- Big Picture: Risk sentiment was negative following the US elections, even though the results were very much as expected. Focus has now shifted to the fiscal cliff. The course of the global economy hinges on its resolution, as well as the euro crisis. We expect US policymakers to reach an agreement to reduce the pace of fiscal tightening to more manageable levels, but it may well be an eleventh-hour affair.
- Europe: Finance ministers are unlikely to come up with a decision on the next tranche of aid for Greece. This is likely to materialize later this month, as European policymakers wait for the Troika’s assessment. In the meantime, the Greek government will be in the tricky position of relying on treasury bill issuance to meet its financing needs. Still, it is difficult to imagine that the authorities will stand by and allow an ‘accidental default’.
- US: Economic data during the week were generally positive. They suggested that Q3 GDP is likely to be revised up, while the recovery has since continued to gain pace. Hurricane Sandy is starting to introduce some noise into the numbers, which will make reading trends a little more difficult than usual.
- China: Economic data confirmed that the economy is regaining some traction. Meanwhile, the process for the country’s leadership transition is underway. The only two certainties on the Politburo Standing Committee are that Xi Jinping will succeed Hu Jintao, and Li Keqiang will be the next Premier. Both are considered to be cautious reformers at best.
We have long argued that the global business cycle was likely to turn up a little towards the end of the year and that appears to be happening.
Chinese economic data released last week was clearly upbeat. Industrial production and retail sales were stronger than expected in October and the growth trajectory of both series is now clearly upward sloping again. Chinese inflation was actually a little lower than expected. Stronger output growth and retail spending coinciding with lower inflation is a favourable combination.
In the US, Hurricane Sandy is set to affect some US economic data in the weeks to come, making it harder to read. For example, the drop in jobless claims last week was undoubtedly affected by the adverse weather conditions on the East coast, so one should not become overly enthusiastic about this data.
But the September trade figures, which showed strong exports, and the rise in consumer confidence in November suggest that the US economy is finding a more solid footing.
Europe and Japan are laggards. Having said that, the harder data in Europe is not deteriorating much further. Admittedly, eurozone retail sales fell 0.2% mont-on-month in September, but the year-on-year comparison actually inched up from -0.9% to -0.8%.
In Germany, both industrial production and orders were weak in September, falling 1.8% and 3.3% month-on-month, respectively. Here too, the year-on-year comparison stabilised at -1.2% (versus -1.3%) for production and -4.7% (versus -4.6%) for orders.
Japanese data have been weak, with Q3 GDP shrinking.
Areas of Divergence
While the US economy appears to be making some progress and the cycle in key emerging economies is bottoming out, Europe and Japan remain very weak. Such a divergence does not tend to last forever.
Another area of remarkable divergence can be identified in the US, where the labour market is clearly improving but corporates appear extremely reluctant to raise capital spending. Commentators speculating about why investment is so disappointing recently blame the 'fiscal cliff'. If the cliff can be avoided, which, admitted, is a big if, then it would appear that pent-up demand is building for corporate investment.
Some commentators argue that the labour market may not be all that strong. We think that line of thought is not correct. Recent revisions to payroll data have been consistently positive, which is typical for a turning or an inflexion point.
In addition, the so-called household survey is showing strong gains in employment. While that survey is more volatile than the more closely watched 'establishment survey', the household survey tends to be quite a useful variable for identifying turning points.
The preliminary consumer confidence survey of the University of Michigan showed confidence at its highest level since mid-2007. Consumers are undoubtedly more optimistic as the housing market is turning, but a rise in consumer confidence could hardly happen if the labour market was weak.
US Fiscal Cliff
Unfortunately, there is no clear sign that the US fiscal cliff can be easily avoided now that the elections are out of the way and relative political strengths have not changed decisively. Downside risks therefore remain and the clock is ticking.
The next couple of weeks are set to be volatile and potentially nerve- wracking for market participants. If the cliff is avoided, the US economy can perhaps hang on to its improving momentum. In such a scenario, pent-up demand in the US will be unlocked, making for an acceleration of growth, which will likely take the rest of the world with it, unless Europe manages to lose control over the euro crisis.
On the other hand, if the cliff question remains unresolved and sizeable automatic fiscal consolidation kicks in, the US economy would be thrown into recession, pushing the rest of the world economy downhill as well, surely to the detriment of markets for risky assets.
If tension within the eurozone were to rise significantly as well, then the downturn in markets for risky assets would be all the more negative. The most likely course is somewhere in the middle.
Retail sales in the eurozone fell by 0.2% month-on-month in September after they rose by 0.2% in August. During Q3 as a whole, sales were up by 0.4% quarter-on-quarter, a significant improvement from Q2, when they fell by 0.7%.
However, part of the strength in retail sales was compensated by falling new passenger car registrations (minus-6.4% quarter-on-quarter in Q3 after minus-0.6% in Q2), implying that private consumption probably continued to decline somewhat in Q3 after it fell by 0.4% quarter-on-quarter in Q2.
The European Commission published its Autumn Economic Forecast last week. It lowered its forecast for GDP growth and expects further weakness in the second half of the year. Indeed, it now expects GDP to have been flat last quarter, before shrinking in the current quarter.
The economy will pick up at a snail’s pace next year. Consequently, the Commission now expects GDP to fall by 0.4% on average this year and to grow by merely 0.1% in 2013 (revised lower from -0.3% and +1.0%, respectively). The Commission’s forecasts are very close to our own.
Germany published disappointing data last week. Factory orders dropped by 3.3% month-on-month in September (August: -0.8%). Orders from within the eurozone were the weakest, plummeting by more than 11% month-on-month.
Capital goods orders from other eurozone countries were particularly sluggish, falling by more than 9% month-on-month and almost 16% year-on-year. This suggests that fixed investment in the eurozone, which declined by 1.5% quarter-on-quarter in Q2, will probably continue to contract sharply in the second half of this year, as companies postpone investment plans due to the ongoing uncertainty surrounding the eurozone crisis.
Meanwhile, industrial production in Germany fell by 1.8% month-on-month in September and exports declined by 2.5%. Both were still positive during Q3 as a whole (production +0.7% quarter-on-quarter and exports +1.5%), but their weakness at the end of the quarter means both series started Q4 on a very weak note. Consequently, it seems very likely that GDP will contract slightly in Q4 after it probably rose moderately in Q3.
In Greece, the government forecasts government debt to rise to around 190% GDP next year. It will take some rather heroic assumptions for the Troika [the European Commission, European Central Bank and International Monetary Fund] to project that debt will approach the (probably still unsustainable) 120% GDP level in 2020.
However, the Troika has no choice as there does not seem to be the political will to put in place another debt restructuring right now. In addition, the authorities want to keep the pressure on Greece to carry out reforms. However, a new debt restructuring looks to be a matter of when, rather than if.
Data on Q3 GDP growth (0.9% decline quarter-on-quarter compared with 1.3% and 0.1% increases in Q1 and Q2) confirm that the economy is moving towards a new recession, just one year after the previous downturn ended.
Private consumption and exports were particularly disappointing, with exports falling 5% 0 quarter-on-quarter compared with a 1.3% rise in the previous quarter. The decline in exports came as no surprise because monthly export data already pointed in this direction. The figures reflect the combined effects of the euro crisis, the strong yen and, to a lesser extent, the dispute with China over the Senkaku/Diaoyu islands.
We had pencilled in flat growth rates for Q3 and Q4, but we will be presenting a new forecast. It now seems likely that GDP will also contract in Q4 given that the problems in the export sector will continue, while subsidies that support consumer demand will end in November. Still, we expect Japan’s own fiscal cliff issue to be resolved soon.
The October Economy Watchers Survey (survey of professionals whose businesses are sensitive to consumer demand) indicates that the index on current conditions fell from 41.2 to 39. Meanwhile, the outlook index was also down. The continuous declines since April are another indication that the economy is moving towards a recession.
In September, machine orders (an indicator of corporate investment over the next three to six months) fell by a larger-than-expected 4.3% month-on-month. Looking at the quarter-on-quarter figure, the trend line is negative.
One should not exaggerate the quality of this investment indicator. However, given other evidence development of exports, the Tankan), we continue to assume that corporate investment will rise only marginally, if at all, for the time being.
The list of poor data out of Japan is a long one this week. In September, the current account was in deficit (on a seasonally-adjusted basis). We do not consider this an acute issue, but evidence of large problems looming in the longer term.
Data released last week showed that the economy is clearly stabilizing, reinforcing some of the positive data released earlier, including October’s purchasing managers’index.
Indeed October’s data for industrial production growth improved to 9.6% year-on-year from 9.2% (steel production rose to 12.6% year-on-year in October compared with 9.6% in September), fixed asset investment growth edged up to 20.7% from 20.5% (property investment stabilising at around 15%) and retail sales remained robust, reaching 14.5% year-on-year from 14.2%.
Meanwhile China’s exports rose 11.6%, higher than 9.9% in September. Exports to the EU declined at a slower pace (-8.1% from -10.7%). Overall, the positive data may point to some upside risks to our fourth quarter GDP forecast of 7.5% year-on-year.
However, the improved economic conditions will reduce the urgency of any additional easing. As such, we think that the recovery will be a modest one.
Meanwhile CPI inflation in October reached 1.7% year-on-year a 33 month low, coming down from 1.9% the previous month. This was the result of falling food price inflation, with vegetable prices subtracting 0.3pp from overall inflation. Non-food inflation was flat.
Our CPI forecast for 2012 is 2.8% year-on-year. Despite the low inflation, property-price stability remains a major objective. This is probably one of the reasons why monetary easing has been more cautious than expected this time. However, the central bank has lately made use of reverse repo operations to increase liquidity in the system.
Because non-credit financing and short-term capital flows are returning, we think that this implies that targeting bank credit is no longer sufficient and more focus will probably be given to market liquidity. Given the improvement in economic conditions, we maintain our stance of no interest rate or reserve requirement cuts in the near term, despite the lower inflation context.
Every ten years, major leadership changes take place in China. The only two certainties on the standing committee are Xi Jinping, Hu Jintao’s successor, and Li Keqiang, the next Premier. Both are considered to be at best cautious reformers.
Given the limited information on the agenda of the National Party Congress, it is difficult to evaluate the impact that this will have on economic policy. There is already guidance provided by the 12th five-year-plan announced in 2011 and any new reforms that could be announced will probably complement the five-year-plan.
About the Author
ABN AMRO serves retail, private and commercial banking customers in the Netherlands and across the globe. This article is excerpted from “Macro Weekly: Focus on the Fiscal Cliff” published on 12 November 2012 and has been re-edited for clarity and conciseness. It is solely intended to provide financial and general information on economics and does not constitute an offer of securities to the public nor a solicitation to make such an offer.