What We Will Likely Learn in the Coming Days
The most important economic events of August are behind us. The ECB meeting and the US employment data are have taken place. The purchasing managers surveys for July have already been reported.
Much of the data due out in the coming days will flesh out details of what is generally understood in broad strokes. This is especially true of Japan and euro zone's first estimates of Q2 GDP.
The available data indicates that the euro zone economy enjoys no momentum, and questions have been raised whether the growth is has reported (0.2% in Q1) is sufficient to signal that the recession truly ended. Draghi's formulation of the recovery being weak, fragile and uneven is not inconsistent with this view.
The consensus expects the most meager of growth in Q2 (0.1%) and the risks are on the downside. The Bundesbank warned that the Germany economy may have stalled in Q2, and investors have already been told the Italian economy contracted by 0.2%. The Italian economy grew in one-quarter (0.1% in Q4 13) since Q3 11, and some clever pundits want to call this a triple dip. Surely it is more compelling and accurate to recognize that the Italian economy never emerged from the recession that began in Q4 11.
Already reported data points to a steep contraction in Japan's Q2 GDP under the weight of the retail sales tax increase on April 1. The consensus calls for a contraction of around 7.5% at an annualized pace. Much of the key economic data, like household consumption and industrial production, were weaker than economists had expected.
This warns of potential downside risks to the GDP estimate, as if the consensus has yet to fully appreciate the fullimpact of the sales tax increase. A consensus report would erase in full the 6.7% expansion in Q1 (annualized pace), and mean that the world's third largest economy contracted in H1. Both the government and the central bank have cut their economic assessments but are reluctant to indicate the need for new stimulative measures.
With the euro zone and Japan's GDP figures, the second quarter is statistically over and June data, barring a significant surprise will lose its potential to impact the market. Third quarter data is considerably more important for investors and policy makers. This is true of several pieces of economic data to be released in the coming day, including the US JOLTS data.
With the Fed broadening its focus from simply the unemployment rate to several other measures, the June JOLTS data may of interest. However, it is unlikely to alter the general perception that, even if not healthy yet, the US labor market is healing. An increase in job openings and not just a decline in layoffs have become evident over the last couple of months.
The euro area industrial output for June is unlikely to provide new information. Many large countries have already reported their figures, and they point to a small increase on the aggregate level. On the other hand, the June core machinery orders may be of interest as an indicator of future capex. A rise that recoups a third to half of what was lost in April and May seems reasonable.
July data can be expected to confirm what we already know. More people working in the US, stronger confidence, the already reported chain store results, and the surge in the service sector ISM points to a robust retail sales report, when adjusted for autos, gasoline and building materials, a measure used for GDP calculations. Even though July industrial output may be kept in check by the decline in manufacturing hours, and a possible decline in utility output, auto output appears robust. On balance, it appears the US economic momentum of Q2 has carried into the start of Q3.
The final euro area July CPI is expected to confirm the preliminary down tick to 0.4% year-over-year. The ECB staff's latest (June) forecast is for a 0.7% this year. This implies the harmonized measure is bottoming. The risk is that the staff is once again forced by circumstances to revise it lower as early as next month. While the ECB needs to wait for the effect of the recent rates cuts and TLTROs, an ABS purchase program looks increasingly likely. We would pencil it in for Q1 15.
The UK July employment figures likely point to a continued absorption of slack. Yet, the risk as seen in most of the high income countries, wage growth remains anemic. Indeed, the risk in the UK is still on the downside, despite the continued fall in the claimant count and the likely decline in the unemployment rate.
The Bank of England's inflation report the same day (August 13) is the venue for forward guidance. While keeping its growth forecast unchanged, it might lower its unemployment estimate. However, the key in preparing the market for a rate hike (we think Q1 2015) is forecasting inflation to reach its 2% inflation target.
China’s July data has already begun being reported. The CPI and PPI were released on August 9. The former was unchanged at 2.3%, while the latter fell for the 29th consecutive month. The pace of decline, -0.9%, is the least since April 2012. Food inflation eased 0.1% on the month for a 3.6% year-over-year pace. The Food and Agriculture Organization (part of the United Nations) estimates that worldwide, food prices fell in July for the fourth consecutive month. In China, non-food prices edged higher by 0.1% for a year-over-year rate of 1.6%.
Industrial production, retail sales and fixed asset investments are all expected to remain near June levels. Separately, aggregate financing is expected to have slowed in July, but this is most a reflection of pullback in loans from the formal banking system rather than from shadow banking. We note that with its pre-weekend gains, the yuan itself has recouped half of the ground it lows earlier in the year.
To note, among the other emerging markets, India’s July CPI and June industrial production figures standout, as do a possible rate cut by the South Korean central bank and a hike by the Chilean central bank.
Lastly, geopolitical anxiety continues to run high. The disturbing and tragic events in Gaza have little market impact. The US airstrikes on insurgent forces in Iraq also have little immediate market impact. The territorial disputes dominated the weekend ASEAN meeting, according to press reports, but there is unlikely to be immediate market impact. In this context, we note reports that India and Vietnam will conduct joint exercises.
The situation in Ukraine is reaching a climax. With the insurgency in east Ukraine facing defeat, Russia is faced with difficult choices. The risk, as we have argued, is that Putin doubles down by sending “humanitarian “ support with the assistance its 20-40k troops (according differing accounts) that have been amassed on the Ukrainian border. This would be viewed as an escalation by officials in Washington and Brussels, which in turn would trigger further sanctions. This only adds to the euro area’s economic challenges.
Although some observers have argued to the contrary, we do not see the international role of the dollar in jeopardy by the confrontation over Ukraine or the Russia-China energy deal. We see much irony in the BRICS' decision to capitalize its new development bank only with US dollars, which not even the World Bank does.
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