Tax about-turn in France and slight uptick of the manufacturing PMI in China

Macro Highlights - 7/12/2017

In short
  • Tax about-turn in France and slight uptick of the manufacturing PMI in China
  • Focus on the United States: Ongoing re-acceleration of US GDP growth

Key Takeaways of the week with Matthias van den Heuvel, Economist, Lisa Turk, United States economist, and François Léonet, Economist, Emerging Markets

Tax about-turn in France

  • Part of the tax relief measures were confirmed by the French government this weekend, which should boost household confidence, at a record high since June 2007

In the eurozone, purchasing managers indices (PMI) were adjusted up in their final version of June. The composite index has moved from 56.8 in May to 56.3 in June versus 55.7 in its preliminary version. Despite a slight drop, it remains firmly in the expansion zone which confirms our dynamic growth scenario in the second quarter of 2017.

There is a similar trend in France with final PMI adjusted up. The composite index settled at 56.6 in June versus 55.3 in its preliminary version, slightly down compared to May (56.9). However, as in the eurozone, the composite index remains at one of its highest levels since 2011. Furthermore, consumer and corporate confidence is up since the election of E. Macron. The European Commission's economic sentiment indicator climbed from 106.2 in April to 109.8 in June, driven by all economic sectors. The outlook for growth is therefore positive in France at a time when the new French president unveils the details of his economic policy.

During his inaugural speech to parliament, outlining his government's general policies on 4 July, French Prime Minister E. Philippe indicated that several tax cuts initially planned for 2018 would be postponed to 2019, such as the conversion of the competitiveness and employment tax credit (CICE) into a payroll-charge reduction and reform of the wealth tax (ISF) to be based solely on real-estate assets. Indeed, the audit commissioned by the government from France's independent auditor, the Cour des Comptes, had confirmed that the public deficit could reach 3.2% of GDP in 2017 and not 2.8% as projected by the Finance Act. [...]

Slight uptick of the manufacturing PMI in China

  • In China, the manufacturing PMI is slightly up after contracting in May. This is in line with the slowdown in growth, which we expect to be at 6.6% in 2017
  • Chinese mid-market industrial companies should continue to be affected by the greater attention paid to financial risk control and tougher lending conditions

In China, the purchasing managers' index for the manufacturing sector published by private company Caixin settled at 50.4 in June, back in economic expansion territory after contracting in May. It is back on track with the level reached in April but below the average of 51.3 reached in the first quarter.

The index's rebound echoes the improved outlook also recorded by the NBS official index, which changed from 51.2 in May to 51.7 in June. The level gap between the two indices – and the better performance of the official index – can be explained by the prevailing construction difference between the two. The Caixin index is mostly based on small and medium-sized companies, while the official index includes larger-sized companies, often Chinese state-owned corporations.

The latter's better performance tends to illustrate the continued support of economic activity in China by the fixed-asset investments performed by state-owned enterprises.

Smaller-sized companies are more affected by the tougher refinancing conditions, a consequence of the determination of Chinese authorities to contain financing risks by keeping credit creation at a moderate level. The newly issued informal credit, on which smaller-sized companies significantly depend, contracted sharply, dropping from CNY 177 billion in April to CNY 29 billion in May. [...]

Matthias van den Heuvel, Economist, and François Léonet, Economist, Emerging Markets



Ongoing re-acceleration of US GDP growth

  • The latest activity figures support our forecast of a moderate pick-up of GDP growth to 2.4% year on year in the second quarter

  • The increase in capital goods orders and the reactivation of nearly 100 drilling machines since late March should boost corporate investment

  • We still anticipate average GDP growth of 2.1% in 2017 and inflation above 2% in the second half of the year, which should allow the Fed to gradually raise its Fed funds rates

In the second quarter of 2017, a wave of pessimism swept across the United States. Long-term Treasury yields dropped from a high of 2.6% in mid-March to an average 2.2% in June, while inflation expectations fell temporarily below 2% and the per-barrel oil price reached USD 42.5 in mid-June. However, GDP growth in the first quarter was adjusted up, to 2.1% year on year, and the outlook for the second quarter is positive, with expected growth of 2.4% (see left-hand chart). Corporate investment is likely to remain vigorous, stimulated by oil-sector consolidation. Regarding the recent drop of inflation to 1.9% in May, we expect it to increase slightly in the second half of the year and exceed 2%. With regard to the latest activity data, we are not changing our forecast for a modest GDP growth, averaging 2.1% in 2017.

Corporate investment should remain dynamic

Despite the sharp decline in oil prices in June, the number of drilling rigs in use increased by 126% compared to the previous year. Since the start of the second quarter, 96 rigs have been reactivated, versus 133 in the first quarter. This slight fall in rig count can be explained by the drop in oil price, from USD 51.7 per barrel in the first quarter of 2017 to an average of USD 48.3 per barrel in June. Although less numerous, the newly reactivated rigs should stimulate investment in structures, machines and equipment and, as at the start of the year, contribute to US GDP growth in the second quarter, albeit more modestly than anticipated.

Furthermore, if oil persistently remains below USD 50 per barrel – the average breakeven price for shale oil production in the United States – some companies could decide not to reactivate their drilling rigs, or even decommission them entirely. Such a scenario could limit corporate investment in the coming quarters. Note, however, that the profitability threshold varies strongly by company and by region. It could be less than USD 30 for some oil companies that have managed to bring down their operating costs, but as high as USD 70 for others. [...]

Lisa Turk, United States Economist