Posts tagged ‘economics’

UK Snapshot

Today is all about the election: uncertainty, Brexit, uncertainty over Brexit, the pound, the effect of uncertainty on the pound, the effect of an uncertain Brexit on the pound, etc. ad infinitum. As we have had occasion to observe before, speculation on unknowable outcomes is pure idleness. One might as well invest on the basis of the weather.

So while others preoccupy themselves with whimsical guesses about the impact of the country’s eye-popping day out at the polls, this blog will follow up its recent drains-up summary of the global banking system with a brief, brass-tacks tour of the UK’s current and prospective economic landscape.

Economists traditionally divide indicators into one of three categories: leading, lagging, and coincident. We will take a look at all of these in chronological order to serve both logic and completeness.

The classic lagging indicators are inflation and unemployment as they represent embedded economic trends, among other things.

Readers will know that price increases have been accelerating in Britain for some time, driven by sterling weakness and commodity strength. The rate of RPI inflation has more than doubled over the last 12 months from +1.6% to +3.5%, while CPI has recovered from near zero (+0.5%) to +2.7%. This might represent a normalization of price behaviour following an unusual depression, and / or turn out to be a relatively transient phenomenon. Although we know it is consistent with a sustained upward trend in economic activity, then, it is not possible to read this from the various inflation prints alone.

The labour market is a different kettle of fish. The longstanding claimant count measure of the unemployment rate hit a more than 40-year low of just over 2% last year and has bobbled around there ever since. The more highly-favoured, internationally comparable ILO survey measure has pointed towards a steadier recent strengthening, reaching a 40-year low of 4.6% in the March release down from 5.1% a year earlier. Both measures are indicators of rude economic health and suggest that the economy is now at or around full employment.

Coincident indicators occupy a broad universe: there is a lot of data on what people have been doing just now, from consumer purchases to business activity to construction. To cover all these bases we can look at retail sales, purchasing manager surveys and broad growth in GDP.

Retail sales came under a lot of scrunity earlier this year as evidence that consumer activity was being squeezed by higher prices. Monthly figures for this series are volatile but the annual increase for the year to April came in unexpectedly high at +4.5%, bang in line with the 12-month rolling average both currently and for the pre-referendum peaks of 2015. Consumer activity, by this measure, is currently strong.

The composite PMI measure provides a snapshot of business conditions across all sectors (manufacturing, services and construction). A reading of >50 indicates expansion; of <50, shrinkage. The May print came in at 54.4, a healthy but not overly exuberant result consistent with the pace of activity observed in both of the two prior quarters.

The second estimate of broad GDP growth for Q1 came in for much attention when it was released a couple of weeks ago. Revised down all the way from +0.3% on the quarter to +0.2%, and thus equalling the level attained back in the ancient past of Q1 2016 it was taken as evidence that Brexit fears were beginning to bite. Export growth in particular came in for some scrutiny as it seemed that net trade was failing to profit from cheap sterling. Fortunately, scrutiny of ONS methodology revealed that the export fall was largely an accounting offset against increased fixed capital formation pertaining to “non-monetary gold” [further detail available on request]. Look through the noise and the top line measure of real GDP growth over the year to Q1 reached +2.0%, 0.4% more than the rate for Q1 2016.

Finally, if we are to look to the future it is the leading indicators which are of most interest. The principal leading data are confidence surveys, so we will cover the main bases and take in the GfK consumer survey, the Lloyds UK Business Barometer and the EC Economic Sentiment indicator for the UK overall.

Consumer confidence has remained steady this year at between -5 and -7, a little higher than its long run (20 and 30 year) averages. The May figure actually ticked back up to the top of this very narrow range. This stacks up pretty favourably against the low of -12 hit in the aftermath of the referendum, the -29 seen five years ago and the low of -39 plumbed in the depths of the Great Recession.

The Lloyds series is a very volatile beast indeed so I have looked only at the rolling 6-month average. This has recovered all the ground it lost in the second half of last year, though remains lower than the peaks attained in 2014-15 (+37 as against +50 to +55).

Finally, the EC’s measure has shown a steady recovery from a referendum-driven dip last year to a range of 108-111, consistent with the highest ranges reached in the 2000s.

There, then, is a broad, conventional snapshot of the UK economy as it stands today, regardless of panic (or elation?) at the various politically-led uncertainties we now undoubtedly face. Readers will be able to make their own judgements as to our economic health, sickness, or for that matter, equilibrium as these data continue to evolve.

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09/06/2017 at 5:25 pm

A Long Time In Politics

This morning’s most widely-read headline on Bloomberg was “Pound Falls on Tighter Polls as Traders Wake Up to Election Risk”. As the article puts it:

Sterling fell against all of its 16 major peers on Friday after a poll showed the Conservative Party’s lead over the main opposition Labour Party has narrowed to five percentage points with two weeks to go until the June 8 election. That comes after weeks of surveys showing a bigger Tory lead had made the vote all but a foregone conclusion for the market . . .

If the swing to Labour were uniform across the country, May would lose seats in the House of Commons, with the Tory majority falling to two from 17, the Times said.

As Harold Wilson is supposed to have said, a week truly is a long time in politics.

When Theresa May announced the election at the end of last month her lead in the polls was so towering that the contest looked cruelly unfair to her opponents. One April survey put her party on 50% against only 25% for Labour. Predictions were being made of electoral wipeout for the latter and a landslide victory for Mrs May on a similar scale to that achieved by Tony Blair in 1997.

And then the Conservative manifesto was launched.

This contained a novel commitment to strip those of the nation’s elderly unfortunate enough to suffer dementia of their family homes after death. At the same time the existing commitment to preserve the real value of the state pension was dropped. The coup de grace was delivered a few days later, when May – slogan, “strong and stable” – U-turned abruptly on the Dementia Tax proposal by suggesting that the raid on the estates of the mentally ill would be subject to an unspecified cap. Now branded “weak and wobbly”, and having stamped all over some of her party’s core vote, Mrs May’s victory is no longer in the bag. Indeed, with a 25-point lead reduced to a slender 5-point advantage in less than a month it is arguable whether she could have done a better job of throwing the contest on purpose.

To investors today, then, falls what had seemed like a redundant exercise: we need to assess the possible consequences of a Conservative defeat.

Those traders mentioned by Bloomberg have identified sterling weakness as a product of this, either at the hands of a Labour-led coalition or a hung parliament. But the fall so far has actually been rather muted: yes, the pound is a cent and a bit weaker against the dollar but it is still well above its January low. It has fallen by less than a cent against the euro. So far, it has stabilized above its morning bottom against both currencies.

Staying with sterling, uncertainty can cut both ways. Our 8 June vote was billed as the Brexit Election. The Labour manifesto commits to remaining in the single market and customs union (i.e. no economic, nor much political change from the status quo) and ditching the “Great Repeal” of EU law. It also rejects a “no deal” / WTO rules exit and commits to a parliamentary vote on the final offer from Brussels. And the Lib Dems are calling for a second referendum. So a Tory defeat could well see the end of Brexit altogether, or at least its indefinite postponement. Would this not be taken as positive for the pound?

A Labour triumph, now no longer unthinkable, would have consequences far beyond the currency of course. The party commits itself to £250bn worth of spending on railways, energy projects and data networks. It also commits to £250bn of lending to “small businesses, co-operatives and innovative projects” via a National Investment Bank. That is comfortably more than the level of current annual lending to SMEs by the entire British banking system, and not far off the total group balance sheet value of customer lending at RBS (£352bn in 2016). Might there not be some consequences for bank profitability here?

Similar points could be made about plans for price caps on energy bills, or railway nationalization. And then there is the broader point about the national debt, and interest costs. The latter are already troubling and for 2016-17 were set to bust through the £50bn mark, only a little less than the entire education budget – and that’s with gilt yields of around 1%. Adding to the nation’s debt burden by more than a quarter would push it past 110% of GDP and see interest costs rise still further. Again, this might well have consequences for the pound, the gilt market, stocks . . .

Despite the headlines, then, it is safe to say that a Conservative defeat is not being much priced in at all. It is true that it would still be a surprise, and that there are almost two weeks of the campaign left to run. But it is now a real possibility.

This election is turning out to be much more exciting, and potentially more consequential, than anyone could have expected.

26/05/2017 at 5:37 pm

Fire!

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?

03/03/2017 at 5:24 pm

Every Cloud . . .

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.

24/02/2017 at 5:32 pm

End Of An Era

“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.

25/11/2016 at 5:10 pm

Taking A Hike

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.

04/11/2016 at 4:32 pm

Simmering Gently

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:

  1. 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).
  2. 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.

21/10/2016 at 5:01 pm

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