Solid momentum in the US, postponement of discussions regarding a Eurozone budget and drop in Chinese manufacturing PMIs

Macro Highlights - 7/10/2018

In short
  • In the US, strong economic data in the second quarter confirmed our scenario according to which GDP growth should continue to accelerate, despite a slowdown in household consumption
  • The European summit favoured the adoption of a coordinated response to the migrant, security and trade issues. However, the adoption of a eurozone budget was postponed to December 2018
  • In China, manufacturing PMIs were down slightly but continue to indicate expansion despite the China-US trade tensions

Growth momentum remains strong in the US according to the latest published figures

While trade tensions are intensifying and are creating uncertainty, US economic statistics and confidence surveys remained positive in Q2 2018. The labour market continues to improve, industrial production continues to grow at a solid pace, and purchasing manager surveys still indicate economic expansion. These positive factors should more than offset the slowdown in household consumption. The rise in inflation in April and May 2018, linked to energy prices, did indeed weigh on the purchasi ng power of US households. Despite this, we still anticipate an acceleration in GDP growth in Q2 2018 to 3.2% year-on-year.

The June employment report was encouraging, despite the slight rise in the unemployment rate to 4.0%. 213,000 jobs were created and the participation rate increased by 0.2 percentage point (pp) to 62.9%. Public-sector employment as a percentage of the workforce continued to follow the downward trend it had started in 2010, falling to 13.8% in June vs.13.9% in 2017 and 14.6% in 2010. However, private-sector employment largely offset this drop, reaching 78.1% of the workforce in June vs. 77.5% in 2017 and 70.1% in 2016.

While the labour market is improving, wage growth nevertheless remains moderate. Despite the high number of jobs created in June, year-on-year growth in nominal wages was stable at 2.7%, in line with its average in H1 2018, after 2.5% in 2017. In May, growth in real wages, i.e. adjusted for inflation, fell to 0% year-on-year. Household consumer spending thus slowed to 2.3% in May over one year, after 2.6% in April and in Q1 2018.

  • The weakness of wage trends is notably explained by the still-high number of available resources on the labour market: the participation rate of the 25-54 age bracket remains low at 81.8% in June compared to the pre-crisis level (84.3% at the start of 2000) and the number of involuntary part-time workers is still high (2.9% of the workforce vs. 2.4% in 2000). The return to the labour market of these available workers over the upcoming months could thus continue to limit the rise in wages in 2018 as well as core inflationary pressure.

However, beyond the slowdown in consumer spending, economic data and lead indicators in the US are positive.

  • The purchasing manager surveys carried out by the Institute for Supply Management (ISM) continue to indicate a positive outlook. In June the ISM manufacturing index was up at 60.2 from 58.7 in May. While this rise was above all due to the increase in delivery times, which may have resulted from additional demand in anticipation of trade tariffs, the “production” and “new orders” sub-components of the index also remained solid in June, at 62.3 and 63.5, respectively, still indicating economic expansion. The non-manufacturing index also rose by 0.5 points to 59.1 in June. The rises in the indices for new orders and business activity were the main contributors to this increase.
  • Industrial production continued on its good trend, with average annual growth of 3.5% in April and May 2018, after 3.4% in Q1 2018 and 1.6% in 2017. While the mining sector was one of the main drivers of this acceleration (average annual growth of 10.9% since January 2018), the manufacturing sector also saw its growth accelerate to 2% year-on-year since the start of 2018, after 1.5% in 2017.
  • New orders for manufactured goods continued to rise in April and May, with year-on-year growth of 8.5% on average (vs. 5.7% on average in 2017). This rise was due more to the increase in orders of durable and non-durable goods than to capital goods orders, which slowed slightly over this same period (annual growth of 6.6% in April and May, vs. 6.7% on average in 2017).
  • New construction spending rose 4.7% on average in April and May after 3.9% in Q1, thanks above all to a pick -up in public spending on construction, by 6.5% in April and May following a 3.2% decline in 2017. Moreover, new home sales were up while existing home sales continued to slow due to a low stock. Building permits thus increased by 8.1% in May year-on-year, after average growth of 4.8% in Q1.
  • The trade deficit showed an improvement, according to the data published by the Census Bureau in April and May, to - 46.1 billion dollars and -43.1 billion dollars, respectively, after a monthly average of -51.9 billion dollars in Q1. This was due to a slight drop in imports and a rise in exports. Nevertheless, the surveys point to a slowdown in exports in the near future, which could be linked to the appreciation of the dollar since mid-April (up 5.2% in terms of nominal effective exchange rates since 19 April).

Implications:

  • The most recent economic data underpins our scenario according to which GDP growth could show an acceleration to 3.2% year-on-year in the second quarter and, more generally, to 3% in 2018.
  • Given the resources still available on the labour market, we do not anticipate a strong acceleration in wages this year, which should limit core inflationary pressure.
  • Given this environment, the Federal Reserve should continue its monetary tightening at a gradual pace. It is thus still likely to raise its key fed funds rate twice in 2018 according to our estimates.

The Franco-German proposals will be discussed in December 2018

In our Weekly of 25 June 2018, we highlighted the good intentions for cooperation between Angela Merkel and Emmanuel Macron ahead of the European summit on 28 and 29 June. However, the agreements to strengthen the economic and monetary union were put on the back burner during discussions.

The European Council meeting of the 28 June 2018 thus formalised the European Union’s position on four major issues:

  • In terms of the policy on migration, the Council decided on the set-up of control centres and a transfer of 500 million euros from the European Development Fund (EDF) to the EU-Africa Infrastructure Trust Fund (EU-AITF) and called on the States to increase their contribution to this fund.
  • In terms of security and defence, the necessity to develop defence capacities justified a call to increase these investments.
  • In terms of employment, growth and competitiveness, the Council underlined the importance of (1) the fight against tax optimisation, evasion and  fraud, (2) strengthening  the  multilateral system, the role of the WTO and calling  for a systematic response of the EU to all protectionist measures, including with regard to the Common Agricultural Policy (CAP).
  • Concerning Brexit, the Council welcomed the progress made on  the legal text of the withdrawal agreement, but highlighted the lack of an agreement for Ireland and Northern Ireland, despite the commitments made by the UK at the previous European summits.

Thus, only three decisions were taken on 29 June 2018 during the eurozone's summit:

  • To adopt the European Stability Mechanism (ESM) as a common safety net for the Single Resolution Fund (SRF). The latter aims to offer financing solutions for the banks concerned (primarily in the eurozone) via a single resolution plan in the event of risk of failure – a cost that used to be assumed by public structures. This fund should reach 55 to 60 billion euros in 2026 and could be used once the shareholders, creditors and certain depositors have assumed the resolution costs for up to 8% of the balance sheet.
  • To start working on the roadmap for setting up a European deposit insurance scheme (EDIS).
  • To discuss in December 2018: strengthening the banking union, the European supervisory mechanism and the Franco- German proposals (to set up a eurozone budget and reinforce the capital markets union).

Implications:

  • The implementation of a eurozone budget for the 2021-2027 period, strengthening the European Stability Mechanism (ESM) and the banking and capital markets unions will be discussed on 13 and 14 December 2018, confirming very gradual discussions before the adoption of these measures, probably after the next European elections in May 2019.

In China, manufacturing PMIs continue to indicate expansion despite the China-US trade tension

In China, the official manufacturing PMIs  (NBS) and the Caixin PMI posted a moderate decline in June. Conversely, they remain slightly above the 50-point threshold, which indicates economic expansion. While the Caixin manufacturing indicator lost just 0.1 points in June compared to the month before to reach 51.0 points, the official indicator lost more ground (-0.4 points) and settled at 51.5. Nevertheless, despite the drop, figures highlight the stable nature of these indicators over the past few months compared to the past. This stability is confirmed by the trend of its sub-components. Moreover, the purchasing managers who participated in the surveys carried out by Caixin only rarely mentioned the China-US trade tensions as the main reason for the third consecutive drop in the new export orders component.

In the current context of trade tension, the Chinese central bank – the People’s Bank of China, or PBoC – announced on 24 June a further decrease in its required reserve ratio after the one recorded on 17 April. It thus expects a cash injection of 700 billion yuan into the banking sector. This monetary stimulus could rekindle fears about the sustainability of the debt of Chinese non-financial corporations, which reached 160% of GDP in Q4 2017. The slowdown in the Chinese economy that we expect, combined with a rise in credit volumes, would increase the debt-to-GDP ratio and could thus increase the risk of default by companies, notably for those that are the least productive (State companies for example) and the most vulnerable to the drop in exports resulting from higher trade tariffs.