Macroeconomic focus - October 2023

United States: pockets of resilience

Household spending and the labour market were pockets of resilience for the US economy according to third-quarter data. Following a sharp rise in July, household spending held up well in August and retail sales rebounded sharply in September. Goods consumption in GDP calculated from market basket data analysis rose by 0.6% over the month. Job creations in September totalled 336,000. The figure exceeded expectations and data for the previous two months were revised upwards. The unemployment rate stabilised at 3.8%, slightly higher than a low of 3.4% that was reached last spring.

These pockets of resilience in the US economy could push the Fed to maintain restrictive monetary policy, yet downside risks to the economy are significant. The effects of the rise in interest rates are still materialising, as can be seen from fresh tightening in credit conditions for small businesses and weaker property sector data. Existing home sales sit at their lowest level since 2010, mortgage applications are falling and housebuilder confidence is waning. In addition, rising oil prices and the restart of student loan payments are likely to weigh on household spending in the months ahead. Congress passed an emergency extension to federal government funding until 17 November, but the impeachment of the House of Representatives Speaker is preventing a new budget from being voted, raising the risk of a budget shock. The strike action by the United Auto Workers union has done limited damage so far, but has further to go.

Despite the resilient economy, inflation is slowing sharply. The Fed’s preferred measure, the core personal consumption expenditure deflator (Core PCE inflation) excluding food and energy, rose by just 0.14% in August compared with July. If core inflation remains at the average level established over the past three months, the annual rate could fall below 2.5% towards the end of the first half of 2024, compared with 3.9% currently. Wages are also growing at a slower pace. For the second straight month, hourly earnings rose by just 0.2% in September, bringing the year-on-year change to 4.2% compared with a peak of almost 6.0% at the start of 2022.

Despite leaving the policy rate range unchanged at 5.25–5.50%, the Fed was more hawkish than expected at its September meeting. The dot plot, which displays the policy rate projections for each member of the Federal Open Market Committee (FOMC), foresees another rise before the end of the year and smaller cuts for the following two years. As such, the policy rate appears set to remain higher for longer. Since then, central bankers have adopted a more dovish stance, given that rising bond yields could produce the same effect as tighter monetary policy would.

Eurozone: weakness taking hold

Eurozone data for August and September’s PMI* surveys continue to signal a contracting economy. Retail sales fell sharply and industrial output only partially recovered following a slump in July. The eurozone’s composite PMI rose from 46.7 to 47.2, which is consistent with an annualised fall in GDP of around 1%. The new orders component continued to slip, which is not a good sign for future output levels.

This fall in new orders could now affect growth more than previously. During the pandemic, companies had built up bulging order books that made production less sensitive to falling demand. With data for Germany showing that production has caught up with orders, the impact on business of falling new orders could increase.

In addition, until last spring companies had been inclined to keep employees despite falling demand in a bid to avoid the challenges arising from labour shortages. The situation now seems to have reversed, with the employment and new orders components of business surveys back in lockstep. For the time being, the unemployment rate remains at approximately 6.5%, which is low.

The ECB’s August data show that monetary tightening pass-through is strong. The average interest rate on new bank loans was almost 5% for businesses, 8% for consumer loans and 4% for mortgages. Credit creation had already slowed significantly and this has been exacerbated by a sharp fall in new business loans.

A look at September’s inflation data reveals significant easing. Year on year, headline inflation fell from 5.2% to 4.3% and the rate excluding food and energy dropped from 5.3% to 4.5%. Underlying inflation was distorted, dragged down by changes in German transport prices and in some category weightings. That being said, when the monthly data is adjusted to account for these distortions, inflation is clearly abating. Core inflation is estimated to have risen at an annualised rate of around 3% in the last three months, only half the rate observed at the start of the year.

Following the ECB’s 25-bps policy rate increase in September, the central bank now considers that rates are high enough to bring inflation down. The question is how long they will stay this high.

*PMI: Purchasing Managers Index. The Purchasing Managers’ Index (PMI) summarises confidence levels among business purchasing managers. A figure above 50 indicates positive sentiment, while a figure below 50 indicates negative sentiment.

China: signs of stabilisation

Third-quarter growth figures and September’s data indicate that the Chinese economy is stabilising. Annualised GDP grew faster than expected at 5.3% in the third quarter following 2.0% in the second quarter. Carry-over growth for the first nine months of 2023 now stands at 5.2%. Barring the unforeseeable, the government is on the way to achieving this year’s growth target of 5%.

Following August’s positive economic readings, September’s figures brought more good news. Annualised manufacturing output stabilised at 4.5% and the services sector accelerated, growing 6.9%. Retail sales rebounded by 5.5% and investment by 2.5%. Exports contracted by -0.6%, imports by -6.2%, and new loans in China rose more than expected.

September’s PMI surveys diverged, with the official PMI rising from 51.3 to 52.0 and the Caixin PMI falling from 51.7 to 50.9. This can be explained by the fact that the official PMI focuses on large state-owned companies while the Caixin gathers data primarily from private sector small- and medium-sized companies. The average of these two indices reveals a composite PMI reading that has been stable at 51.5 for three months.

While the data is encouraging, the road to recovery for China’s economy remains uncertain due to turmoil on the property market. While the pace of contraction in housing sales eased in September, it stands at -17% year on year, suggesting that the impact of the government’s measures to support demand has been limited so far. Property prices are still falling, which is not good news for buyers.

Another source of bad news in the sector are the embattled property developers. Country Garden has warned that it expects to miss its bond debt payments and Evergrande has announced that it is unable to issue new bonds due to a regulatory investigation in China. This is a setback in the plan to restructure its offshore debt, which includes replacing defaulted debt by issuing new debt. A request to liquidate Evergrande’s assets has been filed with a Hong Kong court and awaits a decision. A hearing is scheduled for 30 October.