Over the last few months, US data suggests that inflationary pressures have been building up. May CPI rose to +2.1% Y/Y, with the core rate at 2.0%. However, the FED does not believe that inflation will pose a problem. Whilst being more upbeat on the economy, it forecast that core PCE (its preferred inflation measure) would be at a maximum of 2.0% through 2016. Mrs Yellen was particularly dovish, even though the FED’s forecasts suggest that interest rates will start rising early next year and will do so at a faster pace than currently anticipated by the markets. I suspect that inflationary pressures are greater than that estimated by the FED, though with the FED remaining dovish, as are most of the major central banks, markets should continue to drift higher from present record levels. The liquidity being provided by Central Banks should also be positive for emerging markets. However, the risks posed by the deteriorating situation in Iraq are material, though are being ignored by markets at present. There is a serious possibility that Iraq could fragment, together with a threat to its oil production. Brent has risen to around US$115.
Mrs Yellen was more dovish than the markets expected, which resulted in a weaker US$ and lower bond yields. US Q1 GDP is likely to be revised even lower than the -1.0% reported previously, which could put some pressure on the US$. However, I believe that growth in Q2 will rebound sharply (2.75% to 3.0%) and that the US$ will strengthen, in particular against the Euro, in coming months. In addition, subject to geopolitical risks, I believe that US bond yields will rise, with the 10 year nearer 3.0% by the year end, up from 2.61% at present.
US
Mrs Yellen remained particularly dovish last week. Whilst acknowledging that labour markets were improving, she repeated that there was significant under-utilisation, though reduced the forecast unemployment rate. As expected, the tapering programme continued with a further reduction of US$10bn. The 2014 growth forecast was cut sharply to 2.1% to 2.3%, down from 2.8% to 3.0% previously. The 2015 and 2016 forecasts were left unchanged. Core PCE for 2014 was nudged slightly higher to 1.5% to 1.6%, up from 1.4% to 1.6% previously, with highs for 2015 and 2016 at 2.0%. US markets closed at record highs following Mrs Yellen’s comments.
US industrial production rose by +0.6% in May, with April’s data revised higher to a decline of just -0.1%, from the decline of -0.4% announced previously. Capacity utilisation rose to 79.1%, roughly in line with the average since the 80’s. That would suggest that US businesses either spend more on capex, or prices will rise as spare capacity declines.
After a weak start to the year, the June homebuilders survey rose to 49, up from 45 in May. Importantly, both the current sales component, together with the expectations component rose above the 50 level and into positive territory.
US May housing starts came in at an annualised pace of 1.0mn, down -6.5% from 1.07 mn in April and lower than the 1.03mn expected. Building permits declined to 0.991mn, down -6.4% from 1.059mn in April and below the forecast of 1.05mn.
US May CPI came in at +0.4% M/M, (+2.1% Y/Y), higher than the rise of +0.2% expected and the fastest rise since February 2013. Core CPI was +0.3% higher (+2.0% Y/Y), above the rise of +0.2% expected and the largest rise in almost 3 years.
Weekly initial jobless claims came in at 312k, down from a revised 318k and marginally better than the decline to 313k expected. The 4 week moving average was 311.75k, down from 315.5k previously.
The Philly Fed index rose to 17.8 in June, up from 15.4 in May. Importantly, the new orders and the employment components rose to 16.8 and 11.9, up from 10.5 and 7.8 respectively.
The IMF has reduced its forecast for US 2014 GDP to +2.0%, down from +2.8% previously, mainly due to the weak Q1, though kept its 2015 forecast unchanged at +3.0%. However, they added that growth going forward should average around +2.0%, as the population ages and productivity growth slows.
Europe
The Bundesbank has forecast that German Q3 GDP will be higher than that achieved in Q2, but that growth in H2 will be less than that achieved in H1.
The head of the Bundesbank has rejected call by France and Italy to implement measures to devalue the Euro.
German prospective investor confidence (the ZEW index) declined for the 6th consecutive month. The expectations index declined to 29.8 in June, down from 33.1 in May and well below the rise to 35.0 expected. The current conditions component came in higher at 67.7, as opposed to 62.1 previously.
EZ final May CPI was unchanged at +0.5% Y/Y.
UK inflation (CPI) rose by +1.5% in May Y/Y, the lowest since October 2009 and below both the +1.8% in April and the forecast of +1.7%.
Factory input costs declined by -0.9% in May M/M and by -5.0% Y/Y. Output prices declined by -0.1% M/M (+0.5% Y/Y) , as opposed to the rise of +0.1% previously.
The BoE minutes state that the UK economy is likely to maintain its current rate of growth and that the slack in the system would be absorbed more quickly than previously expected. Whilst no member voted for a rate increase, they stated that the decision was more balanced and hinted that interest rates may rise sooner than markets expected, possibly as early as Q4 this year. The BoE is the only one of the major central banks which is talking about raising rates, which has and should continue to be been positive for Sterling
Japan
The BoJ governor Mr Kuroda has warned that the country needs to implement structural and economic reforms or risk squandering the impact of the monetary easing policy introduced by the BoJ. However, there are few signs that the Japanese PM will introduce meaningful structural and economic reforms, the so called 3rd arrow.
Japanese exports declined by -2.7% in May, worse than the decline of -1.3% expected and much worse than the increase of +5.1% in April. It was the 1st decline in 15 months. Exports to the US and Asia declined. However, imports declined by -3.6%, resulting in the trade deficit narrowing to Yen 909bn. The decline of exports is a blow to the BoJ and the government who had hoped that rising exports would compensate for weaker domestic demand, following the sales tax hike.
China
S&P reports that China has superseded the US as the largest issuer of debt. Outstanding corporate debt amounted to $14.2tr as at 31st December 2013, as opposed to US$13.1tr for US companies and is expected to increase to 1/3rd of outstanding debt globally by 2018. They add that up to 1/3rd of the debt is provided by the shadow banking sector. There is mounting concern about the ability of Chinese borrowers to meet their debt obligations.
Foreign investment into China is declining. FDI declined by -6.7% in May Y/Y, the most since January 2013 and well below the rise of +3.2% expected.
Residential property prices declined in 35 of the 70 cities tracked by the government in May, the most in over 2 years. Average home prices fell by -0.2% M/M, though were up +5.6% Y/Y. Further declines in property prices are expected and a continued downturn poses a material risk to the Chinese economy
Other
Iron ore prices declined below US$90 per metric ton during the week. The decline reflects reduced demand from China, as the economy slows.
Kiron Sarkar
21st June 2014
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