- US Surprise Trend Index still in 'shutdown' distortion. Last week only 4 of the 11 US macro indicators I planned to track were released due to the continued government shutdown fallout. Hence, the signals coming from surprise indicators these days are still distorted by the skewed indicator distribution. Last week's 50% score wasn't enough to pull the 4-week trend index also above that critical level as well. My Developed World trend index improved to 46% and my EM index to 44%. Evidently, macro is still not supportive for financial markets here in the US or abroad.
- Early October US manufacturing surveys show mixed picture. The Empire State Manufacturing Index fell 4.8 points and at 1.5 was barely positive in October. However, 'New Orders' improved and 'Production' remained strong. The Philadelphia Fed Index was more bullish losing just 2.5 points with both 'New Orders' and 'Employment' still improving further. So far the evidence of economic damage from the October government shutdown is not convincing. Not much evidence of 'shutdown' damage in US home builder index either.
- The NAHB Housing Market Index declined in October, but hasn't given back much of the 17-point surge over the summer. Another surveys that so far shows little government shutdown effect. If the index doesn't fall any further in November, I'd say the hosing market has come through the shutdown episode undamaged.
- China confirms expectations of a growth rebound. Q3 GDP growth increased 7.8% from a year ago up from the 7.5% in the prior period. The 9.1% annualized growth rate for the quarter - a 2-year high - showed an even stronger momentum. Evidently, the government's stimulus package worked and the economy bounced back despite the continued weakness in global trade.
- Chinese credit supply continues to expand too rapidly. Total Social Financing, the broadest measure of credit supply in China, recorded a bigger-than-expected increase in September and the average for the year so far is running 18% above last year's levels. Not much evidence the government is successful in reigning in credit expansion, which may trigger more aggressive monetary policy action in the coming months.
- UK labor market rebound still gathering steam. Unemployment claims fell at the fastest pace in more than 16 years during the last quarter(!) and employment growth picked up as well through August. Stronger labor markets should give the current growth spurt some legs and push up UK GDP forecasts for the rest of the year and possibly 2014 as well.
- Canadian inflation remains well below target. CPI inflation came in below expectations in September maintaining the prior month's 1.1% growth rate. Though inflation remains stuck at the lower end of the Bank of Canada's 1% to 3% target range, I expect the bank won't react and rather stay on the sidelines.
- Some progress in Brazil. The key story last week was the continued inflation slowdown in September. At 5.85% it still exceeded expectations, but is back within the bank's 4.5 - 6.5% target range and has trended lower for four straight months now. Banco Central do Brazil's Economic Activity Index missed expectations, but 2 months into Q3 shows GDP tracking at about the same pace as in the prior period. Evidence that domestic demand is holding up came from a stronger-than-expected Retail Sales report, which showed sales growth up 6.2% from a year ago in August. It seems the June/July current account crisis hasn't affected Brazilian consumer spending, though it's too early to assess the effect of recent policy tightening.
- India's policy makers still challenged by rising inflation. CPI inflation re-accelerated to 9.84% in September still an excessive rate that must worry the Reserve Bank. The lack of a slowdown in the pace of price increases despite evidence of weaker demand may compel the bank to tighten policy further in the coming months.
- Russia's growth momentum continues to slow. Both Retail Sales and Industrial Production missed expectations last week. At 3% from a year ago Retail Sales are still growing, but at the joint-slowest rate since the initial post-recession rebound. Industrial Production meanwhile has stalled and essentially shown no growth in the past 8 months.
- Last Week's Highlights: There were 5 central bank policy meetings on the calendar last week. The only rate change came from Banco Central do Brasil, which raised rates for the 5th time in the past 7 meetings(!). Furthermore, the 50 basis point move to 9.50% was more than central bank watchers had expected. Economists were surprised because Brazilian inflation has started to slow and at 5.86% is back within the bank's 2.50% to 6.50% target range. Growth has remained resilient during the spring, though most recent indicators do point to a weaker summer. Finally, the Real had already regained more than 8% since mid-August and the latest trade balance data swung back showed a renewed surplus. Hence, it seems last week's 50 basis point surprise was probably BdB's last shot to stabilize the currency and accelerate the reduction in inflation.
- Also on the calendar last week: The Bank of England left policy rates and its Asset Purchase Target unchanged at 0.50% and £375 billion, respectively. None of the forecasters polled by Bloomberg expected a change. The fact that inflation is running above one of bank's 3 'knockouts' that can trigger a change in the bank’s “highly stimulative stance in monetary policy”, doesn’t seem to worry the MPC too much. The minutes of the previous meeting showed members expect inflation to ease back to 2% in the next 18 to 24 months pertinent to the bank’s forward guidance. We will see how much longer the bank can justify to expect inflation to slow, while growth accelerates driven by rising house prices and domestic employment - both classic inflation drivers. Bank of Korea also left policy rates unchanged - in this case at 2.50%. The bank last cut rates in May, but has left the task to provide more stimulus to fiscal policy in the past few months. None of the 18 economists surveyed by Bloomberg expected a rate change. Inflation has fallen below 1%, well outside the bank's 2% to 4% target range. The Won has strengthened during the recent currency account crisis hitting Korea's export competitiveness and even though growth at 1.5% in Q2 improved from the previous 2 quarters, it remains well below the countries potential. Hence, the door remains open for further rate cuts in Korea.
- Bank Indonesia took a pause in its current tightening cycle maintaining the previous month's 7.25%. BI had raised rates 4 times between June and September in response to the dramatic depreciation of the Ruphia, which was triggered by capital flow reversal following Fed Chairman Bernanke's 'taper talk' in May. Inflation has started to roll over, though, at 8.4% remains well above the bank's 3.5% to 5.5% target range. The Fed's decision not to taper has taken the pressure off central banks to lean against potentially inflationary currency depreciation. Unless forced by the FX market BI will try to leave rates unchanged in the coming months. And finally, Peru's BCRP left policy rates unchanged at 4.25%. The bank has been on hold since May 2011 and managed to get through this summer's current account crisis without additional monetary tightening, allowing the exchange rate, which is down more than 7% this year against the US dollar, to carry much of the adjustment burden. Growth has held up well and inflation at 2.8% remains within BCRP's 2% to 3% target range. Hence, unless inflation rises well above target, the bank is likely to remain on the sidelines.
- Ok, Congress stepped back from the brink of a default, I guess that is good news. The US government is funded through January 15 and the Debt Ceiling extended through February 7 (some pundits believe the Treasury may be able to stretch that through the middle of March). However, Congress did so not by solving the underlying fiscal disagreements and challenges, but by merely extending all the deadline; it’s like hitting the snooze button on a ticking time bomb.
- It is unclear what happens next. Cooler heads could now prevail and the ‘Budget Commission’ set up as part of the deal may be able to hash out a broader agreement on spending and revenue that restores the erstwhile budget process. That’s exactly what optimists hoped for after the 2011 Debt Ceiling crisis and the 2012 Fiscal Cliff, yet we learnt there just aren’t enough cooler heads.
- In the past, differences between Senate and House budget resolutions would be resolved in ‘Conference’, where a select group of Senators and Representatives hashed out compromises to fuse the 2 bills into 1. That process broke down in 2011 and Congress invented the ‘Super Committee’ that should do the same job, yet under the threat of draconian automatic spending cuts that would severely hurt both Republican and Democrat interests. The threat was insufficient and what was previously thought to be draconian cuts are now hailed as achievements and are the new normal. The ‘Budget Commission’ will operate under the threat of another government shutdown and potential default. Yet, the underlying problem remains the same: Democrats will only accept a deal that includes higher revenue, which is exactly what Republican will not accept.
- Having just seen how politically damaging a shutdown/default crisis can be, but having also just learnt how easy it is to simply postpone everything rather than compromise, I believe it’s highly likely the latter will be the outcome of the ‘Budget Commission’ deliberations in early January. So, there we are: perpetual government-by-crisis; at least until the mid-term elections in November of 2014. S&P downgraded the US credit rating AFTER the 2011 Debt Ceiling crisis was ‘resolved’. I wouldn’t be surprised, if Fitch and eventually Moody’s follow suit before the end of the year.
- The near term damage to the economy is still manageable; I reduced my Q4 GDP forecast to 2.2% from 2.8% and my 2014 forecast to 2.4% from 2.9% anticipating the current sluggish growth backdrop to prevails through the first half of next year and the pick-up in the recovery I initially predicted for the start of 2014 postponed to the second half.
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