Macroeconomic focus - October 2021 Economic outlook

Higher rates on the horizon

US economic data suggest fourth-quarter economic growth will be very high at approximately 7% on an annualised basis. The carry-over effect in consumption is significant and capital goods orders are robust, which indicates healthy investment expenditure. Despite falling back in December, the PMI surveys remain at high levels, with flash estimates coming in at 57.8 for the manufacturing sector and 57.5 for the services sector.

The latest employment report was solid. Job creations from the business survey came in below expectations at 210,000, but those calculated based on the household survey were buoyant at 1.9 million in like-for-like terms. The unemployment rate, given that it is calculated from the household survey, fell from 4.6% to 4.2%. The labour force participation rate rebounded, although it remained well below its pre-crisis level. Hourly earnings came in slightly below expectations but remained relatively strong for non-managerial employees.

The October JOLTS survey revealed that labour market pressure remains high with job vacancies nearing a peak and a record high quit rate. Inflationary pressures do not seem to be easing either. November’s figures remained high but in line with expectations. Year-on-year headline inflation reached its highest level since 1982 at 6.8% and the core rate (excluding food and energy) reached its highest level since 1991 at 4.9%.

Against this backdrop, the Fed is beginning to gradually scale back its support for the US economy. At the end of the 15 December meeting, Fed Chair Jerome Powell announced that the pace of its monthly tapering would double from 15 to 30 billion dollars, meaning that purchases could reach zero by March 2022. The FOMC members also raised their interest rate forecasts, with the median forecast now for three 25 bps increases in 2022 and again in 2023, followed by another two in 2024. The long-term rate remains unchanged at 2.5%.

Pivoting policy is a delicate exercise and Jerome Powell seems to have succeeded so far given that the market has been pricing in rate tightening as early as 2022. The question now is the extent of the tightening. We still expect the Fed to have to gradually shift its interest-rate path upwards.

[1] PMI : The Purchasing Managers’ Index (PMI) is an index of the prevailing direction of economic trends in the manufacturing and service sectors.

[2] JOLTS survey : The Jobs Openings and Labor Turnover Survey interprets the state of the U.S. labor market by asking companies quantitatively and qualitatively about job openings and hiring and firing prospects.

[3]Fed: The United States Federal Reserve, the central bank of the United States.

A smooth transition for the ECB

After holding up well in November in the face of a Covid resurgence and tighter health restrictions, the PMI survey index fell back in December. The flash eurozone composite PMI fell 1.9 points to 53.4, a level consistent with fourth-quarter year-on-year growth of around 2.0%. The decline in the composite PMI is primarily due to a slowdown in the services sector. The manufacturing sector also slowed but to a lesser extent.

Breaking down the manufacturing PMI data reveals that supply chain bottlenecks, while still significant, are abating. The increase in delivery times has been slowing for the past two months, stocks of intermediate products are rising, and the pace of price increases is slowing. German car production also rebounded after falling sharply due to the semi-conductor shortage.

November’s inflation figures indicate further acceleration across the eurozone. The year-on-year increase in the headline index jumped from 4.1% to 4.9%, a record high since the early 1990s, and core inflation rose from 2.0% to 2.6%, marking another record since the eurozone was created. Base effects explain some but not all of the high figures and the ECB’s monthly seasonally adjusted data indicate that upward price momentum is now much stronger than in the past.

That being said, the ECB does not appear to be in any great hurry to raise interest rates. At the end of its 16 December meeting, Christine Lagarde stated that she thought a rate hike in 2022 was highly unlikely. The ECB believes that the current spike in inflation is temporary and mainly due to supply chain issues. The central bank’s forecasting division now sees inflation at 1.8% in 2023 and 2024, which is below its 2% medium-term objective.

The ECB notes that progress has been made in terms of moving towards its inflation target and that scaling back its support measures is justified. The emergency programme set up to combat the effects of the pandemic (PEPP) will end as planned from March 2022. Proceeds from maturing bonds will be reinvested until at least the end of 2024. To smooth the decrease in the monthly volume of asset purchases, the ECB will temporarily increase those made under its regular asset purchase programme (APP), for which no end date has been set.

[1]PMI: PMI indices are confidence indicators that summarize the results of surveys conducted among company purchasing managers. A value greater than 50 indicates a positive sentiment in the sector concerned (manufacturing or service).

[2] ECB: European Central Bank (ECB)

[3] PEPP: Pandemic Emergency Purchase Program, a plan to purchase debt on the markets to lower the cost of financing for governments, businesses and households

Economic policy easing

November’s economic data was a mixed bag but remain consistent with a fourth-quarter growth rebound.

Retail sales were particularly disappointing, increasing just 3.9% year-on-year compared to 4.9% the previous month. Sales fell markedly in the catering sector amid tighter health restrictions. The authorities continue to pursue their zero-Covid strategy, with residents in various regions encouraged not to travel for the Lunar New Year on 1 February and as initial evidence suggests that the Chinese Sinopharm vaccine fails to protect from Omicron even after a third dose.

Property sector data improved slightly but remained weak overall. The fall in year-on-year investment spending improved from -5.4% to -4.3%, housing starts fell -21.0% versus -33.1% previously, and residential sales improved from -24.1% to -16.3%. House prices fell for the third straight month, bringing the year-on-year increase to 2.4%.

Industrial output was better than expected with a year-on-year increase of 3.8%. Healthy export volumes underpinned manufacturing, but production remains down in some energy-intensive industries such as cement and steel, which are highly exposed to energy rationing as well as the property sector slowdown. Energy shortages appear to be easing given the fall in the price of coal per ton and helped by expanding coal production. This is slowing the rise in production prices, which are up 12.9% year-on-year.

Consumer price inflation remains contained at 1.2% year-on-year excluding food and energy. The authorities have been able to ease monetary policy in a bid to boost credit growth and business activity. Banks’ reserve requirements have been lowered by 50 bps and the 1-year base lending rate, the cheapest rate that banks can offer to businesses and households, has been reduced by 5 bps to 3.80%.

At the end of the annual economic conference, which sets the broad guidelines for 2022, and pending the target figures that are traditionally published in March, the authorities emphasised that stability will be a priority in 2022. It was suggested that economic policy will be more accommodating and that the long-term goal of shared prosperity will necessitate greater wealth, which in turn implies maintaining buoyant growth.