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Outlook 4Q18 - Macro

15 Oct 2018

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Macro

(slide 3) 

US: a persistent upswing in capital expenditures could mean that the business cycle has more room to run, despite its advanced age

  • Tariffs have increased the cost of some durable goods. Higher fuel prices are a headwind to consumption;
  • Government spending is yet to make its way fully through the economy;
  • Investment spending has momentum (not just in the oil & gas sector). However, the US economy is likely to face intensifying supply-side constraints (Markit);
  • Lending standards suggest that industrial production will continue to show a solid pace of growth. US consumer confidence unaffected by tariff concerns and high oil prices.

(slide 4)

US: there are no signs of momentum eroding in the labour market. Amazon increased its hourly minimum wage to $15

  • 75% of labour market entrants has been able to find a job within one month;
  • Forward-looking series like job openings and temporary help employment suggest continued strength in job growth in coming months. US labour demand has accelerated in 2018;
  • Tightening labour market conditions reflected in lower U6-U3 gap. Higher wage growth increases risks of a business cycle slowdown;
  • Involuntary unemployment is low, supporting the idea of low slack in the labour market.

(slide 5)

US: should we be worried about the “end of the cycle”? When are monetary and fiscal monetary policies expected to reach restrictive territory?

  • We should not look to FOMC median projections to get a forecast of recession for the year ahead;
  • According to the model provided by the Federal Reserve of New York, using the difference between 10-year and 3-month Treasury rates, the probability associated to a recession twelve months ahead is around 15%. This figure remains well below the values recorded in the past for previous recessions;
  • And what about imbalances in the US economy?

(slide 6)

US: divergences between the US and the rest of the world usually end with a US slowdown…

  • Federal Reserve policymakers note that most recessions in the past have been preceded by yield curve inversion;
  • Paper from economic staff at the Federal Reserve Bank of San Francisco prefer to look at the spread between the 3-month and 10-year yield (spread is sill relatively “healthy”…);
  • The Conference Board leading index still supports a constructive view for the US economy;
  • Interest rate sensitive sectors such as autos and housing confirm that the US economic expansion has moved into its late stage.

(slide 7)

US: ahead of the November mid-term elections, Republicans are pushing for more tax cuts and Democrats are calling for more spending…

  • House Republicans pushed “tax reform 2.0”, a follow up to the tax cuts enacted in December 2017. Its key aim is to make permanent the tax cuts for households voted in December and scheduled to end in 2025. 60 votes in the 100-seat Senate needed to get permanent changes to the tax code;
  • The scenario of a divided Congress suggests the potential for gridlock. A bipartisan decision will likely delay the 2020 fiscal cliff. Economy and monetary policy more important for markets than politics;
  • Unclear what could change on trade disputes if Democrats control one or both chambers of Congress. A divided Congress may still allow President Trump to find a compromise on an infrastructure bill. The Trump administration’s confrontation with China & Iran will probably continue after the mid-term elections.

(slide 8)

US Dollar: fiscal policy settings are pro-cyclical in the US. Monetary policy will need to keep tightening…

  • Global growth has not bottomed (US Dollar supportive);
  • A stronger US Dollar is still needed given higher growth and inflation in the US vs. the rest of the world;
  • A weak CNY is likely to remain an headwind to emerging markets. Trade tariffs and domestic deleveraging require a weak CNY;
  • A strong US Dollar pushes EM economies towards measures needed to deal with their excesses;
  • The market could revise up its estimate for the terminal rate, in the US. 

(slide 9)

Euro Area: strong wage growth in 2Q18 suggests upside to inflation… but will core inflation achieve 2% given that periphery HICP inflation remains weak?

  • Growth of compensation per employee in the euro area accelerated by 0.4pp to 2.3%y/y in 2Q18. This is the highest reading since 4Q08 and slightly below the 1996-2008 average (2.4%y/y)… but the outlook is not uniform…
  • Markit PMIs pointed to price pressures in most countries and sectors amid signs of “bad inflation”, as companies remained constrained in terms of margins, in a backdrop of rising commodity prices, wages and other input costs;
  • Inflation fears given the oil-wages-tariffs context. Slowdown in global trade remains a key risk.

(slide 10)

Euro area: stabilising growth numbers in the Eurozone. Still weakening manufacturing sector but domestic economy remains resilient

  • Domestic demand offsets weak exports;
  • Low unemployment (on the back of the service sector) is fuelling higher wage growth. Real income probably will not be squeezed that much from higher oil prices;
  • Moderate economic growth due to manufacturing weakness;
  • Slowing China and weaker global trade weighing on Eurozone manufacturing confidence;
  • Eurocoin growth indicator consistent with annualised GDP growth of 2%. Confidence converges towards “hard data”.

(slide 11)

Euro area: Italian constitution requires “balanced budgets and the sustainability of debt…”. Confidence is needed to rollover debt.

  • A weak growth in Italy shows vulnerability to potential external shocks, in a backdrop where QE net asset purchases is coming to an end soon. Debt sustainability more difficult to achieve;
  • Poor prospects for supply side reform (cut in the retirement age). Italy needs a dovish ECB;
  • Has Lega shifted from business friendly policies to populist policies? (less growth in the future for the Italian economy?);
  • Italy remains a source of volatility for the euro area.

(slide 12)

Euro area: political fragmentation as a key trend in European politics. Are markets complacent about the US/China confrontation?

  • Populist wave in Europe cause fragmentation in the region’s political mainstream. Divided government means that it is difficult to undertake big initiatives but also “really bad ideas”;
  • Political fragmentation increases the odds that general election produces weak governments;
  • Nationalist & populist parties benefit from increased support across Europe, resulting in policy changes (through coalition governments or forcing traditional parties to shift their agenda). Despite electoral losses, mainstream parties remain relevant;
  • Higher chance that fiscal policy could play a bigger role in future economic downturns (speeches from Jens Weidmann, Mario Draghi, Franco-German agreement on a eurozone budget);
  • “China was on the way to being bigger than us in a very short period of time. That’s not going to happen anymore” - Donald Trump speaking at a rally in West Virginia on 21 August;
  • The Center for Automotive Research estimated that auto tariffs would put at least 750k jobs at risk and cost the US as much as $42.2bn in lost GDP (even without considering the effect from the likely retaliation);
  • Will China retaliate against US firms with operations in China?
  • US-Mexico-Canada agreement: Does it suggest similar deals with the EU and Japan? *
  • US-China: conflict over trade, investment, technology and geopolitical dominance. Mid-term US elections and potential institutional constraints on Donald Trump. A US slowdown or a higher trade deficit could increase the tension between Donald Trump and the Fed/China;
  • Will the UK be able to strike a last minute deal with the EU.

(slide 13)

Portugal: GDP growth is slowing… but remains above potential… 

(slide 14)

Portugal: Government consumption has showed a modest growth over the current expansion

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