DR.CHENJIAZI ZHONG

In Brief

• U.S.: PMI pop in August 2017 amid milder trend; dollar index clocks 15-month low
• EU: ZEW sentiment fading; sentiment also easing elsewhere in Europe; euro appreciation is a headwind to European growth; Eurozone manufacturing sector supports strong expansion of economy
• U.K.: GDP grew by 0.3% in 2Q17; pound edged up; composition of growth drivers is changing
• Asia: Asia markets resilient; Japan’s July core CPI up 0.5% YoY, more growth in the works for the third quarter
• At Jackson Hole, the death of an economic model may concern central bankers

On the U.S.

U.S. private sector companies showed a sharp and accelerated increase in business activity during August, indicated by the IHS Markit Flash U.S. Composite PMI Output Index escalating to a 27-month high of 56.0 in August, largely driven by the robust orders, output, and hiring in the services sector, the index of which was at 56.9 in August.

Business conditions continued to improve across the U.S. manufacturing sector in August. The HIS Markit Flash U.S. Manufacturing Purchasing Managers’ Index eased to 52.5. Investors could expect a resurgence in the PMIs at the start of 2018 if tax reform comes to fruition.

The Dollar Index fell to a fresh 15-month low of 92.42 after ECB President Draghi, while speaking at the Jackson Hole Symposium, refrained from commenting on the EUR exchange rate. The resulting spike in the EUR/USD yielded another leg lower in the USD across the board. Draghi’s silence on the exchange rate means the central bank is not as alarmed by the recent appreciation in the EUR as previously thought. His U.S. counterpart, Yellen, also disappointed the hawks earlier today by avoiding the policy talk. Yellen’s speech was a recitation of the financial crisis, regulatory failures, and how things have improved since then.

On the EU

Positive sentiment in the euro-area has had a nice run. However, the German Zentrum für Europäische Wirtschaftsforschung (ZEW) Economic Sentiment fell for a third month to 10.0 in August, compared with the forecast of 15.0. The current situation sentiment measurement remained euphoric at 86.7. The fall in economic expectations is due to the auto industry, rather than the upcoming election. Profit expectations for automobile companies plummeted -31.8 points in August as the sector battled fines and changing preferences. This is worrisome as the auto industry is one of the bigger employers in Germany.

Sentiment is also easing elsewhere in Europe. In France, President Macron is facing resistance implementing “spinach” reforms. Like the U.S. post-election, optimism is tempering in Europe as structural changes are not coming as easily as hoped. EU consumer confidence is beginning to trend sideways.

Euro appreciation is a headwind to European growth. While the ECB president startled investors in 2014 by laying the groundwork for quantitative easing, his published remarks at the Federal Reserve symposium in Wyoming on Friday included nothing on policy makers’ deliberations scheduled for September 7 or on their concerns over the euro appreciation. In response to his silence, the single currency jumped to the highest level in more than two and a half years against the dollar.

Based on the headline IHS Markit Eurozone PMI’s 55.8 in August, the euro zone economy maintained growth momentum; the index again signaled strong growth of the euro area private sector. The expansion was supported by a strong rise in manufacturing production, while services business activity increased at a weaker pace.

On the U.K.

The U.K. economy grew by 0.3% in the second quarter, in line with the initial estimates. While the pound regained some ground following the GDP numbers, after languishing at an eight-year low against the euro.

Consumer spending slowed for the third time to 0.1% due to the VED tax and steep inflation. Despite the robust labor market, consumers are no longer the workhorse of the U.K. economy. More people are becoming employed, but real wage growth is still in negative territory. Residents are spending in less in volume terms and using debt to pay for necessities. Government spending, up 0.6%, and capex, up 0.7%, helped picked up the slack again, contributing 0.1% pts each. Net trade added 0.0% pts.

On Asia

Asian stocks advanced on Friday, once again shrugging off a sluggish day on Wall Street, and the dollar strengthened as attention shifted to the central bankers’ symposium that began on Thursday in Jackson Hole, Wyoming. MSCI’s broadest index of Asia-Pacific shares outside Japan, was up 0.25%, set to end the week 1.6% higher. The MSCI World index was steady, heading for a 0.7% weekly gain. Japan’s Nikkei advanced 0.6%, heading for a flat end to the week. China’s Shanghai Composite index jumped 1.5% to its highest level since January 2016. Hong Kong’s Hang Seng gained almost 1%. South Korea’s KOSPI climbed almost 0.1% and Australia’s S&P/ASX 200 index was little changed.

Like the European and U.S. PMIs, Japanese activity surprised to the upside in August. The Manufacturing PMI made a broad-based move up to 52.8. Unlike the European and U.S. PMIs, the Markit Manufacturing PMI for Japan is trending sideways, ranging 52-53 since December 2016. According to the summer PMI readings, Japan’s quiet recovery is still on track in the third quarter. Yet, structural problems still exist and are restraining growth.

Central Bankers’ Annual Gathering at Jackson Hole

As central bankers gather at the annual Jackson Hole symposium on Friday, analysts think the death of a major economic concept could dominate discussions. Known as Phillips curve, an economic concept developed by New Zealand economist William Phillips, it shows that inflation and unemployment have a stable and inverse relationship. However, in the recent months with central banks using artificial ways to pump money into the economy, this inverse relationship is seen to be dying. A number of analysts have warned that this could be risky for the global economy and discussions around the death of the Phillips curve could dominate the Jackson Hole symposium.

Thoughts

It is odd for an economy like the U.S. to accelerate in the second half of a business cycle. Similarly, it would be odd for the yield curve to stay constant or steepen. But this is not a normal cycle, and one of the key unique items, QE, is set to be undone. True, this will occur slowly at first, but the market has not taken the Fed all that seriously for years, as the FOMC has said they wanted to normalize.

The ECB minutes, meanwhile, worried about a currency overshoot. “While it was remarked that the appreciation of the euro to date could be seen in part as reflecting changes in relative fundamentals in the euro area vis-a-vis the rest of the world, concerns were expressed about the risk of the exchange-rate overshooting in the future,” an account of the July 19-20 policy meeting published by the ECB showed. Bottom line is that the Fed is looking for ways to tighten while the ECB is watching any additional euro strength closely. The U.S. data remains broadly positive, though housing starts still restrained.