In Brief

• U.S.: Economic activity in both manufacturing sector and non-manufacturing sector continued to expand in September 2017; light vehicle sales in September realized the first gain of the year; weekly jobless claims fell more than expected
• Eurozone: The final IHS Markit Eurozone PMI Composite Output Index increased in September; recovery continued to firm according to the hard data
• U.K.: The manufacturing sector continued to be a bright spot in the U.K. economy
• Japan: Growth remains an under-the-radar story
• Asia Ex-Japan: CFLP PMI increased and continued above the 51-mark for the 12th consecutive month with gradual improvement being obvious; there does not appear to be imminent risk ahead of the political shuffle in China; more on India and Taiwan
• Thought

On the U.S.

Economic activity in the manufacturing sector expanded in September, with the PMI registered 60.8%, an increase of 2% from the August reading and its highest reading since January 2004. The Composite Index was driven by The New Orders Index, which increased by 4.3% month on month, The Production Index, by 1.2%, The Employment Index, by 0.4%, The Supplier Deliveries Index, by 7.3%. the Price Index, by 9.5%. From the perspective of inventories, a slower rate of growth indicates a significant replenishment cycle is beginning and inventories are too low at the finished goods level. Overall, manufacturing is seeing a strong recovery and 17 of the 18 manufacturing industries reported growth in September; this could be diminished with supply constraints and rising. A key manufacturing measure is New Orders Minus Inventories. In September, the gap between New Orders and Inventories indicates a surge in output that will continue into the fourth quarter.

The non-manufacturing sector accelerated during September, indicating stronger growth in the sector; the ISM Non-Manufacturing Index (NMI) grew 4.5% to 59.8. The NMI is now substantially above the January-September average of 56.7 and at a level that will support improvement in employment and is more in line with the rate of the manufacturing expansion. The quickening pace in the NMI was led by across the board improvements in New Orders, Business Activity, Supplier Deliveries, and Employment. In September, pricing pressure intensified as the increase in the Non-Manufacturing Prices Index indicated higher prices on average with a possible hint of inflation; inflation concerns historically begin when the Index exceeds 60 for an extended period. 15 of the 17 non-manufacturing industries reported growth in September; the two industries reporting contraction in September were Arts, Entertainment and Recreation, and Mining.

U.S. light-vehicle sales rose 6.3% in September, which was the first gain of the year, largely attributed to strong demand for light trucks and fatter deals. The robust results underscored by a seasonally adjusted annualized sales rate (SAAR) of 18.58 million for the month blew well past the most optimistic forecasts. It is the highest SAAR since the 20.64 million rate recorded in July 2005 behind employee-style discounts.

The number of Americans filing for unemployment benefits fell more than expected for the week ended September 30. Hurricanes Harvey and Irma continued to impact the data but making it difficult to get a clear picture of the labor market. Initial claims for state unemployment benefits dropped 12,000 to a seasonally adjusted 260,000 for the week.

On Eurozone

The final IHS Markit Eurozone PMI Composite Output Index increased to 56.7 in September, which signaled expansion throughout the past months. September saw rates of output expansion accelerate in both the manufacturing and service sectors, although the former continued to register the superior performance overall. Manufacturing production rose at the quickest pace since April 2011. The rate of expansion in services business activity improved to a four-month high and was one of the best seen over the past six years. The outlook also remained bright, with business optimism rising to a four-month high.

All eight eurozone countries reported a PMI above the 50 percent mark, according to HIS Markit. Germany rose back to the top of the PMI Output Index rankings in September, which expanded at its best pace since April 2011, supported by surging manufacturing sector growth aided by a steep gain in new export business. Ireland was in the second position despite seeing growth slipping to a two-month low. Revival in France gathered pace.

According to the hard data, the recovery continues to firm which, in turn, is creating more taper talk. Also, the euro weakness spurred by the German election could catalyze more inflation, but some soft data is toppy while other series are fading as structural changes are not coming as swiftly or easily as hoped. The hard data shows solid growth in the eurozone is still on track for the third quarter.

On the U.K.

15 months have passed since the Brexit vote in the U.K. During that time, the U.K. PMI has averaged 54.7 with a high of 57.2 and a low of 48.4. The Markit manufacturing PMI posted another strong reading in September of 55.9. The manufacturing sector continues to be a bright spot in the U.K. economy as the industry benefits from a weaker currency and single-market access. It seems that the Brexit has not been detrimental to the manufacturing recovery to this point. Economic conditions in the U.K. were more of the same in September. The OECD released its revised estimates in September and now it sees the U.K. growing the slowest out of the G7 countries this year and next year.

Despite the robust labor market, consumers are no longer the workhorse of the U.K. economy. Jobs are plentiful, but real wage growth is still in negative territory. Residents are spending in less in volume terms and using debt to pay for necessities. Consumer debt to income ratios is creeping up again with consumer credit nearing its pre-recession peak while savings plunge. Mounting consumer credit has been worrisome for some time and then exacerbated by Brexit.

On Japan

The recovery is looking sturdy and durable ahead of the snap election on October 22. The upward trend in inflation continued in Japan. The weakness in the Yen has helped exports, which is a key for Japan. Market participants ran into and out of the safe-haven currency in August and September in response geopolitical tensions. According to the latest trade data, that volatility did not dent exports.

The manufacturing PMI made a broad-based move up to 52.9, finishing the third quarter on a strong note. Sentiment remains upbeat through escalating North Korea threats and ahead of the general elections. The Tankan survey for the third quarter showed business sentiment in the manufacturing was the most upbeat in a decade. Business sentiment in the nonmanufacturing sector continued to move largely sideways. Manufacturing sector profits and prices were also on the rise across all firm sizes. Production capacity and labor became less sufficient, signaling less slack in the economy.

Prime Minister Abe announced snap elections for October 22nd and an economic stimulus package. Initial polls show Abe’s LDP party is ahead, but the estimates vary widely. Tokyo Mayor Yuriko Koike just launched a new national political party called “Party of Hope.”

On Asia Ex-Japan

The China’s CFLP PMI increased by 0.7% and continued above the 51-mark for the 12th  consecutive month with gradual improvement being obvious. The Caixin China general Manufacturing PMI (51.0, -0.6) provided a weaker signal in a four-month expansion after a one-month decline. It is tough to see much rocking the boat before the Politburo meeting in mid-October. There does not appear to be imminent risk ahead of the political shuffle. China’s soft-landing is still intact, as evidenced by the latest PMI readings. The CFLP manufacturing PMI ticked up to 52.4 while the non-manufacturing PMI moved up to 55.4 in September. Growth in retail sales, fixed asset investment, and industrial production all deaccelerated further in August, but are still exhibiting respectable growth. The PBOC’s action to relax currency controls is another sign of confidence. However, the recent drop in iron ore is worth noting. India’s manufacturing sector and the posting of PMI for September indicated a slowness to adapt to the new Goods and Services Tax is implemented. Taiwan’s CIER/SMIT PMI continues to post very strong numbers, particularly in its Computers, Electronic and Optical Products industries.

Thought

Looking ahead, the OECD’s Leading Economic Indicators (LEIs) continue to indicate economic activities for both the third quarter and fourth quarter will be milder in most G7 countries, as the “spinach” period commences in U.S. politics and real growth drivers are pushed out further and further. On the flip side, LEIs for India, China, and Mexico are all reaccelerating, signaling better growth for the second half of 2017 in each of those countries. Despite, the OECD’s Total LEI is still showing the global economy will undergo a softer patch over the next six months, though growth should remain adequate.

In Brief

• U.S.: Trump gives a new “red line” for his 20% corporate tax rate; tax reform framework; consumer confidence index fell to 119.8 while data skewed by hurricanes
• Europe: France consumer confidence fell; both German and French business optimism was also appearing toppy; German election update
• Asia: S&P warns of correction as Asia bond spreads hit decade low; recovery durable through politics and now stimulus in Japan; polls show Abe in the lead for snap election; sales tax to be hiked in 2019 unless disaster strikes
• Thought: Implications of the Leadership from the Party Congress in October

On the U.S.

President Donald Trump said September 27 that the 20% corporate tax rate proposed in the newly released Republican tax reform plan is a “red line” and he will not go higher. Trump long ago promised to decrease the rate to 15% for corporations, but a nine-page outline released by the “Big Six” tax negotiators in the White House and Congress called for a rate of 20%. By making it slightly above the president’s originally desired level, it will make the budgetary math easier. Most analysts believe that the corporate tax rate will eventually have to be increased to the mid- to high- 20s for the tax reform plan to qualify under Senate rules.

According to the September 27 Tax Reform Overview, President Trump has laid out four principles for tax reform: (a) make the tax code simple, fair and easy to understand; (b) give American workers a pay raise by allowing them to keep more of their hard-earned paychecks; (c) make America the jobs magnet of the world by leveling the playing field for American businesses and workers; and (d) bring back trillions of dollars that are currently kept offshore to reinvest in the American economy.

A Conference Board report showed the September U.S. consumer confidence index faded to 119.8 from a revised 120.4 in August but within expectations; consensus expectations from most news organizations called for a headline index reading of around 119.5 to 120.2. Optimism has been unwavering, but the latest wave of events, including healthcare bill, hurricanes, North Korea threats, and budget uncertainty, could have been too much. Confidence in Texas and Florida decreased considerably, as these two states were the most severely impacted by hurricanes Harvey and Irma.

On Europe

French household confidence fell for a third successive month in September, wiping out most of its post-election spike as new president Emmanuel Macron pushed through contentious labor market reforms. The official measure of household confidence fell from 103 to 101, compared to expectations that it would stay steady. Household assessments of their past and future financial situation, saving capacity, standard of living and unemployment fears all deteriorated, but the main index is still well above the depths it plumbed over the last few years. Both German and French business optimism is also appearing toppy.

On German Election, the Chancellor Merkel’s CSU/CDU party maintained its majority in the Bundestag, but did worse than anticipated; it was its worst performance since 1949: (a) the AfD party, the right-wing populist party, obtained more votes than expected; (b) SPD raked in less votes than expected, resulting in its worst performance in the post-WWII era. SPD leader, Martin Schulz, announced he will make the party the opposition, ending its grand coalition with the CSU/CDU. That would make SPD the largest opposition party in parliament; (c) the composition of the Bundestag moved from center to the left and right extremes; (d) the election results present an alternative coalition called the Jamaica coalition among the CSU/CDU, FDP, and the Greens. Nothing was resolved at the so-called “Elephant round” where the party leaders met and stated their coalition intentions; (e) party leaders are waiting to see how the Lower Saxony regional election goes; and (f) the final coalition outcome will likely be the Jamaica coalition, which has mixed implications.

On Asia

According to S&P Global Ratings, the trend of falling premiums on Asian bonds amid abundant liquidity may not last for long, as global monetary stimulus will inevitably fade, and a significant correction in process of assets, such as bonds, equity, and real property, is likely. Rising threats include market overreaction to geographic conflicts, such as North Korea’s missile testing, the rise of populist or extremist trends, and tax or trade wars.   

In Japan, the Mfg PMI moved up broad base to 52.6, finishing the third quarter on a strong note. Sentiment remains upbeat through escalating North Korea threats and ahead of the general elections. Japanese Prime Minister Shinzo Abe announced snap elections for October 22, and an economic stimulus package of two trillion yen or $17.8 billion for subsidizing education and child-care costs and boosting corporate investment to, in turn, improve productivity. Additionally, Abe has reiterated his government’s plan to hike the consumption tax to 10% from the current 8% in October 2019 unless a setback such as a major financial crisis or massive earthquake occurs.

Thought: Implications of the Leadership from the Party Congress in October

The new or old leadership will focus on further suppressing economic and financial volatility through a combination of continued leverage expansion, financial repression including tight capital controls and an imposition of supply discipline in commodities industries. If so, unlike in 2015–2016, China would not be an exporter of volatility to global financial markets. While this is a possible outcome, another distinct possibility is that the likely consolidation and concentration of power opens the door for significant and surprising policy changes, including major reforms affecting state-owned enterprises and forced deleveraging, which would weigh heavily on growth and could lead to more tolerance for currency depreciation. This could potentially be signaled by a highly symbolic shift, such as the leadership dropping the growth target. Such changes, or the fear thereof, have potential to disrupt global markets. In addition, a more assertive China in foreign affairs under President Xi Jinping raises the risk of an escalating trade conflict in case the U.S. administration decides to get tough on trade policy.

In Brief

• U.S.: FOMC meeting September 20: Fed is leaving short-term interest rates unchanged, but December Fed hike possible; QE unwind, fiscal progress?
• Eurozone: Eurozone upturn regains momentum in September; ZEW current sentiment situation; German general elections on September 24
• U.K.: U.K. households experience the strongest squeeze on finances for three years in the third quarter of 2017
• Japan: August exports rose 18.1% YoY vs. est. 14.3%; weakness in the Yen has helped exports
• China: Yuan fixed back; downgrade ahead of politburo
• LEIs: Signaling softer global activity over next six months

On the U.S.

The Federal Reserve is leaving short-term interest rates unchanged, while announcing a plan to start shrinking its massive bond holdings in a move to normalize its balance sheet. The Federal Open Market Committee (FOMC) said September 20 that it would keep the federal funds rate in a range of 1% to 1.25%, but Fed officials hinted that they might raise rates one more time by year-end if inflation rises. Their latest economic forecasts show policymakers expect three rates hikes in 2018, which would bring the benchmark rate to between 2% and 2.25% by the end of next year. The Fed announced it will begin unwinding its balance sheet. Fiscal stimulus could boost the outlook.

On Europe

The headline HIS Markit Eurozone PMI increased to 56.7 in September from 55.7 in August, a four-month high; inflows of new orders showed the largest monthly increase since April 2011, representing a renewed surge in demand. Flash Eurozone Services PMI Activity Index grew to 55.6 from 54.7 in August, which is a four-month high; service sector activity showed the largest rise since May. Flash Eurozone Manufacturing PMI Output Index increased to 59.5 from 58.3 in August, a 77-month high, and flash Eurozone Manufacturing PMI increased to 58.2 from 57.4 in August, a 79-month high; the outperformance of manufacturing relative to services also increased to the widest since January 2014.

The faster pace of business activity growth and the upturn in demand in September was accompanied by rising price pressures. Input cost and selling price inflation gathered pace for a second successive month, with both reaching the highest rates since April. Prices charged for services rose to the greatest extent since May, while the increase in factory gate prices was the joint-highest since June 2011.

ZEW current situation sentiment, as well as expectations towards rates, inflation, and markets, were little changed in September in the euro area countries. Economic expectations ticked up slightly across the board. Euro area consumer confidence moved largely sideways again. While the soft data is topping, the hard data is still catching up. Solid growth is still on track for the third quarter.

German general elections are this Sunday, September 24th. According to the polls, Chancellor Merkel’s party, the Christian Democratic Union, and its sister party, the Christian Social Union, are expected to claim most seats in the Bundestag again. As a result, Chancellor Merkel would serve for her fourth term. The AfD and FDP parties are unlikely to gain overwhelming popularity, ousting Merkel. Yet the two parties are likely to garner over 5% of the vote each and thus enter the 19th Bundestag. If so, it would be the first time the AfD, the Populist Party in Germany founded a few short years ago, gains national parliamentary representation.

On the U.K.

September data confirmed that U.K. household finances deteriorated at the sharpest pace for three years in the third quarter. The seasonally adjusted IHS Markit Household Finance Index (HFI) was down to 42.8 in September from 43.4 in August and well below the neutral 50.0 threshold. The average index reading dropped to 42.6 in the third quarter, which was the lowest since the third quarter of 2014.

Intense pressures on household finances were recorded across all regions in September, driven principally by the on-going squeeze on real incomes from higher prices and low wage growth. The amount of cash available to spend continued to fall at one of the steepest rates seen over the past three years. However, spending rose again, and at an increased rate, fueled by a combination of modest growth in income from employment and reduced savings.

Households meanwhile indicated a continued recovery in their house price expectations from the 10-month low seen in June. Expectations for finances in the next 12 months September data also indicated that UK households expect a sustained deterioration in their financial well-being over the next 12 months. However, the seasonally adjusted index edged up to 47.8 from 47.3 in August, to signal the lowest degree of pessimism for seven months. There was a wide divergence across UK regions during September.

On Japan

Japanese exports and imports surged in August, with both treating expectations as a recovery in trade appeared to gain momentum. Exports rose 18.1% from a year earlier, the biggest increase since November 2013. Imports climbed 15.2%. The trade surplus was 113.6 billion yen. Shipments of autos to the U.S. increased 28.3%, though part of the increase in overall shipments to the U.S. can be attributed to lower exports the previous year, according to the Ministry of Finance. Shipments of electronic parts to Asia rose 21.6%. The weakness in the Yen has helped exports, which is key for Japan.

On China

China’s yuan firmed against the U.S. dollar on September 22 as the greenback pared gains made following the Federal Reserve’s hawkish policy statement and as investors took the latest Chinese sovereign rating downgrade in their stride. However, the Chinese currency remains on course for its second weekly loss. It has lost more than 1,500 pips from a 21-month peak hit on August 8 as a rallying yuan forced authorities to put a brake on its rise and relax some restrictions on capital outflows.

S&P cut China’s credit rating, as China’s attempts to reduce risks from its rapid buildup in debt are not working as quickly as expected and credit growth is still too fast. This follows a similar downgrade by Moody’s in late May, but the timing raised eyebrows as it came just weeks ahead of one of the country’s most politically sensitive events, the twice-a-decade Communist Party Congress (CPC). It is tough to see much rocking the boat before the key Politburo reshuffle in mid-October.

On LEIs

The OECD’s Leading Economic Indicators (LEIs) continue to indicate economic activities in the third quarter and fourth quarter will be milder in most G7 countries, as (a) the nominal reacceleration concludes, (b) the “spinach” period commences in U.S. politics, and (c) real growth drivers are pushed out further and further. On the flip side, LEIs for India, China, and Mexico are all reaccelerating, signaling better 2H17 growth in each of those countries. However, the OECD’s Total LEI is still showing the global economy will undergo a softer patch over the next six months.

In Brief

• U.S.: August NFIB small business confidence index up 0.1 month on month to 105.3; CPI surprises to the upside in August; inflation expectations continue to rise
• Eurozone: Earlier in the cycle, job gains are still nascent; Bank of France estimated French GDP growth of 0.5% in 3Q17; eurozone industrial production up 0.1% in July; EU posts record card registration figures
• U.K.: Inflation rate up to 2.9%
• Japan: More inflation in the pipeline
• China: Yuan has weakened as the government has relaxed currency controls; PPI ticks higher as retail, IP moderate
• Thought: Potential impact from hurricanes

On the U.S.

The latest issue of The National Federation of Independent Business (NFIB) Small Business Economic Trends came out on September 12. The headline number came in at 105.3, up 0.1 from the previous month. Five of the components increased while five declined. The lofty reading kept intact a string of historically high performance extending back to last November. Small business owners reported a seasonally-adjusted average employment change per firm of 0.18 workers per firm over the past three months, virtually unchanged from July. The net percent of owners raising average selling prices increased 1 point to a net 9%, which was the highest reading since 2014. 3% of owners reported that all their borrowing needs were not satisfied, unchanged, and historically very low. 34% reported all credit needs met and 49% explicitly said they were not interested in a loan. Including those who did not answer the question, 63% of owners have no interest in borrowing.

There is no big inflation worry for now but the U.S. CPI surprised on the upside in August, which rose 0.4% after edging up 0.1% in July. Core is still tame. U.S. consumer prices accelerated in August amid a jump in the cost of gasoline and rents. The data showed signs of firming inflation that could allow further monetary policy tightening from the Federal Reserve this year.

On Europe

Europe had the double dip. While the U.S. is later-cycle, it is tougher to make that case in the euro zone. Other statistical releases this week showed solid growth in the euro area is still on track for the third quarter. French business sentiment surveys, EA industrial production, and new car registrations made good signs.

The Bank of France maintained its forecast for French quarterly GDP growth of 0.5% in the third quarter, unchanged from the second quarter. The prediction was part of the central bank’s August business climate survey. The survey showed that the business sentiment indicator for the manufacturing industry dipped to 104 points in August from 105 points in July, although sentiment in the services industry rose to 100 points last month from 99 points in July. The business sentiment indicator for the construction industry also rose to 103 points in August from 102 in July.

Eurozone industrial production rose a little in July following a drop the month before as a jump in the production of capital and consumer goods offset a decline in energy, according to data released by Eurostat on September 13. Industrial production was up 0.1%, in line with estimates and compared to a 0.6% decline in June. The production of capital goods rose by 0.8%, durable consumer goods by 0.7% and intermediate goods by 0.5%. Meanwhile, production of non-durable consumer goods fell by 0.4% and energy by 1.2%. Compared with July 2016, industrial production in the eurozone was up 3.2%, missing expectations for a 3.4% gain. The production of durable consumer goods rose by 5.7%, intermediate goods by 4.8%, capital goods by 4.3% and energy by 1.2%, while production of non-durable consumer goods fell by 0.5%. In the EU-28 group of nations, industrial production was down by 0.3% on the month and up 3.1% on the year.

Passenger car registrations in Europe in August increased by 5.6% totaling 865,047 units. In volume terms, the figures topped those of August 2008, marking the European market’s best performance in a decade. Among the five big markets, Italy and Spain posted strongest increases with 15.8% and 13.0% rises respectively. France and Germany with 9.4% and 3.5% rises respectively also registered positive growth while demand in the UK declined 6.4%.

On the U.K.

The U.K.’s inflation rate climbed to its joint highest in more than five years in August as general commodity price appreciation, month-on-month rises in travel, apparel, and petrol. The UK CPI rose to 2.9% in August, up from 2.6% in July. The Bank of England has repeatedly said it would look through the transitory effects on inflation, and tightening monetary policy to offset hot inflation of this sort would be too costly for the economy.

On Japan

The upward trend in inflation continues in Japan. Import prices ascended 12.5% year on year and headline producer prices rose 2.9% in August. The biggest price increases were from petroleum and coal products, 12.5% y/y, iron and steel, 11.2%, and nonferrous metals, 16.8%, which is consistent with the global commodity reflation.

Meanwhile, domestic politics are looking better. Prime Minister Abe is pushing structural reforms to increase the labor force. Meanwhile, his approval rates are recovering. “Abe directed a government council on regulatory reform to devise frameworks as early as this year toward clearing Japan’s day-care waiting lists, reworking the system for wireless spectrum allocation and promoting the growth of the forestry industry. The council also will resume discussion of topics such as encouraging the hiring of overseas workers and promoting foreign tourism, issuing conclusions next summer,” Nikkei noted on September 13.

On China

The PBOC has scrapped a reserve requirement rule on trades called currency forwards, making it cheaper for investors to buy dollars while selling the yuan. The PBOC is also removing a reserve requirement on yuan deposits for foreign banks. The China yuan could weaken as local investors diversify abroad, but this is not a bad thing; the removal of emergency controls should be interpreted as a positive now.

Producers’ input and output prices rose again to 7.7% y/y and 6.5% in August. Like Japan’s PPI, energy and metals experienced the largest price increases. The strength in copper, iron ore, and China stocks indicates that there is currently no problem in China. The PBOC’s action to relax currency controls is another sign of confidence.

Potential Impact from Hurricanes

Two major hurricanes disrupted activity in the third quarter, making jobless claims rise and likely depressing payrolls in September, but rebuilding should help the data as we measure it going forward. Used car prices should rise.

The ISM Report on Business Survey found that two-thirds of responding supply managers believe input materials pricing would be at least somewhat negatively impacted over the next three months with greater than 27% expecting prices to be negatively or very negatively impacted. Relatedly, 56% of respondents believe supplier deliveries will be at least somewhat negatively impacted over the next three months with nearly 19% expecting deliveries to be negatively or very negatively impacted. Overall, 67% of respondents expect at least some negative impact to prices over the next three months with 27% of respondents expecting negative to very negative impacts. Even six months out, 56% expect at least some negative impact on prices. The manufacturing sub-sectors are more concerned than their non-manufacturing counterparts about negative price impacts three and six months out. The findings about supplier deliveries are similar, but less dramatic. Overall, 54% of respondents expect at least some negative impact to deliveries over the next three months with 19% expecting negative to very negative impacts. Six months out, a more than 36% expect at least some negative impact on prices. The manufacturing sub-sectors are notably more concerned than their non-manufacturing counterparts about slowed deliveries three and six months out.