Over the last month, there have been two clear US economic trends, which are related to each other. The first is a continuation of the US economy strengthening, which has increased the expectation that US interest rates will rise at a faster pace than previously expected. On the back of this positive trend, the US Dollar has finally started to strengthen.
Historically, a strong US Dollar impacts negatively the emerging markets. This is because in aggregate, emerging market countries are large borrowers of Dollar funds. The devaluation of the Argentinian Peso and the increase in interest rates to 40% has highlighted this issue. Argentina is also seeking aid from the International Monetary Fund.
It must not be forgotten that a strengthening economy never goes up in a straight line, in fact, US GDP in the first quarter, on an annualised basis, has slowed to 2.3%. However, this has been viewed in a positive light because it has reduced fears of the US economy overheating. For the record, US GDP was down from 2.9% in the previous quarter.
US non-farm payrolls also illustrate the continuing strength of the US economy. The US unemployment rate is 3.9%, which is the lowest level since December 2000.
In April 2018, US core inflation, which strips out food and energy prices, rose on an annual basis, by 2.1%. This is slightly below market expectations of 2.2%. US interest rates are expected to rise a further two times in the current year. In anticipation of the increase in interest rates, the US 10 year Treasury yield has risen above 3%, for the first time in more than four years.
The Bank of England has announced there will be no interest rate rise in May. This follows the UK economy recording its weakest quarter since 2012, with growth of 0.1%, down from 0.4% in the previous quarter. Although the weather played its role, the UK economy was weak in the first quarter. Other signs of a weakening UK economy were a 13%, year-on-year, decline in car production and a sharp fall in the number of UK residential property transactions.
UK retail sales in April also fell, 3.1%, year-on-year. This is the biggest like-for-like sales decline since April 2005. The decline in retail sales represents structural change on the high street and not necessarily underlying weakness in the economy, after all, wages have risen at an annual rate of 2.9% in the three months to March, whilst inflation, as measured by the Consumer Prices Index (CPI), rose 2.4% in the 12 months, to April. This is the first time wages have been higher than inflation since February 2017.
According to the Office for National Statistics, the UK manufacturing sector contracted 0.1% in March. However, this was marginally stronger than market expectations. A poll by Thomson Reuters found that the consensus was for a 0.2% contraction.
Not all the economic news has been negative. On the positive, the Construction Purchasing Managers’ Index (PMI) for March was 52.5 and significantly ahead of the previous month’s reading of 47. A reading above the 50 mark indicates economic expansion.
The Bank of England regional agent survey has revealed investment plans from the UK manufacturing sector hit a four year high in April. UK unemployment has also fallen to 4.2%, which is the lowest level since 1975.
The main political event in the UK remains the Brexit negotiations and the future relationship with the EU. Although there has been talk of the UK entering a customs union with the EU, there has been no breakthrough and the negotiations are ongoing.
Similar to the UK, GDP growth for the Eurozone in the first quarter of 2018 was below expectations, at 0.4%. This was the weakest growth rate for eighteen months. Manufacturing and services PMIs have also been weak, together with German retail sales, which fell for the fourth consecutive month.
The European Central Bank (ECB) has opted to leave interest rates at 0%, with its quantitative easing programme remaining at €30 billion per month. The ECB will also retain its negative interest rate of -0.4% on a portion of the lenders’ deposits it holds. The ECB has also committed to buying bonds after September, if necessary.
A political risk to the Eurozone has emerged with the formation of the new Italian government, which has been formed through a coalition from the Five Star Movement and the League. Although both parties are at opposite ends of the political spectrum, they both have a ‘Eurosceptic’ agenda. The new government has issued a policy agreement, which has spooked the markets; however, similar to Greece, it is difficult to see how the policies will be implemented. The new Italian government may increase the political tensions within the European Union.
Fears of a trade war have rescinded in that the US has decided to suspend its plans to impose tariffs on $150 billion worth of Chinese imports, whilst China is planning to increase significantly its purchase of US goods.
Iran and the oil price
The threat of a trade war with China is not the only political event being driven by Donald Trump. Donald Trump has unilaterally pulled the US out of the nuclear non-proliferation deal with Iran and has threatened to impose sanctions within 6 months. Despite strong urgings from Europe, Donald Trump has stuck to his 2016 election campaign to withdraw the US from the agreement with Iran.
The prospect of a return to sanctions for Iran has led to the oil price moving higher, with the price of Brent oil now trading at above $78 per barrel. A higher oil price should drive inflation and hit consumer spending.
Although Russia should benefit from a stronger oil price, the US has implemented economic sanctions against the regime.
The US economy is continuing to strengthen, with the market now expecting US interest rates to rise at a faster pace than previous expectations. On the back of this positive news, the US Dollar has strengthened. This is exerting pressure on emerging market economies and is being reflected in stock markets.
The UK and Eurozone economies are still expanding, although they have paused for breath. Perhaps the most important issue for the global economy is that the threat of a trade war between the US and China appears to have been negotiated away, although it could resurface.