, forcing some businesses to make difficult decisions. Profits remain under pressure, although many firms have offset some of their higher costs with strong productivity gains.
Slogging Through The Credit Crunch
The first tidbits from the Fed's annual retreat this weekend in Jackson Hole, Wyoming came out this morning. Ben Bernanke noted that “the financial storm that reached gale force some weeks before our last meeting here in Jackson Hole has not yet subsided, and its effects on the broader economy are becoming apparent in the form of softening economic activity and rising unemployment.” While this sentence, which was in the first paragraph of his remarks, contained little new information, we believe it shows the Fed's primary concern today remains containing the damage from the credit crunch on the broader economy. Talk of a rate hike, which was prevalent a few weeks ago, has resurfaced, while the prospects for a rate cut are now being discounted.
This week's economic reports were generally consistent with our forecast for continued sluggish economic growth. The index of leading indicators fell by a relatively large 0.7 percent in July, but most of the drop was due to a huge decline in building permits which was tied to a change in building regulations in New York. This quirk, however, was not responsible for the entire drop. Rising unemployment claims and declines in the money supply and stock market also pulled the index lower. The only positives were the interest rate spread and consumer sentiment. Hours worked, supplier deliveries and manufacturers new orders were all either unchanged or essentially flat.
The index of coincident indicators rose 0.1 percent in July, with three of the four indicators increasing. The increase marks the first monthly gain this year. The index declined in February and May and was unchanged in all other months. The coincident index is made up of the four key economic indicators that the National Bureau of Economic Research has historically looked at to call turning points in the business cycle. The recent performance, which shows the index of coincident indicators declining 0.4 percent over the past seven months is more consistent with an economy stalling out rather than one falling into recession.
Other key economic reports included the Producer Price Index, Housing Starts, and Philadelphia Fed survey. None broke new ground. The PPI jumped 1.2 percent in July but that was the month that oil prices jumped to $145 a barrel. Oil has come down more recently, however, and we will likely see some declines in the PPI in coming months. Housing starts fell in line with expectations and still appear to be headed lower. Home sales should bottom out in the next six to nine months. The Philadelphia Fed survey rose from -16.3 percent in July to -12.7 percent in August.
U.S. Outlook
Existing Home Sales • Monday
Reversing all of May's two percent increase, existing home sales fell 2.6 percent in June to an annualized rate of 4.86 million units. Elevated inventory levels remain problematic as evidenced by the supply of existing homes on the market rising to 11.1 months (single-family 11.0 months, condos 12.0 months).
The Pending Home Sales index has been strengthening as of late, albeit from depressed levels, and suggests there could be an upward surprise to the July existing home sales numbers. We believe, however, that another modest decline is probable. While it appears the descent of existing home sales could be stabilizing, tightening credit standards, higher mortgage rates and an increasing pace of foreclosures will continue to weigh on the housing market throughout 2009.
Previous: 4.86M Wachovia: 4.75M Consensus: 4.90M
Consumer Confidence • Tuesday
A deteriorating labor market, elevated energy prices, falling home prices and tight credit conditions continue to pressure consumers' psyche this summer. The tax rebates checks did provide some temporary relief to consumers but much of the benefit was offset by soaring gasoline costs which saw the average national price of retail gasoline reach $4.17 a gallon by mid-July.
While we expect to see a small rebound this month due to moderating gasoline prices, consumer confidence, on balance, should remain around these depressed levels in the coming months The climbing unemployment rate should result in slower consumer spending in the second half of the year.
Previous: 51.9 Wachovia: 54.0 Consensus: 53.0
Real GDP • Thursday
According to the advanced estimates of the Bureau of Economic Analysis (BEA), real GDP grew at an annualized rate of 1.9 percent in the second quarter. While originally below consensus estimates, it appears growth will be revised significantly higher in the preliminary report. The BEA had assumed the trade deficit would widen in June, thereby subtracting from overall economic growth. Broad-based strength in exports, however, contributed to the unexpected narrowing in the June trade deficit to -$56.8B. By itself, this would require the BEA to revise its estimate of second quarter growth by one full percentage point. Supporting the call for a faster rate of growth are subsequently released data from construction spending and wholesale inventories. On balance, we expect real GDP growth in the second quarter to rise towards a 2.9 percent annual rate. Growth in the third and fourth quarters should trend lower as the consumer spending outlook softens.
Previous: 1.9% Wachovia: 2.9% Consensus: 2.8%
Global Review
Mexican Growth Remains Slow
The Mexican economy continues to expand, albeit at a relatively slow pace. Data released this week showed that real GDP rose 2.8 percent in the second quarter, up marginally from the 2.6 percent year-over-year growth rate registered in the first quarter (see graph at left). Indeed, Mexican GDP growth has generally followed a downward trend since early 2006, in line with the slowdown observed in the U.S. economy.
A breakdown of real GDP into its underlying demand components is not yet available, but monthly data offer some clues as to the culprits behind the slowdown. As shown in the top graph on page four, growth in Mexican industrial production has essentially stalled this year. No doubt the slowdown in the United States, to which Mexico sends 85 percent of its exports, is contributing to slower growth south of the border.
Indeed, the volume of U.S. imports from Mexico in the first half of the year may be off as much as 10 percent relative to the same period in 2007.
CPI Inflation Remains Elevated
On the surface, consumer spending appears to be holding up rather well. The value of retail sales grew at a year-over-year pace of 4.3 percent in the first two months of the second quarter, little changed from the 4.5 percent pace registered in the first quarter. However, the rise in inflation over the past few months, which will be discussed in greater detail below, suggests that the pace of real consumer spending has slowed more than the headline figures on nominal retail sales suggests. The recent drop in consumer confidence to the lowest level since at least 2001, also suggests that the pace of consumer spending growth is probably weakening.
As shown in the middle chart, CPI inflation has risen this year. Although the current year-over-year rate of 5.4 percent is well below the double-digit rates that prevailed in 2000, it is well above the Bank of Mexico's target of 3 percent. If the rise in the overall rate of CPI inflation simply reflected sharp rises in food and energy prices earlier this year, the central bank could take comfort in recent declines in these prices. However, the core rate of inflation, which excludes food and energy prices, has risen to 5.1 percent. Therefore, it could take an extended period of sub-trend economic growth to bring CPI inflation back to target.
In that regard, the Bank of Mexico has been tightening policy, hiking its target for the overnight inter-bank interest rate by 75 basis points since mid-May. The increase in interest rates in Mexico relative to the United States contributed to the rise in the value of the Mexican peso versus the dollar to a six-year high earlier this month (see bottom chart).
The peso has given up some of its gains over the past two weeks as the greenback has rallied versus most currencies. Looking ahead, however, we look for the peso to strengthen anew, at least in the near term. Rates in Mexico should remain high, and the Fed likely won't be tightening policy anytime soon. Therefore, favorable interest rate differentials should continue to attract money south of the border, at least for the next few quarters.
Global Outlook
German Ifo Index • Tuesday
German real GDP contracted at an annualized rate of 2.0 percent in the second quarter, which reflected, at least in part, some statistical payback for the 5.2 percent growth rate registered in the first quarter. However, there is little doubt that the underlying pace of German growth is slowing. The Ifo index of business sentiment, which is fairly correlated with industrial production growth, has dropped sharply in recent months. The Ifo index for August, which will print on Tuesday, will give investors some insights into the current state of the German economy.
Despite signs of slower growth in the Euro-zone, the ECB has been reluctant to cut rates due to the sharp rise in CPI inflation this year. The “flash” estimate of CPI inflation in August will be released on Friday. The consensus forecast anticipates that inflation declined from 4.1 percent in July to 3.9 percent in August.
Previous: 97.5 Consensus: 97.2
Japanese Industrial Production • Friday
The Japanese economy contracted at an annualized rate of 2.4 percent in the second quarter due in part to the 3.3 percent drop that occurred in industrial production during the quarter. If the consensus forecast is realized, which looks for a 0.6 percent decline in industrial production in July relative to the previous month, then real GDP in the third quarter probably got off to a weak start.
Other indicators slated for release next week (CPI inflation, the unemployment rate, housing starts, retail spending, and small business confidence) will give investors even more insight into the current state of the Japanese economy. In our view, the Japanese economy has slipped into a mild recession.
Canadian real GDP fell at an annualized rate of 0.3 percent in the first quarter relative to the previous quarter. Much of the decline can be explained by the massive swing in inventories that sliced more than 5 percentage points off of the overall growth rate. While investors project a modest rebound in real GDP in the second quarter, the underlying pace of growth clearly has weakened.
Data released this week showed that the overall rate of CPI inflation did not rise as much as expected, and the core rate remained steady at only 1.5 percent. Although the Bank of Canada likely will maintain its policy rate at 3.00 percent when it meets on September 3, the combination of weak growth and benign inflation could open the door for further easing early next year.
Interest Rate Inertia: No Easy Out for Credit Adjustment
Sub-par economic growth combined with modest upward inflation pressures suggest the Fed is keeping the benchmark funds rate on hold. There is no easy out for creditors or debtors in our outlook.
Short-term rates are likely to remain steady as the Federal Reserve faces the dual imbalance of a slow growth economy along with above-target inflation. Meanwhile credit availability, as measured by the Fed's own Senior Loan Officer Survey, is being rapidly reduced. For the second half of this year we expect average real growth around 1.6 percent with weakness centered in the domestic economy - consumption and business investment. While inflation, as measured by the core PCE deflator, remains above the top end of the Federal Reserve's target range.
As for long rates we expect the ten-year rate in a tight 3.8 - 4.0 percent range. Yet there is significant uncertainty on both the dollar and federal deficit outlook that suggests that rates could rise above our outlook.
Credit: GSE Uncertainty Means Tighter Credit
Financial concerns about the viability of the GSEs suggest that credit supply will be further constrained. Mortgage backed securities have suffered due to credit concerns on the GSEs. These concerns have ripple effects as many owners of GSE equity and debt attempt to assess their own balance sheet and price in the downside risk of valuations on the GSEs. Capital markets continue to search for a new risk/reward tradeoff. Unfortunately the recent widening of bank CDS and AAA CMBS spreads suggests credit is being further constrained.
Topic of the Week
Challenging Times Ahead for Non-Residential Construction
Commercial construction was one of the economy's bright spots during the first half of 2008 and is expected to remain positive in the current quarter. However, most of the recent strength reflects projects committed to prior to the credit crunch. The pipeline of commercial projects is rapidly winding down and we expect commercial construction to turn down late this year or early 2009. The volume of commercial construction is expected to decline by roughly 25 percent over the next year.
Construction of apartments has been a notable strength for private non-residential construction. Demand is being fueled by the expectation that the housing slump and tighter lending standards for home mortgages would compel potential homeowners locked out of the housing market to rent.
Demand for lodging has held up surprisingly well considering the run-up in gasoline prices and cutbacks at major airlines. Private lodging construction is now up roughly 41 percent, but the pace of growth is slowing.
The greatest source of demand is currently coming from the energy sector, with new gas-fired electric plants, oil refinery expansions, ethanol, and bio-fuel plants leading the way. Education and healthcare also remain very strong and there is also a long pipeline of highway and road projects.
With relatively little overbuilding, income properties should weather the current credit storm fairly well. More ambitious projects will certainly run into trouble, but outright declines in property values should be less problematic than we are seeing in the residential sector. Please read our full report for more color.
Disclaimer: The information and opinions herein are for general information use only. Wachovia Corporation and its affiliates, including Wachovia Bank, N.A., do not guarantee their accuracy or completeness, nor does Wachovia Corporation or any of its affiliates, including Wachovia Bank, N.A., assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or any foreign exchange transaction, or as personalized investment advice. Securities and foreign exchange transactions are not FDIC-insured, are not bank-guaranteed, and may lose value.
Overview
A little unwinding of the US dollar's recent dramatic strength took place, Kiwi doing best followed by the Yen and the won worst, which helped many hard hit commodities to also rally. Nymex Crude Oil reached $122.00 per barrel, from a low at $111.50 last week, and spot Gold $839.00 per ounce from $774.00. The best performer this week has been LME Tin, +15.5% to $21,950 per tonne, closely followed by New York's Cocoa futures +12.0% to $2,849 per metric ton. Treasury yields dipped again, probably as a result of a flight-to-quality, while interbank markets remain seized up and rates unchanged. Australian benchmark ten-year government bonds have done best, yields dropping from 6.8% to 5.8% since late June. Equity indices are testing pivotal support, most down by between 2% and 4% since last Friday. Hardest hit was South Korea's Kospi which dropped 7% and closed below key long term support. Their government announced plans to stabilise the housing market which has been hit by the economic slowdown, rising interest rates and indebted households. Sounds familiar?
Political and Economic Developments
The world is still stuck on the horns of a dilemma facing slower growth and very high inflation. German Producer Prices rose an annualised 8.9% in July, way higher than anything since 1981, and likewise US ones at 9.8% Y/Y. UK Q2 GDP was flat, zero, nothing, 'nul points', possibly explaining the 27% drop in Eastern European migrants registering for work here over the same period. US Leading Indicators dropped 0.7% in July, close to the lowest of the last decade. Adding to the problem is the fact that many governments are close to the limits of what they would call 'prudent' government borrowing, or the maximum allowed by the EU (3% of GDP). And the final layer of icing on this toxic cake is the very precarious condition of the financial system. Rumours as to who might be the latest casualty of complex debt structures, those who are in search of working capital, and which business model 'broke' abound. The authorities have been understandably silent on the matter, although astute comments from Swiss National Bank governor warn: 'what we should avoid is some kind of arbitrage by banks, which say they are going to central bank X, instead of central bank Y, because conditions are more attractive'. Maybe they will discuss serious things like this at their annual meeting in Jackson Hole this weekend. The UK's Nationwide Building Society plans operations in Ireland thereby allowing access to ECB funds if needed.
Underlying Themes
What financial market analysts say and what investors actually do can be completely different (some might say a good thing too). For example, while most economists are forecasting a US economic recovery next year, and therefore interest rates back up to more normal levels, Treasury yields have moved relentlessly lower over the last four weeks. Even more interestingly while precious metals prices tumbled over the same period, partly as a function of a strengthening US dollar, there has been a rush to buy one ounce 'American Eagle' gold coins. 'Due to unprecedented demand…our inventories have been depleted' said the Treasury's Mint last Friday having rationed Silver Eagles earlier this year. Conspiracy theorists have had a field day!
For the first time ever there are more old age pensioners living in the UK than there are children under 16, and the fastest growing age group is those over 80 years.
What to watch for next week
Monday August 25th is a UK Bank Holiday as summer drawsto a close. Expect US July Existing Home Sales, Germany's July Import Prices and August CPI for the different states due from this day. Tuesday Japan July Corporate Service Prices, German final Q2 GDP, August IFO and September GfK Consumer Confidence, UK July BBA Mortgages, August Nationwide House Prices, US June Case-Schiller and OFHEO House Price Index, July New Home Sales and August Consumer Confidence, plus Minutes of 5th August FOMC meeting. Wednesday just US July Durable Goods Orders. Thursday German July ILO Unemployment and August Unemployed, Eurozone July Money Supply and August Consumer Confidence and Business Climate, UK CBI Distributive Trades, and US Q2 GDP. Friday UK August GfK Consumer Confidence, Tokyo CPI, Japan Small Business Confidence, July Jobless, National CPI, Industrial Production, Retail Trade and Construction Orders. EZ15 July Unemployment and August CPI, US July Core PCE and Deflator, Personal Income, August Chicago Purchasing Managers and final University of Michigan Confidence. Monday 1st September the US and Canada are on holiday.
Positioning and Technical Analysis
Unfortunately we will probably have to face another week of markets looking for direction after this week's inconclusive price action. Eventually we expect US dollar strength to reverse taking metal prices along for the ride. Likewise Treasury yields which will probably hover at current pivotal levels before taking the plunge (lower yields) in September. Above all investors should opt for safe, conservative places to park their savings, even if inflation chews away at the capital, while considering future borrowing needs. These are likely to be more expensive and limited later this year. Mizuho Corporate Bank Disclaimer The information contained in this paper is based on or derived from information generally available to the public from sources believed to be reliable. No representation or warranty is made or implied that it is accurate or complete. Any opinions expressed in this paper are subject to change without notice. This paper has been prepared solely for information purposes and if so decided, for private circulation and does not constitute any solicitation to buy or sell any instrument, or to engage in any trading strategy.
In the past week the news has once again been dominated by troubles on the financial front. In particular, attention has focused on problems at US mortgage lenders Fannie Mae and Freddie Mac, which currently account for around 75% of all mortgage lending in the US and therefore play a vital role in the country's housing market. These two GSEs have suffered substantial losses on their holdings of mortgage bonds and are under huge pressure to raise new capital. When they came under the spotlight earlier in the summer, the US government was obliged to step in with an explicit guarantee that it would inject money if necessary. The purpose of doing so was to restore confidence in both GSEs so that private investors would put money into them.
However, investor interest still remains very limited, increasing the likelihood that the US government will have to honour its guarantees and inject public money into both GSEs. This has hit their respective share prices hard as such action could dilute the value of existing shareholders' investments.
This situation is particularly crucial for the US economy because it could exacerbate the housing market situation. If the ability of both GSEs to buy mortgage bonds is restricted by a shortage of capital, this would further decrease the availability of mortgage financing, even for good payers. This would in turn dilute the effect of the Federal Reserve's substantial easing of monetary policy earlier this year, and emphasise the problems involved in getting monetary policy to make a difference where it really counts. Latest housing market data also give cause for concern, suggesting a renewed deterioration after a measure of stabilisation had begun to look imminent.
Euroland: Spotlight on Germany with weak Ifo expected
The past week has seen the release of PMI data for Euroland, Germany and France. While the PMI for Euroland as a whole was practically unchanged from July, the French PMI and especially the German PMI fell, which means that there has been a much needed improvement in the very weak PMIs for Spain and Italy (data for these countries have yet to be released). Otherwise the most notable thing about the PMIs is that they suggest that inflationary pressure is receding, and that Euroland is teetering on the brink of recession.
As expected, the PMI for the German manufacturing sector dropped below 50, which indicates contraction, and we believe that the drop in the PMI marks a fresh period of decline. We will see this reflected in the coming week's Ifo index, which we expect to fall from 97.5 to 96.5. We also expect the index for the current business climate to drop from 97.5 to 96.5, and the expectations index from 90 to 89.5. In all three cases, our forecast is below the level generally predicted by other analysts. In other words, our view of the German economy is more pessimistic than the consensus.
The coming week also brings detailed Q2 national accounts figures for Germany which will tell us more about how much of the high level of activity in Q1 was down to temporary factors (such as good winter weather for construction and stockbuilding) that reversed in Q2. We will also get August inflation figures for Germany and Euroland. We expect inflation in Euroland to hold at 4.0% in August and then begin to fall. Key events of the week ahead
Tuesday: We expect the detailed Q2 national accounts data for Germany to confirm the flash estimate for GDP growth of -0.5% q/q. We also predict weak Ifo data, with the main index and the current climate index both falling from 97.5 to 96.5 and the expectations index from 90 to 89.5.
Friday: We expect Euroland HICP inflation to hold at 4.0%.
The week will also bring German inflation figures for August. We forecast HICP inflation of 3.5% y/y.
Switzerland: Weak outlook for private consumption
The latest figures from the Swiss economy seem to confirm the picture of a slowdown in private consumption. On 14 August consumer confidence slipped to its lowest level since Q1 2004, and the past week has brought figures for retail sales in June, which grew by just 0.7% y/y despite EURO 2008, down from 7.4% in May. That said, the retail sales series is highly volatile, and if we allow for the number of trading days, retail sales grew by 4.7% y/y. There is no definitive answer as to which method is best for measuring retail sales, but clearly the two methods lead to very different conclusions about Swiss private consumption.
Foreign trade statistics for July were released on Thursday. Switzerland still has a healthy trade surplus, currently CHF 2.4bn. If we drill a little deeper, exports grew by 0.8% m/m, while imports grew by 0.4% m/m. This adds weight to the impression that private consumption in Switzerland is running out of steam, while exports have been propped up partly by demand for Swiss luxury goods in emerging markets. Producer and import prices for July were also released on Thursday. Prices climbed 4.9% y/y, with oil products again contributing to the increase.
Swiss National Bank governor Jean-Pierre Roth has returned from his summer holidays. In an interview in the Financial Times, he says that the economy has slowed more quickly than the bank expected. When it comes to inflation, he seems relatively relaxed: there has been a downward correction in oil prices, the SNB expects the second-round effects to be “acceptable” (due partly to flexible wage formation), and Roth expects inflation to peak in August.
The market has reacted to these comments from Roth, which were seen as dovish, and the OIS curve now shows 10bp lower yields priced in at 12M. In other words, the market now considers it likely that interest rates will come down, whereas only a week ago a 25bp rate increase was priced into the curve. Key events of the week ahead
Thursday brings the employment report for Q2.
Friday sees the publication of the KOF leading indicator. Last time the index was dragged down primarily by a weak outlook for private consumption.
UK: Minutes highlight the dilemma of weak growth and high inflation
The past week didn't reveal much new in the general picture of a rapidly weakening British economy. Retail sales rebounded a bit, rising 0.8% in July, but this was after a drop of 4.3% in June. GDP for Q2 came out weaker than expected at 0.0% q/q after rising only 0.2% in Q2. Hence the overall economy has more or less stagnated in the first half of 2008. Exports and investments were very weak and private consumption fell slightly. Private consumption is likely to soften a lot more in H2, as signalled for example, by the distributive trades survey which is at an all time low (started in 1985). The housing market is also in the doldrums as witnessed by the house price index from Rightmove, which fell 2.3% m/m in August. Overall the picture in the UK is gloomy, and the Bank of England (BoE) is very much aware of that.
The minutes from the meeting of 7 August showed again a split in the BoE which voted 7-1-1 for keeping base rate unchanged at 5%. Tim Besley voted for a 25bp hike, David Blanchflower preferred a 25bp cut while the rest voted for unchanged rates. The split reflects the dilemma of high inflation and very weak growth. Inflation is currently running at 4.4% and heading for 5% in coming months - way above the target of 2%. BoE' went through all the options of raising the Bank Rate, cutting it and keeping it unchanged. A rate hike was would send a strong signal to wage and price setters which would reduce wage pressures and this way constrain the rise in unemployment. The case for a cut is clear with the ailing economy, but the main risk associated with an immediate cut was that “it could cause wage and price setters to conclude that the Committee was more concerned about sustaining output growth than about returning inflation to the target” The third option - unchanged rates - balances the risks from lower growth and higher inflation.
The dilemma for BoE is clear and we think they will be sidelined until inflation gets into a territory where they can cut rates without spurring doubts over their commitment to price stability. This will likely happen in February next year when we expect the first cut in a cycle that should take the Bank Rate to 4% by the end of 2009 (currently 5%). The market currently expects rate cuts of around 60bp next year. Key events of the week ahead
Tuesday: BBA loans for house purchase.
Thursday: CBI distributives trade survey. It is at very weak levels and should be broadly unchanged
During the week Nationwide house prices for August. Prices are likely to have fallen further. The price declines over the last 3 months have been around 2%. m/m
USA: Just how divided is the FOMC?
The divide in the Federal Open Markets Committee (FOMC) seems to have closed up somewhat in recent weeks, due probably to the drop in commodity prices helping to reassure the hawks on the committee. At the latest meeting on 5 August, only one member (Dallas Fed president Richard Fisher) voted for a rate increase, although it was feared that others would follow suit (see Flash Comment - FOMC: Firmly on hold). The most inveterate hawks on the FOMC have softened their rhetoric slightly in recent weeks and are no longer talking about the need for an immediate rate increase, settling instead for a warning that a hike could come sooner than the market expects. The minutes of the FOMC meeting on 5 August will be released on Tuesday night, and it will be interesting to see how much disagreement there was between the hawks and the doves on the committee.
Before then we will gain an insight into what the Fed believes to be the most important topics in the US economy right now, as this weekend brings the Fed's annual symposium at Jackson Hole. Ben Bernanke will talk about financial stability on Friday afternoon, and it will be interesting to see if he touches on the turmoil surrounding the two big mortgage lenders Fanny Mae and Freddie Mac, which flared up again during the week. An article in Barron's focused sharply on the two GSEs' problems in raising sufficient capital to counter the losses they face as a result of the downturn in the US housing market. The renewed turmoil caused the two lenders' share prices to virtually halve in the last week, and the yield on their mortgage bonds has risen further. The drastic drop in share price will make it hard for the two to raise capital through share issues, and the market is speculating about an imminent government takeover of the two institutions (see Flash Comment - US: Confidence in GSEs is fading rapidly).
The coming week also brings data for personal income and spending. Going from July's retail sales figures, the effect of the tax rebates already seems to be petering out. We expect a decrease in personal spending of 0.1% m/m in July, which would make it very difficult to see positive growth in personal spending in Q3 as a whole. It also seems that most of the rebate payments were made before the end of June, so we expect to see a drop in personal income in July. Key events of the week ahead
Monday: We expect sales of existing homes to fall 0.3% m/m.
Tuesday: We expect sales of new homes to fall to 520,000.
Tuesday: Minutes of the latest FOMC meeting are released.
Thursday: The revised GDP figures for Q2 are expected to entail an upward revision of growth to 2.5%.
Friday: We expect drops in personal spending and income in July.
Asia: Speculation about Chinese stimulus package
In the past week there has been speculation in China that the government is set to announce a fiscal policy stimulus package. As we have mentioned before, there is much more scope for stimulating growth now that inflation has come back down and is probably set to continue falling in the coming months (see Flash Comment - China: Inflation drops more than expected in July). At the same time, exports have moved into a slightly lower gear (see Flash Comment - China: Industrial production slows in July). However, we do not expect any major fiscal policy moves from the Chinese government in the short term. Data for July have been better than expected and suggest that the slowdown in economic growth was only modest, thanks to continued relatively robust domestic demand (see Flash Comment - China: Investment accelerates slightly going into Q3). It is therefore too early to completely disregard the inflation risk. As a result, we anticipate a relatively cautious line from the Chinese administration - a line most recently seen when the government chose to raise bank lending quotas at the beginning of August rather than lift them altogether (see Flash Comment - China: No need for more tightening). If there is a need to stimulate growth, the first step will probably be the complete abolition of these quotas. Major fiscal policy easing could be the next Chinese bulwark against weaker international activity, but hardly one that China will be needing in the short term.
In Japan, the past week has brought some relatively good news for a change. Exports grew again in July after falling sharply in Q2 (see Flash Comment - Japan: Exports recover in July), which suggests that exports are not in freefall in Q3 after all, and that net exports will again make a slight positive contribution to GDP growth. The downside risk to our GDP growth forecast of 0.2% q/q in Q3 therefore seems to have eased somewhat. The coming week is a busy one for economic data in Japan. We expect inflation to climb above 2% in July, so moving outside the Bank of Japan's official price stability definition of 0-2%. In connection with the week's monetary policy meeting, though, the BoJ signalled clearly that this is not a major cause for concern at present (see Flash Comment - Japan: Rates unchanged, slightly softer view). It will therefore be growth that is the key to the direction and timing of the bank's next move. We still expect it to leave its key rate unchanged over the next year. Key events of the week ahead
Friday brings figures for consumer prices, unemployment and industrial production in Japan.
No important economic data are due out in China during the week.
Monetary policy meetings are scheduled in Malaysia on Monday, Thailand on Wednesday and the Philippines on Thursday. We predict 25bp rate increases in Thailand and the Philippines but no change in Malaysia.
Foreign exchange: Bullish on JPY, bearish on GBP
Our latest FX forecast update takes a more positive view on the USD than before (see: On the brink of a global recession), due mainly, as we discussed in last week's Weekly Focus (see: EUR/USD turnaround could be slow and bumpy) to a more pessimistic assessment of the economic outlook for non-US markets, and our belief that the year-old financial crisis will continue to impact negatively on risk-seeking in FX markets. We therefore expect the USD to rally against the vast majority of currencies in coming months. JPY is the only major currency we expect to outperform the USD in the next three months. The JPY is generally undervalued (by 10% vs. USD and 40% vs. EUR), normally copes well during a global economic downturn, and typically strengthens when volatility increases and speculative positions are wound down. Most financial indicators also suggest upside potential in the short term. The latest movements in both bond and equity markets thus suggest that the JPY should be stronger than it actually is. Our short-term model for USD/JPY indicates a neutral level of 106, compared with a spot rate of 108.8. We expect GBP to perform worst in coming months. We have taken a negative view of the GBP for the past year, initially in response to the financial crisis, then subsequently due to the economic downturn in the UK. The Bank of England is under pressure from weaker economic growth on the one hand and a surprisingly sharp upswing in inflation on the other. We expect the BOE to make room for substantial rate cuts once inflation begins to fall back, but we will probably have to wait until early 2009 for this to happen. We predict that interest rates will be cut by 1pp to 4% in 2009. The GBP will probably remain under pressure in coming months, but more against the USD than against other European currencies. Given the current sharp economic slowdown in Euroland, we have cut our 3m EUR/GBP forecast from 0.82 to 0.81. Against the USD, we expect the GBP to fall to 1.77 from a spot rate of 1.86. We take a moderately negative view of the SEK over the next couple of months. The Riksbank may still raise interest rates at its meeting on 3 September, although in view of the expected economic downturn, the real question is how many rate cuts we can expect in 2009. As in 2001, there may well be a very short gap between the final rate hike and the first rate cut, implying that the SEK could be unable to draw much strength from any rate increase. With movements in equity markets and changes in risk appetite the main drivers behind the SEK recently, without an improvement in both it seems probable that the SEK will weaken moderately over the coming months. Our 3m EUR/SEK forecast is 9.45, up from 9.38 today. Our view of the CHF is unchanged - we expect the currency to appreciate moderately against the EUR over the next 3m, bringing the EUR/CHF down from 1.618 to 1.60.
Fixed Income: Rise in oil price puts inflation back on the agenda
Bond markets continue to trade on three broad themes - recession fears, financial crisis and inflation. Ebbs and flows in the news flow on these three factors explain most of the moves in the bond market currently. Over the last two months the market changed its focus rapidly from high inflation to recession fears. The reason was clear: growth figures dropped dramatically in Germany while commodity prices fell back, easing the inflation concerns. Now the market is to a greater extent pricing in economic weakness: for example, in Euroland rate cuts of approximately 50bp from ECB during next year are priced in.
Market activity this week suggested it may be hard to push yields much lower in the short term without significant renewed negative growth surprises. Despite financial turbulence the beginning of the week and a fairly weak German Flash PMI yesterday, bond yields quickly recovered after falling. A first sign that it may be hard to go much lower yield wise in the short term. At the same time, inflation fear is creeping back into the market after oil prices rose strongly on Thursday on the back of renewed geo-political tensions between the US and Russia. We believe the oil price could rise further (see Commodities) and hence provide more upward pressure on bond yields in the short term. Investors who are long bonds may use it a reason to cash in as the volatility this year means profits can come and go very quickly. More profit taking on long positions would add to upward pressure on bond yields. Overall, we think the market is in a consolidation phase after the recent bullish run in bonds.
This is purely a short term view, though. Ultimately we still expect bond yields to end the year lower as the risk of global recession will continue to be a big underlying theme. Growth numbers should weaken further globally in the coming quarters, and unemployment should rise in most countries. The tensions in the US mortgage system are adding to downward pressure on the housing market, and in Euroland the lack of any real tailwinds and slowing employment growth pose downside risks to 2009 growth. Hence the pressure for ECB rate cuts will only increase as we move closer to year end.
Next week the market has a lot of US data to chew on. Housing data will be interesting given the latest turmoil in the mortgage market (see front page). Home sales (both new and existing) and house prices (both Case/Shiller and OFHEO) are scheduled for release during the week. In Euroland, Flash CPI and consumer confidence (includes inflation expectations) will be of interest. Otherwise oil price developments will be key.
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World growth is slowing...
The global economy is slowing down. And some countries could have a recession - or two consecutive quarters of negative growth - including the UK. After world growth of 5% on average in the last four years, the fastest sustained period since the early 1970s, the rate of expansion is set to ease to 4% this year and to 3.5% in 2009. This growth slowdown would imply a need to lower nominal interest rates but action like that by the monetary authorities would be wrong, and perhaps be a huge policy mistake. The reason is that real interest rates - nominal interest rates deflated by price inflation - are too low at a global level. What do we mean by this? ...but perversely monetary policy is still too loose at a global and regional level...
When real interest rates are below real long run average growth, the monetary policy stance can be said to be expansionary and contractionary when above real growth. Following on from that, low real interest rates therefore generate upward pressure on inflation, as growth is pushed above its long run average, while high real rates create downward pressure on inflation, as growth is pushed lower. Real interest rates are a good guide therefore to whether monetary policy interest rates are too loose or too tight. We have calculated real interest rates for the global economy, and this shows that they are presently too loose, in fact negative, encouraging upward pressure on price inflation. This needs to be tackled. The question is how? ...this is shown by the fact that price inflation is accelerating and real interest rates are negative...
World inflation is accelerating, driven by higher commodity prices and too strong a rise in global demand, but also by a loose monetary stance. This may seem odd, since the credit crisis implies a squeeze on the availability of money and so in theory a tighter policy stance. But that is true only in some countries and, even there, it is not the whole story. The excesses of the credit boom were caused by a too loose monetary stance and its consequences therefore suggest that a return to those policies is neither possible nor desirable nor in fact sustainable. The sharp rise in global inflation is a sign that inflation problems are not confined to one country or region but are a worldwide phenomena and issue. Ignoring rising global inflation would put at risk the achievement of fast global growth that low inflation has brought about. Chart b shows that it was the fall in global inflation that led to lower nominal interest rates and hence a rise in the pace of real growth and its improved sustainability. This achievement risks being lost if inflation is allowed to rise too rapidly. ...including in the major economies hit by the credit crisis
In many countries, from the US to India and China, inflation is at 15 to 20 year highs or more. And chart a illustrates why this is, in the key economic areas, developing and developed, real interest rates are negative. For inflation to fall, real interest rates need to be positive, as the experience of the high global inflation period shows that low real interest rates generate high price inflation. Chart c shows this point more clearly that, currently, real rates are too low in some of the major economies of the world. The good news is that they are still not as low as the level experienced in the 1980s and early 1990s, but will continue to push inflation higher if not reversed. Expectations, using consensus forecasts, suggest that monetary tightening will occur next year. The problem is that it still leaves real interest rates well below their average since 2000, and worse, the rise in real rates only occurs because of falling price inflation. Forward markets suggest that interest rates are expected to be cut in the UK and eurozone. Only in the US are they raised, and then from a very low, and unsustainable, nominal rate of 2%. This is not the case everywhere, of course, and nominal interest rates are being raised in the large emerging markets, but the key question is whether this is enough at the global level? Hence, the danger is that inflation does not remain low as real interest rates are still low after falling next year so that price inflation then accelerates again in 2010 and beyond as growth recovers. Charts d, e and f illustrate strikingly, just how negative real interest rates are in the US, UK and eurozone and how much they have to rise just to get back to the average since 2000, never mind to a tight stance. The question is will monetary policy be tightened enough to squeeze inflation for more than just a year?
What needs to be done therefore is for real interest rates to rise. That can be accomplished by a combination of falling inflation and by a rise in nominal interest rates. But for price inflation to fall for a sustained period, nominal interest rates must be raised so that real rates are tightened further. In some parts of the world this is already happening but weak growth and the credit crisis has meant this has been half hearted, especially as slower growth hits employment and the poor hard. However, rising inflation erodes real incomes and leads to a longer period of slow growth than if policy responds aggressively in the near term. This is shown by the historical fact depicted in chart b that continued low inflation generates positive effects that lead to long periods of sustained high real growth. However, there are limits to the rate of economic expansion. Beyond that point, excessive inflation is triggered, and the level of real interest rates suggests that too easy monetary policy has now helped to bring that about.
There are also other ways of toughening the overall policy stance, by allowing exchange rates to appreciate, though this is not a global solution, and by tightening fiscal policy, but at the heart of it must be a sustained rise in real interest rates. Unfortunately, this may mean the unpalatable outcome of higher, not lower, nominal interest rates in a number of major developed economies in the future. Chart a: Global interest rates are negative in all major economic areas
Chart b: Low global inflation has generated high and stable economic growth
Chart c: Real interest rates are forecast to rise, but perhaps not by enough to quell inflation
Chart d: The UK's real interest rate has been falling but still positive for now though below its average
Chart e: The US real interest rate has fallen sharply and is already negative
Chart f: Rising inflation has pushed euro zone's real interest rate sharply lower
Focus on US growth this week
The second estimate of annualised US Q2 GDP may be revised up to 2.8% from 1.9% as factory orders, retail sales and net trade in Q2 have either been revised higher or exceeded expectations since the first release. The July core PCE deflator is likely to have increased by 2.4%, remaining above the Fed's 2% preferred rate. Also, the Fed publishes the minutes off its 5th August FOMC meeting. Inflation data are also published by the EU-15 - the August forecast is for growth of 4.1%, more than double the ECB's target. With the downward revision to zero from 0.2% growth in UK Q2 GDP, the GfK consumer confidence, the distributive trades' survey and the latest Nationwide house price survey may provide further insight into the likelihood of UK recession in Q3. Japan is likely to publish an improvement in industrial output and retail sales in July, adding to the debate about the country's growth path.
UK financial markets are closed for the Bank Holiday on Monday. Last week's downward revision to flat quarterly Q2 GDP growth (+0.2% first estimate), 1.4% (1.6%) on an annual basis, will increase focus on indicators that may be reflective of GDP performance in Q3, including the possibility of recession. The CBI distributive trades' survey may improve to -30 in August from -36 in July, but still significantly weaker than the 12-month average of -2, signalling that higher costs and weaker sales are weighing on profit margins. GfK consumer confidence could deteriorate further, from -39 in July to -41 in August, as rising utilities charges and food costs and the negative impact of falling house prices on household wealth weigh heavily on sentiment in the consumer sector. Following Rightmove's publication of a record 4.8% drop in house prices in August, the Nationwide house prices survey may show double digit declines following July's 8.1% drop in annual terms, adding to the housing market gloom.
The US Q2 GDP second estimate may show that the economy outpaced the initial growth forecast - an upward revision from 1.9% to 2.8% is likely. (See chart 1 for regional GDP trends.) In addition, July monthly growth of personal income and spending may come in at a robust 0.1% (0.1% in June) and 0.3% (0.6% in June). The Chicago PMI index for August may also improve compared with July, suggestive of a better factory performance. The upward growth revision and some survey evidence of improvement so far in Q3 may strengthen the argument that the US economy bottomed out in Q4 2007 and that subsequent data point to recovery. This, together with the likelihood of a rise in the core PCE deflator, the Fed's preferred inflation measure from 2.3% in June to 2.4% in July, is cementing perceptions that the Fed will soon start normalising the level of interest rates. (Chart 2 shows rising CPI inflation in the major economies.) Other data published this week includes existing home sales, which may have risen from 4.86m in June to 4.92m in July and new home sales which may stabilise at around 0.53m, adding to the view that the US housing market may be over the worst. S&P /Case Shiller house prices for June are also important - the market consensus is for a decline of 16.2% (- 15.8% in May). Finally, we will be looking to see whether or not initial jobless claims again total over 400,000 this week, indicative of a soft labour market.
The EU-15 publish a plethora of economic data releases to add to the debate about whether the region will enter technical recession or return to quarterly growth in Q3. The German ZEW survey improved in August, so we will be looking to see whether or not the German IFO business survey strengthened as well - we expect a slight improvement to from 97.5 in July to 97.9 in August. The PMI business survey results suggested EU-15 business confidence may be stabilising, but still remains at levels suggesting output contraction. Another key data release is the preliminary August CPI figure, which may rise from 4.0% in July to 4.1% in August, more than twice the ECB's 2% target. Other releases include money supply growth, the unemployment rate and EU-15 consumer and industrial confidence surveys. Chart 1: Growing contrast between GDP trends - the US (early signs of recovery) and the UK/ EU-15 (signs of recession)...
Chart 2: ...but the US, the EU-15 and the UK are experiencing well above target CPI inflation
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Wholesalers and retailers present a mixed picture to close out Q2
Canada on the edge of a technical recession
CPI inflation up to 3.4% in July
With mostly second-tier economic data emanating from the U.S. this week, our focus lay mostly on Canadian data, which we think helps to frame answers to some key questions that have emerged in recent weeks. While inseparable, some of these questions relate to inflation while others pertain to economic growth. In the growth-related batch of questions, the near-term focus is on whether or not the Canadian economy will experience a technical recession, i.e. two consecutive declines in quarterly real GDP. Meanwhile, in the basket of questions pertaining to prices, of high interest are issues like: how high will Canadian inflation go, and when will it come back down to target? Not much 'bling'
First, what to make of the risk that real GDP declined further in Q2? After losing much of its shine late in 2007 and then contracting by a slight 0.3% (annualized) in Q1, Canadian real GDP is expected to have grown in Q2, but just barely. Since our June forecast for a mere 0.4% gain and the Bank of Canada's (BoC) modest July forecast of 0.8%, the data have lined up well enough against both these forecasts to keep a 0-1% outcome as the most likely. Taken together, the last pieces of economic data before next week's release of the Q2 GDP figures did not do much to pin down whether growth in that quarter was slightly positive or slightly negative. They did, however, help to reduce the possibility of an outcome significantly off forecast, meaning Q2 real GDP growth outside the (-1.0, +1.0) range. While wholesalers finished Q2 with a good 1.0% monthly increase in June sales volumes, retailers had a harder time of it and recorded a 0.4% decline in their sales volumes during the same month. Many retailers' overall receipts were boosted by higher prices, mostly at gasoline stations, but after stripping out price changes (which do not feed into calculations of real GDP), it becomes apparent that the retail story unfolding is one of less bang for your buck from a consumer's standpoint. Some retailers are able to offset lower volumes with higher prices, but times aren't rosy for the many that cannot, because of competitive pressures and/or weaker demand. Bucking the commonly held view, vehicle and overall retail sales held up fine in the first half of this year across Canada (yes, even in downtrodden Ontario) except B.C. and Alberta. After growing by 4.8% in the first half of this year, we think Canadian retail sales will slow to about a 3.0-3.5% pace of growth in the second half of this year. With sales receipts forecast to expand by 4% for this year as a whole, retailers are still looking at a decent year, albeit sub-par. Overall job and income growth are slowing, as are housing markets and, soon to follow, home-related purchases.
As for the bigger picture, a technical recession is in the cards, but it is one of multiple cards, so we are still in the land of probabilities. We could go on ad nauseam as to what a recession 'really' is, and why the 'two consecutive quarterly real GDP contractions' definition is much too narrow. But we would probably be doing so at the cost of sounding like an aging professor berating the younger generating for not 'getting it'. Furthermore, we are also quite mindful of the media-grabbing impact that a negative print on Q2 real GDP growth would have. The scale of reaction is unfortunately not evenly balanced between ever-so-slightly positive growth (say +0.1%) and a slight contraction (say -0.1%). As discussed at length in a recent "Market Musing" from TD Securities Economics Strategy, we believe the risk of a Q2 contraction in real GDP is significant at 35%, but that readers should treat it as it if were actually the most likely scenario, so as not to be caught off guard by any market gyrations if it were to materialize. If it does not, we doubt that a Q2 expansion of 0.5-1.0% would be anything to write home about either. The one thing that is clear is that while the Canadian economy is certainly not experiencing stagflation comparable to that of the late 1970s, it is suffering through a bout of what can reasonably be dubbed a 'stagflation lite' episode. Indeed, Canadian economic growth has been stagnant since Q4 of last year, and the outlook is that it will continue to move mostly sideways, similarly to the U.S. economy, until the second half of 2009. Which takes us to issues related to inflation, in particular: how high will it go, and how long will it stay there? Plop, Plop, Fizz, Fizz
The surge in commodity and energy prices recorded earlier in the year is making its uneasy way through the world's economies as they experience high inflation rates. In the process of absorbing this commodity price shock, so far Canada only seems to be having a mild case of indigestion, which is much better than what can be said about most other countries. A big part of this is because large parts of the country are commodity exporters and clear benefactors of high commodity prices. While the adjustment is painful for many industries, there are few indications as of yet that other regions of Canada are choking on these higher commodity prices.
In July, the U.S. CPI inflation rate stood at 5.6%, much higher than Canada's CPI inflation rate of 3.4%. While each headline inflation rate is uncomfortable from the perspective of each country's respective central bank, core inflation rates have stayed lower, with the latest (July) readings at 2.5% in the U.S. and 1.5% in Canada. Since commodity prices started retreating in July, it now looks less likely that 4% inflation will be breached in Canada. However, it might be premature to call a peak to inflation at 3.4% in July. Base effects (price declines in 2007) suggest that gasoline and food prices will continue to bubble on a year-over-basis until November, with headline inflation likely to remain in the 3.0-3.5% range throughout much of the second half of this year - assuming commodity prices continue to edge down as per our view. If commodity prices stagnate (increase) post-August, then inflation would near (breach) the 4.0% mark towards year-end.
As for core inflation, we think it will gradually edge up towards 2.0% by year-end. Both headline and core inflation measures should then ease off to below 2.0% by the second quarter of 2009. Since much of the downside risks to inflation and growth seem to be playing out, mostly through lower commodity prices, vis-à-vis the BoC MPR Update of July, does this imply the BoC will change its policy stance and lower the overnight interest rate further? Given that the current real (inflation-adjusted) overnight rate is negative, how much more accommodative could it get? There might be about 50 basis points of easing room left, but not much more. It would take more than a small negative print on Q2 real GDP growth for the BoC to switch to an easing stance. Another significant job loss figure in August - although we expect +5,000-10,000 net new jobs - would most certainly raise a few highbrows at the BoC after July's massive 55,000 net employment drop. The next interest rate decision meeting is set for Sept. 3rd, where we expect them to remain on hold. Beforehand and prior to the release of Q2 GDP and August employment data, the BoC will have an opportunity to signal its intentions for its October meeting at a speech this upcoming Tuesday (Aug 26th), where we will be all ears.
UPCOMING KEY ECONOMIC RELEASES
U.S. Durable Goods Orders - July
Release Date: August 27/08
June Result: total 0.8% M/M; ex-transportation +2.0% M/M
TD Forecast: total -0.5% M/M; ex-transportation -1.3% M/M
Consensus: total +0.1% M/M; ex-transportation -0.5% M/M
Despite the fiscal stimulus-driven rebound in U.S. economic activity in Q2 dollar-induced export demand, the underlying weakness in U.S. business activity remains in place. We expect activity to remain subdued in the coming months. Our call is for durable goods orders to decline by 0.5% M/M decline in July, following the 0.8% M/M gain in June. Excluding transportation, orders are expected to fall by a more profound 1.5% M/M, due in part to a shift in the aerospace industry. Indeed, despite the modest improvement in the auto-related sectors in June, we believe that the unwillingness of business to embark on new investment project will continue to weigh on durable goods orders.
U.S. Personal Income and Spending - July
Release Date: August 29/08
June Result: income +0.1% M/M, spending +0.6% M/M; core PCE deflator +0.3% M/M, +2.3% Y/Y
TD Forecast: income +0.2% M/M; spending +0.4% M/M; core PCE deflator +0.3% M/M, 2.4% Y/Y
Consensus: income 0.0% M/M; spending 0.3% M/M; core PCE deflator 0.3% M/M, 2.4% Y/Y
July represents an inflection point after which the U.S. fiscal stimulus impact may start to wane. As a result, spending could still be somewhat elevated at +0.4% M/M, but income itself is likely to be modest at +0.2% M/M. August could be considerably worse on both fronts, as the true nature of the U.S. economy once again reveals itself, driven by close to 500K jobs already lost in the U.S. since January, an unemployment rate heading towards 6%, and home prices falling by 16% over the past year. In terms of inflation, core PCE prices are expected to increase at a rather robust pace of 0.3% M/M - the same as the monthly gain in core CPI - with the annual core PCE inflation rate remaining flat at 2.4% Y/Y.
Canadian Real GDP - Q2/08
Release Date: August 29/08
Q1 Result: -0.3%
TD Forecast: +0.4%
Consensus: +0.6%
The Canadian economy appears set to squeak out a slightly positive reading in the second quarter of 2008, with a +0.4% annualized gain. Contributing to this, consumer spending and business investment should be so-so, inventory accumulation could be mixed (but with a high degree of uncertainty), while net exports will be sour. There are considerable risks underlying this report, with a non-trivial chance that Q2 GDP could be outright negative, which would make for a second-consecutive quarter of negative GDP in Canada. This would fulfill a popular definition of a "recession", and no doubt result in much hand-wringing. We are not convinced that the Canadian economy is truly quite as soft as this report is likely to portray, but this is not likely to filter into the market's interpretation.
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This week's highlights
The minutes of the FOMC meeting held at the Fed on 5 August will be released. The press release after the meeting showed the committee members to be less anxious than earlier about economic growth and inflation, which is chiefly due to the fall in energy and food prices. The interesting point of the minutes is again the difference of opinion among the committee members. Some of the presidents of the Federal Reserve Banks want to raise interest rates because they worry that the sharp rise in energy and food prices will result in higher wage rises and sharper price rises of other goods. The Board members including Mr Bernanke want to leave interest rates unchanged because the price rise have had little effect so far on other goods.
In that connection it will be interesting to see to what extent the members have been calmed by the fall in commodity prices of energy and food. On 5 August, the oil price had fallen to USD 118.7, i.e., it was 20% lower than at its peak. Moreover, the commodity prices of food have fallen again, which means that the two factors that pulled up the commodity prices the most have fallen back.
However, there are no decisive signs that the fronts have softened. The latest announcements by Lacker and Fisher indicate that they are still hawkish. But it is clear that the fall in energy and food prices must have strengthened the arguments against a hike.
As mentioned earlier, we expect the Fed to lower interest rates twice. This is because unemployment looks set to increase, and unemployment is, after all, one of the most important parameters of the Fed. Naturally, we also expect the inflation rate to decline in the course of the next six months.
This week's other highlights
The US: home sales, home prices, consumer confidence, personal income and consumption
The euro zone: Consumer prices and unemployment
Germany: consumer prices and IFO
The UK: House prices
Japan: Consumer prices
In the course of the week
Germany: consumer prices for the German states
At 3.3%, the German consumer prices were unchanged in July. The German consumer prices are the first indication of the flash estimate of inflation in the euro zone which will be announced on 29 August. Therefore the indicator will attract much attention.
The UK: house prices from Nationwide - August
UK house prices have been falling for nine consecutive months. In July, the fall was 1.7% m-om and 8.1% y-o-y.. This is the lowest it has been since the series began in 1991.
We expect the housing market to remain soft for some months yet, with home prices falling further. The ratio between housing sales and the stock of unsold houses in the RICS survey - which is a good indicator of future house prices - is still falling, and the number of mortgage loans used for buying a home has fallen to an all-time low since the start of the series in 1993. Home sales are hampered by tighter credit conditions and expectations of further price falls.
Monday
The US: home sales - July
Existing home sales have fallen by 33% since the autumn of 2005, but over the past 7-8 months there has been some stabilisation in home sales, and it is, of course, doubtful if the trend continues. The development will also be of relevance to house prices in future.
The stabilisation of home sales comes after an improvement of the fundamental factors for home purchases. This is due to a combination of falling interest rates, lower home prices and rising household income. The problem is just that the real rate of interest has risen sharply since the beginning of the year. The yield on 30- year mortgage bonds with which US homeowners prefer to fund their homes is now at the upper end of the range we have seen for the past few years.
The latest signals for home sales in July indicate a fall. True, the number of pending home sales has been stable, which indicates stable home sales. On the other hand, applications for mortgage loans have fallen further, and banks are announcing new tightenings of credit conditions, particularly for mortgage borrowers. There is thus a risk that home sales will weaken again.
Also, there is focus on the number of homes for sale. The stock of homes for sale is on the rise again after falling in late 2007. The time it takes to sell a house has risen to 11 months which is the second highest since the mid- 1980s.
Tuesday
The US: house prices, Case-Shiller og Ofheo - June
There are various measurements of house prices in the US. This week data from Case- Shiller and Ofheo will be announced. Case-Shiller measures the price development of homes in the large cities. That is why Case- Schiller often rises/falls more than the entire housing market. In April house prices had fallen by 16.9% over the past twelve months, which is the sharpest fall since the start of the data collection (1988). However, we have seen the fall in house prices slow down lately, which may reflect a stabilisation in home sales.
This week will also see the release of Ofheo prices, which are particularly interesting in the light of recent weeks' crisis at Fannie Mae and Freddie Mac. Ofheo only measures the price development of houses financed through the two mortgage credit institutions Fannie Mae and Freddie Mac. Unlike Case-Shiller, Ofheo disregards the most expensive houses (so far those worth more than USD 417,000) and houses financed by means of sub-prime loans. This means that Ofheo takes into account those houses whose prices are obviously the most stable ones. This is evident from the fact that house prices measured by Ofheo fell by 'only' 4.8% to May y-o-y.
As mentioned above, home sales have tended to stabilise, but there are still a lot of homes for sale, and that will increase the downward pressure on house prices. Prospects are, therefore, that house prices have further to fall. Contrary to the findings of Case-Shiller, we have seen home prices fall faster recently.
We expect a further fall in both house indices in June.
The US: consumer confidence - August
Consumer confidence as reported by the Conference Board is usually the most important consumer confidence indicator. Consumer confidence has declined by almost 55 points over the past 12 months, which is the largest fall ever (since the series started in 1968). It shows that the consumers have been subjected to what has been dubbed the perfect storm, i.e. falling employment, rising unemployment, high energy and food prices, falling house prices, lower rates of wage increases and more reserved banks. The only encouraging element is the tax cuts, and they ceased to have effect at mid-July.
In July we saw a certain stabilisation of consumer confidence which may be due to a combination of the effect of the tax cuts and falling energy and food prices.
Consumer confidence is expected to be affected by the following factors:
the flare-up of the financial crisis has obviously not induced optimism, yet equity prices have been edging up since mid-July;
interest rates on mortgage loans, on the other hand, have risen further;
employment fell again in July, and unemployment shot up again;
petrol prices fell to well below USD 4;
The other consumer confidence indicators, ABC and the University of Michigan, have actually risen slightly.
We expect a small rise in consumer confidence in August because energy prices have fallen back and consumer confidence has already fallen substantially, i.e. most of the bad news has already been discounted.
The financial markets will also focus on consumers' assessment of the labour-market situation through their assessment of 'how difficult it is to get a new job' and 'plenty of new jobs'. The rise in unemployment in recent months is expected to make consumers more pessimistic still.
The US: new home sales - July
New home sales is an important indicator, since it traditionally bottoms out 2-4 months before the end of a recession. The sales are also important because construction firms have a large stock of newly-constructed houses for sale, and there is little prospect of a rise in house construction before those stocks have been reduced. Moreover, new home sales have already fallen by 62% since the index topped in the autumn of 2005, and it is anybody's guess whether the fall will continue. Over the past four months, new home sales have stabilised, while existing home sales have been more or less stable for the past 7-8 months. The question is whether this latest development will continue. We doubt it for the following reasons:
Home buyers may be discouraged by rising mortgage yields, and banks are very reluctant to grant loans for home purchases
The number of applications for mortgage loans is falling sharply.
Builders are still highly pessimistic about sales
The disposable income index has fallen after a period of rises
There is good news:
Pending home sales have shown some stabilisation over the past six months
On the whole, we expect a minor fall in new home sales in July.
The US: minutes of the FOMC meeting on 5 August
See 'This week's highlight'.
The euro zone: M3
M3 is still extraordinarily affected by the turbulence in the financial markets, portfolio switches, etc., and is therefore to a less extent in focus as an inflation indicator. The oil price, inflation expectations and the risk of secondround effects, on the other hand, are in focus. Continued strong growth in lending, which will be announced at the same time as M3, attracts more attention, and these data are always noticed by the ECB and commented on at its monthly press conferences together with M3. For some time, growth in household lending has been in a falling trend while corporate lending has not turned until lately. It is quite important to note whether this is a new trend and naturally the development in household lending should also be noted.
Germany: IFO
IFO has been very strong for a long period of time, but it has come back to earth again. IFO has fallen quite sharply in the past two months - and is about to reach the same level as the development in the PMIs. The current level signals that growth will slow down somewhat in coming quarters. In the latest PMIs for August, there was a major fall in Germany, indicating that IFO falls again, although falling commodity prices of food and oil prices in particular have the opposite effect.
Wednesday
The US: Durable goods orders - July
Durable goods orders are an indicator of the demand for industrial products, and the indicator is thus important as to the assessment of the future industrial production. However, new orders fluctuate heavily thanks to orders for transportation equipment, including private aircraft (from Boeing).
Generally we have seen a very moderate fall in durable goods orders and thus they have done much better than they did during the recession in 2001. Some of the improved development can, however, be attributed to higher price increases in 2008 than in 2001, since new orders are measured as sales and not only as the number of orders. Another reason may be that consumers have financial problems this time, while the corporate sector is still in good shape. In 2001 it was the other way round, thus affecting durable goods orders, since the larger part of the buyers is companies.
We assess, however, that the slowdown in the economy will also affect new orders, which is due to the following:
The ISM order index has fallen to 45, which is the lowest level since the recession in 2001. Boeing reports a small rise in new orders from June to July. Car sales, on the other hand, have fallen sharply, and this will dampen orders from this sector.
One of the sub-components is investment orders exclusive of defence and aircraft, and thus an indicator of corporate investment. These investments are interesting because they almost always fall during a recession. The surprising thing is that new orders for investment goods have increased since the beginning of 2007. We expect that new orders for investment goods will start to fall in coming months, which can be attributed to the slowdown in the economy (capacity utilisation in the manufacturing industry has declined) and also, companies' financing costs have increased in line with the banks' tightening of credit conditions and higher yields on corporate bonds.
Japan: consumer prices - July
Rising global food and energy prices have pushed Japanese consumer prices to the highest level since 1998. We expect that inflation remains high at about 2% y/y in July, since the effect of the significant fall in the oil price as from the end of July will probably not be reflected in the inflation data for this month.
In spite of the significant increase in consumer prices, by Japanese standards, there are no any indications that inflation is generally on the increase. Core inflation (exclusive of food and energy) increases by only 0.1% y/y, wage growth is again close to zero after being positive for a little while and economic growth is in the doldrums.
Japan: unemployment - July
The slowdown in economic growth has started to affect the labour market, and companies are under pressure from several fronts, including high commodity prices and lower domestic and global demand. This has caused a rise in the unemployment rate from 3.6% in mid-2007 to currently 4.1%, and the number of new jobs and the number of vacant jobs per applicant are on the decline. We expect this trend to continue.
Japan: industrial production - July
After a long period of fair increases, the industrial production weakened in the past months, and in y/y terms it is flat. This reflects that the slowdown in growth in Japan and in the global markets is becoming increasingly pronounced and coincides with a slowdown in exports. We expect that the weak development continues, which is also reflected in the forward-looking indicators such as the PMI.
Thursday
The US: GDP, Q2
GDP rose a bit less than expected in Q2, but there are indications that growth will be revised up. At first a rate of 1.9% was recorded. This is due to the fact that the deficit on the balance on goods and services has been lowered. Thus we expect growth to land above 2% in Q2. But this is the second time that these data are announced, and since we are already well into Q3, it is relatively historical data.
Norway: wage growth in the manufacturing industry - Q2
Strong growth over a long period of time and a tight labour market have resulted in significant wage increases, and with a wage growth rate of approx. 5-6%, Norway stands out compared with other countries. Wage growth is strongest in the manufacturing industry (6.5% y/y) while wages in the construction and retail sectors increased by approx. 5% y/y.
We expect that wage growth in Q2 will be high since the labour market normally turns at a later point than the rest of the economy. In spite of high inflation, growth in real wages is still significant, which has a supportive impact on consumer spending which is, however, squeezed from other fronts, e.g. high interest rates and falling house prices. Norges Bank is concerned about the strong rate of growth in wages, and it is one of the reasons why recently, interest rates have been raised repeatedly.
Friday
The US: personal income and consumption - July
These economic indicators include personal income, consumption (personal) and the personal consumption expenditure deflator exclusive of food and energy (the Fed's preferred inflation indicator). The interest in the latter has fallen in the wake of the fall in energy and food prices. On the other hand, personal consumption will attract some attention since most market participants expect that it will be personal consumption that will send the economy into recession.
Personal consumption adjusted for price increases declined in June and has generally showed falling growth lately. This is due to the adverse effects from which the consumers are hit in the form of falling employment, rising unemployment, rising prices for food and energy, falling house prices and banks which are less willing to grant loans. Although commodity prices of energy and food have fallen, it has not been passed on to the been passed on to the consumers (if petrol prices are disregarded). Thus there are still indications that the consumers will be under pressure.
The fall in retail sales of 0.1% combined with significant price increases in July indicates a new fall in personal consumption in July.
The US: Chicago PMI - August
The Chicago PMI is one of the regional sentiment indicators used to gauge sentiment in the business sector; it gives an indication of the development in ISM. But Chicago PMI shows wider fluctuations than ISM, and during some periods the fluctuations of Chicago PMI are almost unrealistic so Chicago PMI should be interpreted with care.
In July it was 50.8, which is largely on level with ISM. In addition to the total index, attention should be paid to new orders, employment and the price index.
The euro zone: consumer prices - July
Consumer prices are high and much too high for the liking of the ECB. Moreover, the high rate of inflation is deadly to growth in consumer spending since it erodes households' purchasing power. In July the annual rate of increase was unchanged compared with June at 4.0%, but in real terms it rose by almost 0.1 percentage point (0.086 percentage point to be exact). We do not expect that inflation will increase further from the current level, since commodity prices of oil and food have fallen somewhat from the very high levels.
The euro zone: unemployment - July
Unemployment seems to have bottomed out for now. However, it is still low and is assessed to be lower than the structural unemployment rate - as stated by the OECD. But the cold winters which have started to blow over Europe have started to affect the labour market. The number of unemployed has increased in the past four months and if it continues to increase it will be noticed by the ECB. For the period ahead, a weaker labour market will reduce the risk of core inflation which will fall due to rising unemployment, which will reduce the wage requirements.
Jyske Markets - FX Research http://www.jyskebank.dk/finansnyt
The analysis is based on information which Jyske Bank finds reliable, but Jyske Bank does not assume any responsibility for the correctness of the material nor for transactions made on the basis of the information or the estimates of the analysis. The estimates and recommendation of the analysis may be changed without notice.
