Economic Entrails in the Week Ahead

The exaggeration of the significance of a few data points led many observers to posit a synchronized global economic rebound.  Disappointing data from China, Japan, and Australia last week suggested that the Asia Pacific region is not experiencing it. 

Japan's export prowess is a thing of the past.  Net exports were a drag on Q3 GDP. The October trade balance is likely to show that there has been little improvement.  Japan has recorded an average monthly trade deficit of about JPY157 bln.  In the first nine months last year, the average monthly surplus nearly JPY3 bln.  In the first nine months of 2017, the average monthly surplus was almost JPY241 bln.  In September exports were off 5.2% year-over-year, and imports had fallen by 1.5%.  

Japan will also report October CPI and flash November PMI on November 21.  Japan's CPI is expected to have stabilized after the headline fell to 0.2% year-over-year in September.  The core measure, which excludes fresh food, fell to 0.3%.  The Q3 GDP deflator (0.6% vs. 0.4% in Q2) suggests Japan that deflation is less a threat than the CPI may have suggested.  The flash PMI may be more important, though it has only recently been tracked.  A revision in October services PMI to 49.8 from 49.1 spurred the upward revision to the composite reading to 50.3 from 49.7.  Between the sales tax increase and the typhoon, and given the lack of any meaningful momentum for from Q3, the risk is that the Japanese economy contracted as the fourth quarter got underway.  

South Korea's trade figures for the first 20-day of November will also shed light on the economic entrails of the region.  Recall the recent trend.  Exports were under pressure all year and in August were off 13.6% year-over-year.  In September, they fell dramatically and were down 21.8% before stabilizing in October when exports were still 19.5% lower from a year ago.  In the first 10-days of November, the preliminary figures suggested they had fallen almost 21% year-over-year.  Computers, chips, and autos sectors appear to be at the heart of it.  

The People's Bank of China raised the significance of the one-year Loan Prime Rate.  It is set on the 20th of every month.  Since it was introduced a few months ago, it has been cut by a measly five basis points to 4.20%.  Yes, we add the PBOC to the list of other central banks that eased policy recently, like the Federal Reserve and the European Central Bank, but not really.  The latest string of data and the slowing of lending, which in China's debt-financed growth is critical, warns that economic growth is slowing. 

It is easy to talk about a sub-6% pace in Q4, but we should not pretend that the figures are precise or particularly accurate.  In testimony to the Joint Economic Committee of Congress last week, Federal Reserve Chairman Powell cited China's stable GDP readings as evidence of its management.  The takeaway is that the Chinese economy is slowing, and more stimulus is likely to be delivered.  One form of this stimulus is lower interest rates, and there is an opportunity to deliver toward the end of next week.  

The recovery narrative is the weakest in Asia and maybe the strongest in Europe.  First, the EMU reported an unexpected rise in September industrial output (0.1% vs., forecasts for a 0.2% decline).  Then Germany surprised with a meager 0.1% expansion in Q3 when nearly everyone had anticipated the second consecutive quarterly contraction.  Q2 growth was revised down, which means that although Germany avoided the simplistic definition of a recession, it still contracted over a six month period. 

Nevertheless, the idea is that with low rates, robust lending figures, a weak currency, and other adjustments, the euro area may be passed its low point.  What would help lend credence to this view is a gain in the flash composite PMI for November.  It would be the second rise in a row, though, in fairness, it is more like stabilizing after taking a step down in September to 50.1 from 51.9 in August.  It edged higher to 50.6 in October.  

Some economists are concerned that the weakness in the manufacturing sector is bleeding into services.  Ideally, the PMI will show that both sectors improved, almost as if the residual strength of the domestic economy (services) was helping underpin the manufacturing.  

The eurozone will also report new auto registrations for October, which is a proxy for auto sales.  They have not been doing particularly well this year.  Through September, they have posted an average monthly decline of 0.1% (year-over-year).  However, some improvement has been seen of late. New auto registrations rose an average of 2.5% year-over-year in Q3.  They finished Q3 with a surge. Still, the early readings for October suggest they have held up well, and an increase of around 7% looks reasonable, based on the preliminary data from Germany, Netherlands, and Austria.  

Risks still remain for Europe.  Whatever stability, there is seems fragile.  Global challenges abound in the form of the continued slowdown in China, trade tensions, and Brexit.  Within Europe, the German and the French relationship is strained just at the moment in time when it would be best if Europe could talk with one strong voice.  

There are differences over are another step toward banking union proposed in broad strokes by the Social Democrat German Finance Minister, apparently without giving advance notice to Paris.  There is also disagreement on expanding the EU (e.g., Northern Macedonia and Albania).  President Macron's recent denunciation of NATO did not play well in Berlin, according to reports.   Lastly, some risk to the German coalition if the leadership changes among the Social Democrats.  

The US economy is slowing.  The four-quarter moving average of GDP is at its lowest level since Q4 2016.  Yet, that puts it at 2.0%, which is slightly more than the median Fed forecast sees as the long-run pace.  The Fed says the economy is in "a good place."  This signals policy is on hold until a material change occurs, which puts the Fed in a reactive mode. 

The US economy appears to have slowed dramatically at the start of Q4.  Our previous back-of-the-envelope projection of 1% growth was dismissed as too pessimistic, but it might be too optimistic. After last week's retail sales, industrial output, and inventories data, the Atlanta Fed's GDPNow was tracking 0.3% growth, and the NY Fed's model showed 0.4%.  Bank economists are somewhat more optimistic, but many also cut their forecasts.  Our argument that the Fed cuts rates before the election next year is not predicated on the US economy necessarily contracting.  We suspect continued slowing is sufficient, provided inflation remains subdued.  

"What are the things that would cause a material change?" one asks.  Powell identified risks, and these were all downside risks.   This warns that the FOMC minutes from last month's meeting (November 20) might not be hawkish, as many observers seemed to think following the meeting. If, and when the Fed has to move rates again, the downside is a better guess than the upside.

One emanated from abroad, slowing global growth.  The other two (trade and the risk that inflation expectations are no longer anchored) are largely domestically-driven.  The day before Powell testified, President Trump had threatened to increase the tariffs on China if a deal was not struck.  A few days after the next FOMC meeting (December 11), the next round of US tariffs are due to be implemented.  That seems to be the timeframe for current talks now that the APEC meeting in Santiago has to be canceled due to social unrest.  

As the talks have continued and the US still has not granted product-specific licenses for sales to Huawei, China has gradually been announcing a wide range of measures that grow out of self-interest but have been sought by the US.  It has renewed purchases of US soy and lifted its ban on American poultry and pork.  It ended the quota system for foreign investment and opened some sectors, including financial services.   

Meanwhile, the US has slapped tariffs on ceramic tile imports from China on dumping grounds, and the US Congress is trying to fast-track legislation that requires an annual certification of Hong Kong's autonomy to extend special trade status.  Hong Kong is not subject to the tariffs that have been levied against the mainland.   China's President Xi has escalated the official rhetoric and calling for "stopping violence" and "restoring order." The use of force by China risk the trade deal with the US and incite the more independent-minded voters in Taiwan who go to the polls in a couple of months.   This risk is particularly difficult to quantify, though Hong Kong's markets (equity and money markets) reflected the rising stress and anxiety.  

The US reports October housing starts and existing home sales in the week ahead.  The month-to-month changes can swing sharply, but both have been stable on a quarterly basis.  Housing starts rose by an average of 1.1% in Q3 after an average increase of 1.0% in Q2.   And despite the fluctuations, the 12-month moving average (1.233 mln) remains near the peak from September 2018 near 1.267 mln.  Building permits remain strong.  Existing home sales rose by an average of 0.5% in Q3 and Q2.  

The housing market appears to remain healthy, but the concern lies elsewhere.  Leading Economic Indicators are due on November 21.  There is a risk that it fell for the third consecutive month in October.  This is important because the Conference Board that calculates it (from already published reports) because it is thought to identify a recession 88% of the time. Admittedly, it is a bit old-school. 

The flash November Markit PMI will be reported at the end of next week.  After falling sharply in August to 50.7 from 52.6, the composite PMI has been stuck in the trough and was at 50.9 in October.  A small gain would not change this observation. Moreover, we suspect the risk is of a weaker report.  First, the November Empire State manufacturing survey, reported before the weekend was not only weaker than expected, but it showed a further decline from October. Second, the recent economic data has been weaker than economists forecast, and this is reflected in the popular data-surprise indices.  

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