North Korea has consistently been in the news over the last couple of months. Equity markets initially responded as one would expect, a pull back, but once the cloud had cleared, most equity markets have recovered what they initially lost and are at or near new highs. The reason for the buoyant market is, quite simply, the improving global economy, particularly in the Eurozone and Japan. Economic concerns do remain, including the significant impact from the hurricane season.
The huge economic impact from Hurricane Harvey has started to be seen from the latest US data. US retail sales fell 0.2% in August, which was below the expectations of an increase of 0.1%. Industrial production also disappointed, declining 0.9% in August to 1.5%, year-on-year, which follows a July upwards revision of 0.4%. The US Federal Reserve’s (Fed) measure of industrial production comprises manufacturing, mining, and electric and gas utilities. The Fed, using a combination of high frequency plant and economic modelling, attributed 0.75% of the decline to the storm effects that temporarily curtailed the drilling, servicing and exploration activity for oil and natural gas.
US jobless claims are also up 298,000 and are the highest figures since early 2015. This increase is probably another swift reaction to Hurricane Harvey. Unemployment data is a key factor in the Fed’s monetary policy decision making and the distortion caused by the hurricanes will make it more difficult for the Fed to make the right decisions.
The economic statistics do not, so far, include the impact of Hurricane Irma, which should be included in next month’s figures. The economic impact of the hurricane season is likely to lead the Fed to delay tightening monetary policy. The US debt ceiling was due to expire on 29 September, but Donald Trump and Congress have agreed to suspend the US debt ceiling in order to approve $15.3 billion of hurricane relief, which should, in the months ahead, support the economy.
The debt ceiling problem has been kicked further down the road, but remains a key risk. In the worst-case scenario in which no long-term agreement is reached, it could lead to a shut down in the US government debt rating downgrades and even recession. There would also be a negative knock-on effect on the global economy. Pragmatism tends to prevail, although there are usually some nervous moments before an agreement.
The Fed has laid out plans for slowly reducing its balance sheet by no longer reinvesting a portion of its maturing bond holdings. However, the Fed is only talking about shrinkage of $120 billion over the next 12 months against an existing balance sheet of around $4.5 trillion, and therefore, is only relatively small change.
The Fed’s big decision is when and how fast will they increase interest rates. A lot will depend on whether Donald Trump can implement his fiscal and tax reform policies. If, like President Obama, Donald Trump becomes deadlocked and unable to implement his policies or they are watered down significantly, the Fed will probably delay raising interest rates.
In the second quarter, UK Gross Domestic Product (GDP) grew 1.7%, year-on-year, and was impacted by the weakness of Sterling and the continuing uncertainty of the Brexit negotiations.
UK inflation, as measured by the Consumer Prices Index (CPI), rose 2.9%, in the 12 months to August 2017, which is up from July’s figure of 2.6% and ahead of market expectations. Although monetary policy remains unchanged, the Bank of England (BoE) hinted strongly that interest rates could rise sooner, rather than later. The direct result of this statement was that Sterling strengthened significantly against all the other major currencies. The BoE Governor, Mark Carney, has stated that inflation should stay above the BoE’s 2% inflation target for the next 3 years and that interest rates will rise only gradually. The uncertainty arising from the Brexit negotiations should keep pressure on the currency.
Unemployment has fallen to 4.3%, the lowest level since 1975; however, wage growth remains subdued at 2.1%. The squeeze on real wages is continuing to impact the consumer. However, in August, UK retail sales rose 1.3%, which although not a boom was better than expected.
Manufacturing output rose 1.9% in the year to July, which is better than expected. The Manufacturing Purchasing Managers’ Index (PMI) provided a positive surprise for the economy, rising 56.9. Although Sterling has improved, it is still providing a tailwind for manufacturers.
The European Central Bank (ECB) has upgraded economic growth this year; raising the GDP growth target for the Eurozone to 2.2% from 1.9%, however, the ECB cut next year’s inflation (CPI) target from 1.3% to 1.2%. Although interest rates are expected to remain unchanged for the foreseeable future, the market is looking towards the ECB to cut its asset purchasing programme from its current 60 million Euros to a consensus view of 30 million Euros. However, the ECB in its September meeting has maintained its current monetary policy.
The economic data indicates that the economic recovery is still progressing. In the second quarter, Eurozone aggregate GDP growth was 2.2%, year on year, marginally ahead of market expectations. What is encouraging is the broad based nature of the upswing, which is starting to spread across the 19-nation region. Spain is growing at its strongest pace in two years. Exports and investments have led France to its strongest continuous GDP expansion since 2011. Italy, which has lagged the pick-up of its peers, is expected to grow by over 1% in 2017. Economic confidence within the Eurozone rose to its highest level in a decade, acting as a tailwind for investment and consumption in the region. Unemployment within the European Union also remains steady at 9.1% in July. The strength of the Euro may negatively impact the economy.
The big political event in Europe is the German election on 24 September. Angela Merkel is the strong favourite to retain her current position as President, although there are some doubts about her coalition partners.
The political tensions of North Korea are impacting Japan; however, the domestic economy remains strong. In the second quarter, Japan’s GDP grew 4%, year on year, which was significantly higher than the market consensus of 2.5%. Corporate earnings remain robust with the recent quarterly corporate earnings results seeing sales beat expectations for the second consecutive quarter, while profit margins continued to rise.
The next big event in China is the Communist Party Conference and the authorities will want the economy to avoid any nasty surprises.
The Chinese economy is still performing, although recent economic data is below market expectations. China’s Industrial Production rose 6%, year on year, in August, which follows a 6.4% increase in July. This was below market expectations and was the weakest industrial production figures since December last year. Chinese Retail sales in August rose 10.1%, which was below the 10.4% rise in July and the 10.5% rise the market expected. China’s Exports were weaker than expected in August, rising 5.5%, whilst Imports, up 13.3%, were higher than expected.
In Q2 Indian GDP grew 5.7%, year on year, which is a sharp fall from the previous quarter, where GDP was 6.1% and below market expectations. Manufacturing surveys and industrial production data appear to have been imparted by destocking after the introduction of the Goods and Services Tax. The Bank of India has cut interest rates, which should support economic growth.
Unlike the equity markets, the price of gold is taking the political instability of North Korea seriously and behaved as you would expect from a defensive asset, rising to over $1,300 per ounce.
The hurricane season has distorted the US economic story and may delay the Fed raising interest rates, however, the big issue for the US and the global economy is Donald Trump. The implementation of his fiscal and tax reform policies and speed of implementation will influence how quickly the Fed will tighten monetary policy, which influences the strength of the US Dollar. The other big uncertainty is the UK and the Brexit negotiations, as these will continue to influence the strength of Sterling, which will probably continue to drive the UK economy. On the positive the Eurozone and Japan are at last showing signs of economic life, when was the last time for that?