Posts tagged ‘economics’
It is almost four months since Donald Trump won the US presidency but the shockwaves from his victory still reverberate. Coverage of supposed scandals, protests and presidential Tweets have continued to abound. Those who were delighted by November’s result, so polling suggests, remain so; those who reverted to hysteria continue their frenzy. Amid all the drama it is perhaps an odd expression to pick, but: Amercian politics has found an equilibrium.
Assumptions about the US economy have also become entrenched. It has long been obvious that a Trump presidency would be inflationary and the bond market reacted to the result accordingly: on the day of the election the ten-year Treasury yielded 1.85%, but by the end of November had hit 2.4%. It has stayed firmly in a range of 2.3%-2.6% ever since. The dollar likewise strengthened sharply after the election and has comfortably held its range against other major currencies. Eurodollar rates moved from pricing in two Fed hikes by the end of this year to pricing in three, and have held that view right up to the present.
While American politics has become energized, however – by the ambition of the new incumbent and the vitriol of his critics – financial opinion has become complacent. While markets and observers have in many cases settled on a static view, the ground since the election has shifted. Look away from fixed income and the currency, and towards risk markets and the data and this is easily clarified.
The US stock market found a secure range after the election, but only for a time. Last month it smashed it. From meandering around the 2,250 level throughout December-January the S&P 500 broke 2,300 in early February and 2,400 less than a month later. The index has now risen by more than 6% since the beginning of the year, comfortably beating other major bourses around the world.
It is not just the stock market that is optimistic, and setting new records. Consumer confidence hit a new high this week, eclipsing the levels reached prior to the credit crunch and threatening to visit territory last occupied during the go-go boom of the later 1990s. This is of a picture with earlier data on retail sales, showing the fastest annual rate of growth (+5.6% in January) since the early stages of the recovery in 2010-11, and buoyant numbers on existing home sales, which have reached a pitch last seen before the credit crunch in 2007. (Bear in mind that mortgage costs have actually been increasing at the same time, pushed up by higher long-term interest rates.)
Industrial indicators have strengthened too. Purchasing manager activity surveys out this week for both manufacturing and service sectors continued their sharp rise. The rotary rig count released last Friday showed that US oil production has continued to recover even though the price of crude has been no better than stable since December. Again, this is consistent with earlier data such as the NFIB survey of smaller firms and the “Philly Fed” report on the national outlook for business, both of which have been rocketing up, in the latter case to a 33-year high.
If one tries very hard to find them there are more equivocal releases. Monthly variability on jobs data, for instance, has been weak in some instances; then again, the broader context is one of effectively full employment, and short-term moves from 4.6% to 4.7% in the headline jobless rate are neither here nor there.
More seriously, while vague expectations of higher inflation have been priced in since November, underlying price indicators have started to move. Import price inflation, which had been negative since mid-2014, flattened out to +0.2% in election month and has since hit +3.7% (year to January). The price components of PMI surveys have also risen. Public statements from various Fed presidents and board governors has been preparing markets for a hike this month which leaves ample scope for those three rises this year, and more.
Put all the pieces together and it seems more and more obvious that there is no longer any broad backdrop of bad economic news, whatever one’s views of American politics. The credit crunch hit housing and the banking sector – all recovered. The oil price collapse hit the shale business – recovering nicely. A strong dollar dampened activity – that effect has fallen away.
On the other hand, sentiment and output indicators are on the up. The economy is at full employment. The core rate of CPI inflation has already been running above 2% for more than a year and in January posted its fastest monthly increase since 2006.
The US economy is catching fire. This will make a novel change from the sclerotic pace of recovery we have seen there to date. The question is: are markets properly discounting the eventual need to put the fire out?
The gilt market has staged a modest rally over the past couple of weeks though this should not fool us: there remains a good deal of attention focused on the inflationary outlook. Data for January, out earlier this month, was entirely unsurprising on this front. Input prices were up by more than 20%, eclipsing the prior peak of +17.6% reached in 2011, CPI is almost back on target and RPI ex mortgage interest payments came in just shy of +3%. The ONS quite predictably singled out currency weakness and fuel costs as the main culprits.
But the weak currency is not all bad news as we were reminded with the publication of GDP figures for the UK this Wednesday. Export growth of over 4% on the final quarter of last year was celebrated by some of those on the Leave side of the Brexit vote; though there is considerable quarter-to-quarter volatility in this data it was, undeniably, positive.
In fact there was already evidence of this effect from industrial production numbers out for December a couple of weeks ago. The yearly IP increase of +4.3% was the highest posted since the country’s recovery from the Great Recession and smashed expectations. Looking beyond exports too there was good news from the personal consumption component of GDP, which hit a solid +0.7% for Q4 while the Q3 estimate was revised up to +0.9%, suggesting a Brexit bounce. Business investment – as highlighted by the Remain side – flattened off into the end of the year but the picture is unequivocally of an economy ticking along rather nicely and enjoying a boost from its currency-enhanced competitiveness.
Returning to the theme of inflation, there has been some coverage of the oncoming squeeze on real wages and that is a perfectly valid concern. However this cloud may not be quite as dark as all that. As of December both headline RPI and average earnings growth hit +2.6%, meaning that real wage growth was zero – not a supportive situation for the economy. But throughout the period from 2010-2014 real wage growth was negative, on several occasions falling below -3% (and hitting a nadir of -3.8% at one point). Over the same horizon annual growth in household consumption averaged 1% and broad GDP growth +2%. Today, RPI inflation would have to hit 5.6% plus to achieve the same depressive force on real wages. That is a risk and by coincidence exactly the peak reached in the autumn of 2011, but we are not there yet.
Some have turned to the second consecutive month of contracting retail sales as evidence of consumer weakness but again the short-term data here is incredibly volatile. The six month running mean for annual growth in retail sales was +4.9% as of January, a little less than double the average rate over the past 20 years. Might there be a sustained reversal in consumer behaviour? It’s possible – but the GfK consumer confidence survey actually rose for two consecutive months into January.
For investors, the big picture is therefore as follows. The UK economy is growing at a healthy rate, “despite Brexit”. This is in part due to the weak pound; a currency depreciation is a straightforward monetary expansion and this seems to have been forgotten. There is presently a risk that rising inflation will take some of the edge off the growth rate but on the basis of current data and recent history we ought not to be too anxious. Markets in some respects do appear complacent about the risk of more seriously damaging price behaviour – but that is another story.
“Mr Speaker, I am abolishing the Autumn Statement.”
2016 has already delivered much in the way of political upheaval. But no one was expecting this! Granted, there was much laughter as the new Chancellor told MPs that, having done away with the traditional spring Budget and Autumn Statement, he would be moving to an autumn Budget and a Spring Statement. (He had to clarify that this really was a significant change because the Spring Statement wouldn’t actually say much.)
Thus concluded the only truly dependable projection from HM Treasury. What did the rest of this, the last ever Autumn Statement, have to tell us?
Reports of the event were dominated by the forecast effects of Brexit. Of course, nobody knows what these will actually be. The Office for Budget Responsibility plumped for lower growth, higher inflation and more borrowing than before. Its guesses are worth no more than the Bank of England’s – though they were, interestingly, very different. The Bank, in its Inflation Report out earlier this month, had GDP for 2018 and 2019 coming in at +1.5% and +1.6%. The OBR thinks the answer will be +1.7% and +2.1%. Counter-intuitively the OBR is also forecasting lower CPI inflation (2.5% and 2.1% as against 2.7% and 2.5% over on Threadneedle Street). It is likely mere coincidence that higher growth and lower inflation will have combined to produce a less alarming debt forecast. In any event, the inconsistency serves to demonstrate nicely the speculative nature of all these kinds of exercise.
Regular readers will know how important the level of gilt yields is too. They have fallen since the Budget and this has delivered a projected bonanza of £24bn over the course of the next five years. That is the impact of a fall in gilt yields of all of 0.3%. (So long as they don’t go up again, the nation’s finances are safe. Well, safeish.)
The Chancellor briefly alluded to longevity and suggested that the next Parliament consider doing something about it. This is a good idea: the state pension bill is forecast to reach £101.9bn in fiscal 2020-21, up from £91.5bn this year. And that represents a compound annual increase of only 2.7%. More aggressive inflation, or a higher rate of earnings growth would push the cost higher.
We have no idea what growth and inflation will be over the next few years. Nor does the Treasury have much, if any, control over interest rates. There are, however, material numbers over which it does have some say. And in this febrile political environment, with Brexit on the horizon (or possibly not), public debt already forecast to reach 90% of GDP soon and no medium-term prospect of balancing the books, what is the expected net impact of the Chancellor’s policy decisions? Why, to widen the budget deficit by £4bn next year, £6bn in 2018-19 and £8bn the year after that! And those numbers are predicated on the basis of 43 discrete policy changes covering everything from tax reliefs available to museums to the exemptions regime for social sector rent downrating. Taxes up, borrowing up and the tax code as complex as ever. The ghost of Gordon Brown still hovers over the building whose magnificent remodelling he instigated all those years ago.
But – as many have felt, at times, this year – enough of politics. Despite the mainly Brexit-related fuss it caused the Autumn Statement contained nothing to suggest that the management of the country’s economy is to undergo change. The UK’s national debt remains problematic, and the Treasury seemingly content to be at the mercy of future events. That, from a pure investment perspective, is the key message from the last Autumn Statement in history.
Well that clinches it, surely. Today’s US data showed the unemployment rate down again to 4.9%. Payroll growth continued at a strong pace, with non-farm jobs up by 161,000 last month. Both these prints came out in line with expectations – but wage growth beat every estimate going, hitting a new post-recession high of +2.8% on the year. Purchasing manager surveys out over the last couple of months suggest that the rate of job creation will accelerate into the end of this year if anything. The American labour market is showing clear signs of warmth. Surely, a Fed hike next month is certain.
This chimes with the consensus view. Of the 66 forecasts currently made available to Bloomberg, 15 expect no change and all the rest are for a 25bp hike. The interest rate markets also expect the Fed to see out 2016 with a target rate of 0.75%, then go on to hike again around the middle of next year.
So far, so uncontentious. Indeed it is reassuring from an investor’s perspective that the market reaction to somewhat firmer expectations for interest rates has, thus far, been sanguine. Halfway through this year a December hike had yet to be priced in; by the autumn the eurodollar futures market had become unequivocal on the subject – Treasuries sold off too – but the S&P 500 still rallied, turning in its strongest quarterly performance of the year so far.
The key word there is: “somewhat”. In the US as in Britain there is now a real risk that tightening occurs more quickly than people think.
That +2.8% wage growth is part of the reason why. A connected reason is that the energy sector has recovered some of its strength this year, taking away a recent source of downward pressure on activity and employment. Then there are import prices: stable oil and a stable dollar have now closed off that source of deflation. Core CPI has already been running at its strongest sustained level this year since the Great Recession. Both the headline CPI measure and the consumption deflator used to calculate chain-weighted GDP have been catching up. Finally, unreliable indicator as it is and completely unfashionable as it has become, broad (M2) money supply growth is running at its fastest pace for nearly four years.
The question to which nobody knows the answer is: will the labour market start really overheating and, in the circumstances, contribute to an uncomfortable level of inflation? At the moment, US policymakers are split on the subject, but the Fed’s actual monetary response to date, together with the interest rate markets’ pricing, implies a near-total lack of concern.
Another wild card is our old friend political risk. At present, polling at the national level and in some of America’s “battleground states” suggests that Secretary Clinton is on course for a narrow victory. If Mr Trump were to pull off a surprise win, however, it is not just the market response but the economic consequences which could be significant. There has already been extensive coverage of the effect that the candidates’ fiscal policies might have on the national debt, but consider some of the Republican candidate’s other measures: the expulsion of migrant labour, swingeing tariffs on imports, less accommodative trade agreements (as well as big tax cuts for businesses and households). All of these would be inflationary.
It would be imprudent to expect a crisis. But the possibility of a problem is clear and what matters to us as investors is that this is not recognised – indeed, quite the reverse. Bond markets think that inflation over the next ten years will run at an average of 1.7%, below the 2.1% they have priced in on that horizon over the last 15 years. Consumer expectations for near term inflation, as measured by the University of Michigan survey, are below average too, and for long term price behaviour are at their lowest ever level.
So there could well be a surprise or two in store. And whatever its scale, this ought to have consequences for portfolio construction.
Followers of the UK’s business media will have noticed coverage of an unfamiliar subject this week. On Tuesday we discovered that the annual rate of CPI inflation had rocketed up to 1%. Last week this blog opined that it was actually input prices which would merit close attention; this did not happen so detail on those shortly. First, however, let us deal very quickly with the headline rates.
1% on the CPI is indeed “the highest rate of inflation for nearly two years”. But that is not saying terribly much for two reasons:
- Over the longer term 1% is an insignificant number. Before the recent period of energy-driven disinflation CPI hadn’t fallen as low as 1% since September 2002, when the world was still recovering from the collapse of the TMT bubble. Its average over the past 20 years has been 1.9%. Exactly five years ago it peaked at 5.2%. So it ought to be difficult to become too excited by the print on Tuesday (which was broadly in line with expectations anyway).
- The “core” CPI measure, which cuts out energy, food, alcohol and tobacco, had already hit a level of +1.5% this March. What we observed this week was the continued closure of the gap between core CPI and the headline rate. In other words, the pickup in headline inflation tells us more about the dwindling influence of cheap oil than it does about, say, the weakness of sterling.
This is not to dismiss the significance of the CPI data entirely. But if we are looking for the fingerprints of the pound we will not find them here.
And so to PPI: producer price inflation.
There has been a little more drama here. Input prices were again up by more than 7% on the prior year – not at quite as high a rate as for August but nonetheless, this measure is showing more heat now than at any other time since 2011. And this time we know sterling has something to do with it since the core measure of input price inflation, which strips out oil among other things, has also reached levels not matched in almost five years. We should expect this to be the case: with the pound down by over 20% on a trade weighted basis in the past year it is a matter of the “basic laws of economics”, as one of the better comment pieces had it this week (it always a pleasure to find that one has friends in common with people).
That piece also carried a forecast from Lord Haskins, former scion and chairman of Northern Foods, that food price inflation in particular is on track to hit about +5% in a year or so. Again, those “basic laws” do tend to repeat themselves. The last time we had a comparable fall in sterling was during the years 2007-8 when the trade weighted index shed nearly 30%. By mid-2008 that input price inflation had peaked not at +7% but at +35%. Back then the food component of the CPI hit a ceiling only at +14.5% making Lord Haskins’ prediction seem quite mild.
Of course in 2008 this didn’t last. The currency found a level and input price inflation fell away again. The domestic economy was contracting, and output would not fully recover until Q3 2013. Unemployment had already started to rise – though it would take three years to reach its peak of 8.5%. And the housing market was in a state of freefall. (It was not until mid-2014 that the average UK price would recover its 2007 high.)
Back to the present.
Should sterling hold its current level the inflationary impact on producer prices will persist, to a greater or lesser extent, into the summer of next year. And nowadays the position of the economy could hardly be more different.
GDP growth of +2.1% is precisely in line with its 20-year average rate and though such estimates are fertile grounds for analytical controversy is likely to be near or at its trend rate. Similarly unemployment of 4.9% could well be regarded as “full employment” and nationwide house price inflation is still running at over 8%.
Given that Britain’s circumstances are so very different today, what is curious is that the policy response to all this is exactly the same as it was in 2008: interest rate cuts and QE from the Bank of England, and if he can get away with it in next month’s Autumn Statement, fiscal largesse from the Chancellor (gilt yields suggest he might be able to fiddle his way to justifying it despite the lousy borrowing numbers out this morning).
Something about this is not quite right. Perhaps the Bank’s expectations that Brexit will see labour market slack and falling output will be met. But even the Bank acknowledges those Basic Laws. And in only a few months’ time, the clear signs of price inflation simmering away at the bottom of the pot could very easily have erupted into a vigorous boil.
At midnight last Thursday, the pound fell by more than 6% against the dollar. Its intraday (intranight?) low was 1.1841. Since then, cable has stabilized somewhat. It currently prices at about 1.22, up from a closing low of 1.2123 reached on Tuesday. So what does the pound’s latest “31-year low” – or even “168-year low” – signify, if anything?
First let us consider the very straightforward economic consequences, which are twofold.
On the positive side, the cost of buying British goods and services from abroad, from JCBs to tour bus tickets, falls. This is growth positive. It is also why currency devaluation is one of the most obvious and best understood forms of monetary easing.
On the negative side, the cost of buying foreign goods and services in Britain, from rice to Ritalin, increases. This is growth negative since it compresses margins for importers and makes consumers poorer. This is also why currency devaluation is a risky and unpredictable means of monetary easing.
One key question for the British economy is: which of these two effects will predominate? That depends purely on the inflationary impact. If this is relatively modest then devaluation will increase growth without hitting people’s pockets, or firms’ margins, too forcefully. If it is significant, however, then the devaluation will depress overall economic activity since domestic demand accounts for a far more substantial part of output than exports (62% versus 30% on Q2 GDP data).
It is hazardous to speculate as to which outcome Britain will face. On the one hand, supranationalist media sources are sure the export benefits will be slight and the inflationary impact severe. On the other, Brexiteering sources seem not to have considered the inflation question at all.
One thing we can do is examine the scale of the pound’s recent fall with some detached perspective.
Cable has fallen by 29% since the high of 1.7166 it reached in early July 2014. Its all-time closing low was posted on 26 February 1985 at 1.0520. However the pound has not yet broken through its December 2008 low against the euro (€1.025) or its more recent (2011) low against the yen. Looking at the Bank of England’s trade weighted index, which pits the pound against a basket of other currencies, this week’s low was barely through the previous record level reached in 2008 (73.3 versus 73.4 back then).
It is understandable that the focus of the media should be on the sterling exchange rate which has moved the most dramatically. However, again with some detachment we ought to observe that cable’s recent history has been affected by dollar strength as well as sterling weakness. The Federal Reserve’s trade weighted dollar index has risen by more than 21% since its 2014 low. Indeed, while the pound has fallen by 29% against the greenback the euro has not been far behind, dropping 21% since its own 2014 high point (from $1.39 to $1.10 today). Without wishing to overdo the point about press coverage one does not see headlines in The Economist about “votes of confidence” in the single currency.
Some sources have taken things further, with Bloomberg claiming that the pound has become an emerging market currency: “the new Mexican peso”. Now at the time of the “tequila crisis” back in 1994 the peso more than halved in value against the dollar in under three months. More recently, the Brazilian real almost halved in value as commodity markets collapsed in 2014-15. Again, a little more perspective would be nice.
This is not to downplay the risks arising from imported inflation. The UK’s next CPI and RPI prints will come out on Tuesday. PPI input prices in particular will merit close attention. Year on year they have already rocketed up from -15% to +8% in the space of 12 months. That inflation has to go somewhere: again, either into shrunken margins or consumer’s pockets (and if it persists, most likely both). Back in 2007, RPI inflation rose at around 4-5% and food prices were making tabloid headlines. Inflation also means higher pensions, higher gilt yields and higher public sector wages, all of which is bad news for Britain’s strained fiscal arithmetic.
Furthermore, Mark Carney today confirmed the Bank of England’s insouciant attitude to inflation at a “public roundtable”, saying that while he appreciated that it could cause problems he was willing to see the Bank miss its target to protect against the supposed loss of jobs into next year. (Readers of this blog will know that the MPC officially abandoned its founding mandate back in August). Markets are less complacent: expectations for a further cut in the base rate have evaporated, and the ten year gilt yield has risen to 1.1% from the record low of 0.52% it established only a couple of months ago.
Now price increases were back in the tabloids again just this week. If imported inflation does cause problems, and the Bank does nothing to stop it, then the ugly devaluation scenario may well end up playing out. Looking at the bigger picture for sterling, and not just the cable rate, we ought not perhaps to panic overmuch. But even at a princely 1.1% the gilt market is not remotely priced either for an uncomfortable patch of price behaviour or the policy normalization required to deal with it. There could be some interesting developments ahead.
At this time last year, markets were preoccupied by the bear case on China. The stock market had collapsed, the yuan was devalued and the country stood supposedly on the brink of a major banking crisis brought on by bad lending and vanishing growth. So appalling were the consequences of such a crisis that the Fed explicitly linked US monetary policy to the wild ride offered by the Shanghai Stock Exchange.
What a difference a year makes! There is the occasional susurration over the Chinese Peril discernible by those who listen intently, but panic on the subject, having waxed to hysteria last summer, has since waned to nothing.
At the same time, Chinese data has continued to be published as before. So what has it been telling us? Are we being complacent to ignore a threat which only twelve months ago was thought to imperil the world? Or was it all nonsense?
A year ago this blog took something of a sceptical stance on the Chinese Peril. On the subject of devaluation in particular we said that “exports matter to the Chinese economy, devaluation ought to help exporters, and monetary softening elsewhere ought to ease some of the pain in the property market and contribute to lending growth.”
Lo and behold, those macroeconomics textbooks turn out not to be a waste of shelf space after all. Trade figures out from China yesterday showed the pace of decline continuing to slow; both export and import numbers exceeded forecasters’ expectations. It is instructive too that the latest bout of renminbi weakness has passed without much comment: the yuan is just under 3% weaker against the dollar for the year to date, almost matching the pace of its decline last year when it made for headline news. (Just as importantly it is also 6% weaker against the euro and 21% weaker against the yen.) So far there is no sign of this translating into higher prices: CPI inflation was +1.3% on the year to August, towards the bottom of its recent range and well below the levels of 5-6% which provoked a policy response in 2010-11.
Further evidence of economic woe last year came from output indexes. It was seen as more surprising than it should have been at the time that a sharp strengthening of the currency had hurt manufacturing. Similarly, when last week’s manufacturing PMI number came out at 50.4 for August – not earth-shattering, but the highest level for two years – it not only beat expectations but fell outside the entire forecast range.
Another area of concern was the property market. Signs of weakness last year were misinterpreted as a dangerous, balance-sheet-threatening bubble collapse. Yet the market has since steadied following its correction and some cities are imposing ownership curbs in an effort to curb precisely the kind of overextension which so many observers thought they had noticed twelve months ago. As to balance sheets, figures out last month showed that the bad loan ratio for the Chinese commercial banking system actually stabilized in the second quarter at 1.75%. (That’s still a large figure in dollar terms – $215bn – but then China has fifteen times that amount in sovereign reserves.)
Looking at some other indicators, retail sales growth has remained steady at levels of +10% on the year and more throughout 2016, and July’s passenger car sales figure (+26.5% on the year) was the highest posted for three and a half years. On the industrial side of things, electricity consumption came in at +8.2% on the year to July, up from -0.2% back in December and the highest print since February 2014; headline industrial production itself seems to have bottomed out last year and has turned out at +6% and better for 2016 so far.
None of this is to say that China does not have her economic issues, like every other country. Here one might think of SOE inefficiency, frustrations to some monetary transmission mechanisms, over-reliance on particular sources of growth, grim demographics and developing world problems such as questionable building standards and the frictional effects of political corruption. But if we are to find the source of the next global catastrophe it seems we must look elsewhere. The Chinese Peril, if such a thing really exists at all, is still biding its time.