Kiron Sarkar’s Weekly Report 28th June 2014

The Japanese PM announced details of his plans to stimulate economic growth. Whilst highlighting the key issues which need to be addressed, his proposals were sketchy, with a lack of concrete measures and unlikely to result in stronger growth anytime soon.

Chinese June PMI was better than expected, reflecting mainly, I believe, the increase in spending by the government. However, with spending brought forward into H1, the question remains as to what happens in the 2nd half of the year. The government is hoping that the economy will pick up, though I suspect that it will have to increase its stimulus programme.

In a reversal from previous comments, Mr Carney, the governor of the Bank of England (BOE), tried to dampen down the prospect of an early rise in interest rates, stating that there was still slack in the system, as wage increases were lower than expected. However, real wages are expected to increase and I suspect that UK interest rates will have to be raised sooner than the BoE would prefer, most likely in Q1 2015, though late this year is a possibility if the economic data remains strong. Sterling dipped following Mr Carney’s comments, though I believe will remain firm in coming months, in particular against the Euro.

There is a possibility that the EU will increase sanctions against Russia next week. Germany seems to be pressing to impose sanctions on Russia unless it implements a peace plan by Monday 30th June. Italy is opposed to additional sanctions. With the continued problems in Iraq, geopolitical risks are increasing. These risks are impacting Europe  more so than the US.

US housing data continues to improve, following the slow, though weather affected, earlier months this year. Consumer confidence is also improving, as unemployment declines. I continue to believe that the US economy will recover strongly from the particularly weak Q1 GDP reading and that the US$ will strengthen, in particular against the Euro. In addition, I suspect that inflationary pressures are being underestimated and that the FED will have to raise rates earlier than currently anticipated by markets. Admittedly, consumer spending is not as robust as anticipated, though should pick up during the year. US bond yields closed lower on the week, with the 10 year at 2.53%. The much weaker revised Q1 GDP data, together with weaker than expected personal spending and increased geopolitical risks contributed to the decline in bond yields.

US Q1 GDP Q/Q was revised much lower to -2.9% on an annualised basis, down from the -1.0% previously reported (which itself was revised lower from the +0.1% initially reported) and well below the expected decline of -1.8%. It was the worst decline in 5 years and the largest downward revision since records began. Lower health care spending was a major reason for the downward revision, though weaker exports also contributed to the decline. Consumer purchases rose by an annualised rate of just +1.0%, much slower than the previous estimate of +3.1%. However, the economy is expected to rebound sharply in Q2 with growth of around +3.0%.

Existing home sales rose by +4.9% in May to an annualised rate of 4.89 mn, better than the annualised rate of 4.65 mn in April and the forecast of 4.73 mn homes. Housing data is improving from a slow start this year.
New home sales rose by a massive +18.6% in May M/M to an annualised rate of 504k, much higher than the 439k expected and April’s revised rate of 425k. The M/M increase was the largest in 22 years and the number of homes sold was the highest since May 2008. The much higher than expected sales reduced inventories to just 4.5 months supply.
The Case-Shiller April 20 city home price index increased by +10.8%, lower than the rise of +11.5% Y/Y expected and the +12.4% gain in March. This and other recent data suggests that property price increases are slowing.

US May durable goods orders declined by -1.0%, worse than the unchanged level expected and the increase of +0.6% in April. However, orders ex defense and aircraft, a better reflection of business spending, increased by +0.7%, as opposed to a decline of -1.0% in April and better than the rise of +0.5% expected. Importantly, the report indicated that inventories are being rebuilt which will be positive for Q2 GDP.

Consumer confidence rose to 85.2 in June, higher than May’s revised 82.2 and the forecast of 83.5. It is the highest reading since January 2008. Both the current situation and future expectations components improved.

Personal incomes rose by +0.4% in May, in line with expectations, whilst personal consumption expenditures (PCE) rose by just +0.2%, below the rise of +0.4% expected. The price index for PCE increased by +0.2%, the same as in April. Excluding food and energy, the FED’s preferred measure for inflation, the core PCE index rose by +0.2% or +1.5% Y/Y.

The US will allow the export of ultra-light crude oil for the 1st time in 40 years. 2 companies were granted export permits and shipments may start as early as August.

Initial jobless claims came in at 312k, slightly below the previous weeks 314k. The 4 week moving average was 314.25k as opposed to 312.25k.

Eurozone (EZ) June manufacturing PMI came in at 51.9, below the 52.2 expected. Germany came in at 52.4, roughly in line with estimates of 52.5. However, the reading for France was particularly poor, coming in at 47.8 as opposed to 49.5 expected, which indicates that France remains in contraction territory.
The regions services PMI came in at 52.8, lower than the 53.3 expected. Germany came in at 54.8, as opposed to the forecast of 55.7. France was also lower than expected, coming in at 48.2, as opposed to the forecast of 49.4, once again in contraction territory.
The data implies that the EZ economy should grow by between +0.3% to +0.4% Q/Q in Q2.

The particularly disappointing French data reconfirms the serious problems affecting the country and with no indication of a solution at present. The government’s forecast of GDP growth of +1.0% this year look particularly optimistic, as does its budget deficit estimate of 3.8% of GDP.

Interestingly, the EZ PMI data suggests that disinflationary pressures are easing and that input prices are rising at the fastest rate since last November. German CPI increased to +1.0% Y/Y in June, up from +0.9% Y/Y in May.

Mr Draghi has hinted that the ECB will keep interest rates at low levels until the end of 2016. He stated that banks will have access to unlimited liquidity until the end of 2016, which should be taken as a signal by markets. (Source Bloomberg).

The German business confidence index (the IFO index), declined to 109.7 in June, its lowest level this year and down both from 110.4 in May and the forecast of 110.3.   The current conditions component was unchanged at 114.8, though the expectations component declined for a 2nd month to 104.8, down from 106.2 in May. The German economy is expected to slow appreciably this Q, though recover in Q3. The domestic economy, together with construction, remains strong.

EZ consumer and business confidence declined to 102 in June, from a revised 102.6 in May and below the rise to 103 expected. Increased tensions in the Ukraine, combined with the strength of the Euro were cited as the main reasons for the decline.

Mr Carney, the governor of the BoE, suggested that there was more spare labour capacity than thought previously, which has accounted for the lower than expected wage increases. However, he expected real wages to rise in coming months, as unemployment continues to decline. Mr Carney’s comments suggest that the BoE is reluctant to raise interest rates too early. However, the BoE remains concerned about large property price increases, which they state was due to a lack of supply of housing. Sterling declined following his comments.

In an attempt to curb home price increases, the Financial Policy Committee of the BoE has imposed certain curbs on mortgage lending, though the restrictions were not as great as was anticipated.

As requested by Mr Putin, Russian lawmakers voted overwhelmingly to cancel the option to use force in the Ukraine to support pro Russian separatists. The Ukraine, Georgia and Moldova have signed partnership agreements with the EU, which bind the 3 countries more closely economically and politically to the EU. The agreement is certainly not one that Russia wanted and Mr Putin has warned of grave consequences. The EU has set Russia a deadline of 30th June to implement a peace plan in eastern Ukraine or face increased sanctions.

Prime Minister Abe unveiled his policies to stimulate economic growth, the so called 3rd arrow. Corporate taxes are to be cut to 30% over the next few years, though the reduction in revenue will be made up by broadening the tax base. He also stressed the importance of encouraging women to enter the workforce and to increase the number of foreign workers, as the Japanese population declines. He stated that changes would be made to employment rules, together with the agricultural and healthcare sectors. The government investment pension fund would also be reformed, with an increased portion of its funds invested into equities, rather than bonds. Whilst highlighting the key problems facing the Japanese economy, the proposals were light in terms of substance.

CPI, excluding fresh food, rose by the fastest rate in 32 years, exclusively due to the sales tax increase in April. Core CPI was up +3.4% Y/Y in May, in line with estimates. May household expenditure declined by -8.0% Y/Y, as a result of the sales tax rise and higher inflation, whilst wages are not being increased to compensate for the higher prices. Wages, excluding overtime and bonuses, fell for the 23rd month in April.

The preliminary HSBC June Chinese PMI came is at 50.8, a 7 month high and above both the estimate of 49.7 and May’s 49.4. It is the 1st time this year that the reading is above the 50 level, which indicates expansion rather than contraction. The new orders component, in particular in respect of domestic consumption, rose and the output component also came in higher. The employment component was weaker, though the rate of contraction slowed from May. The Central Bank has been easing monetary conditions and the government has both increased and brought forward capex spending, which clearly has helped the domestic economy.

Kiron Sarkar
28th June 2014

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