At the halfway point of Q4, the markets’ focus is on three things: inflation, growth, and central banks’ response.
With US and Chinese October inflation readings behind us, the focus shifts to the real economy’s performance, the world’s two largest economies reporting retail sales and industrial production figures. Helped by stronger auto sales, the first increase in six months, US retail sales likely turned in another solid showing of around 0.8%, the average pace in August and September. The core measure, which some models use to help forecast GDP, posted back-to-back increases in August and September for the first time in nearly a year. It rose by 0.8% in September, half of this year’s average in a highly volatile year (range this year -3.3% to up 8.6% month-over-month). More people working and earning more speaks to the income effect that drives consumption while rising equities and home prices reflect the wealth effect.
Industrial production has been kept in check by supply chain issues, not demand. Part of the acceleration in growth expected this quarter after the disappointing 2% annualized pace in Q3 comes from some easing of the supply disruption. Industrial output fell in August and September. It was the first consecutive monthly decline since March-April 2020. Manufacturing also fell in August and September. Oil and gas rigs rose by 23 in October, matching the most since January’s 36-rig increase, which bodes well for mining and drilling.
However, the October PMI and ISM surveys were less constructive. The manufacturing PMI was initially reported at 59.2, down from 60.7. It was subsequently revised in the final reading to 58.4, the first time below 60 since March and the lowest for the year. Still, it can hardly be considered weak. The same is true for the manufacturing ISM. It came in at 60.8 after rising to 61.1 in September (high for the year was set in May at 61.2). The new order component fell 60 for the first time since June 2020.
The Fed’s manufacturing surveys (Empire State, Philadelphia, and Kansas City) for November will be reported in the week ahead. In October, both the Empire State and the Philadelphia results were weaker than expected. However, Kansas City’s survey surprised on the upside. Economists (Bloomberg median forecasts) see the Empire State survey stabilizing and the Philadelphia Fed survey likely easing again.
Lastly, residential investment is expected to contribute to an acceleration of growth. Housing starts fell by almost 6.2% in Q3 and nearly 4% in Q2. The multifamily buildings were accounted for the 1.6% decline in September, and supply disruption and labor shortages appear to have been the most significant factor. Single-family starts were steady (~1.08 mln annualized). The number of single-family homes authorized for construction but not yet begun (~backlogs) slipped a little in September but, at 144,000, remain near 15-year highs.
China’s Xi may be re-interpreting history as he wishes, but the legitimacy of the Communist Party rests on its ability to deliver the goods, a rising living standard to a larger number of people. This is being profoundly called into question. The engines of growth have dissipated. The shift from rural to urban is largely completed. Great strides have been made to close the technology gap with the high-income countries. The collapse of property developers is another blow that can adversely impact almost a third of the economy. The world’s second-largest economy practically stagnated in Q3 (0.2% quarter-over-quarter), and forecasts for 1.5% growth in Q4 are being revised lower.
China reports October retail sales, industrial production, and fixed asset investment. The year-over-year pace of each is expected to slow sequentially on a year-over-year basis. Slow growth, higher inflation, and seemingly less liberty, as in personal freedom, as when young people can play video games, what songs are appropriate for karaoke, and the length of a man’s hair, has now become the state’s interest. Also, some of the regulatory crackdowns on the private sector risks killing the proverbial goose that laid the golden egg by stifling entrepreneurship. There might be greater tolerance for the lack of political freedom if the growth was more robust. Nationalistic strings can be played to fill the vacuum, but this is a dangerous path.
Japan, Canada, and the UK report CPI figures. Ideas that the world is going where Japan-led have been bandied about since the Great Financial Crisis, but as often seems to be the case, it is far too simple. We note too that negative policy rates were introduced in Europe before Japan. One way that Japan currently stands apart is that it is one of few countries that do not have an inflation challenge. On the contrary, Japan’s GDP deflator in Q3 (reported with the preliminary estimate of Q3 GDP on November 15 in Tokyo) is expected to be negative for the third consecutive quarter and the most in a decade (-1.2% year-over-year). Rising food and energy prices helped lift headline CPI above zero in September for the first time since in a year. Excluding fresh food and energy, consumer prices fell 0.5% year-over-year in September. In December 2020, it was at -0.4% year-over-year.
Among the high-income countries, Canada’s inflation is the third-highest behind the US and New Zealand. Last October, CPI rose by 0.4% in Canada, and this high bar means that year-over-year increase is unlikely to accelerate much from the 4.4% reported in September. However, in November and December, inflation is likely to rise sharply. The underlying measures are also increasing. The market is anticipating the first rate hike in Q1 22. It has priced in four hikes over the next twelve months and leans toward a fifth.
The UK’s inflation will likely surge starting with this week’s October reading. Last October, it was, so this year’s increase will translate into an equivalent increase in the year-over-year rate. Recall that in September, the year-over-year rate unexpectedly ticked lower in the headline and core measures. This month is another easy comparison (-0.1% in November 2020). Using monthly time series (EU harmonized measure), UK CPI has risen by nearly 3%.
However, more important for monetary policy will be the employment data on November 16, the day before the CPI report. As we noted before the BOE meeting, the furlough program ended in September, and without a clear view of the labor market, the urgency to do something seemed to be exaggerated. The change in the claimant count will be scrutinized, but most of the other components are for September, including earnings and employment changes. This month’s performance will be reported on December 14, the day before the next Monetary Policy Committee meeting. The overnight index swaps show that the market leans (~60%) chance of a hike in December, and fully priced and a bit more at for following a meeting on February 3.
The UK reports October retail sales at the end of the week. They have fallen without fail for the past five months. The BRC retail sales monitor has weakened steadily since peaking in April. It turned negative in September and unexpectedly remained contracting in October (-0.2%). Economists (Bloomberg survey) had expected a 1% rise.
We conclude with a quick overview of the five central banks from emerging market economies that meet in the coming days. They meet on November 18, except for Hungary, which meets on November 16. After hiking by 30 bp in July and August, the central bank slowed to 15 bp in September and October. The base rate stands at 1.8%. The CPI accelerated, jumping to 6.5% from 5.5% in September. Hungary will likely make a larger move, encouraged perhaps by the more aggressive hikes by Poland and the Czech Republic recently.
Indonesia’s central bank does not need to take any action. The October CPI was 1.66% higher than a year ago, and the core rate was slightly lower at 1.33%. The seven-day repo rate, its policy rate, is at 3.5%. The Philippine central bank is prepared to stand pat, though the October CPI was 4.6% (the second consecutive slowing after surging to 4.9% in August from 4.0% in July. The rate corridor is at 1.50%-2.0% (deposit and borrowing rate, respectively).
The South Africa Reserve Bank has left the repo rate at 3.5% since cutting by 25 bp in June 2020. The day before it meets, the October CPI will be published. The headline stood at 5% in September, and the score was at 3.2%. It does not feel much pressure to act yet, and it’s more likely that its first hike will be delivered early next year. Tha leaves the enigmatic Central Bank of the Republic of Turkey. The 200 bp increase in required reserves for foreign currency deposits and gold did not lend much support to the beleaguered Turkish lira, which fell to fresh record lows last week. Indeed, some took it as a preemptive move ahead of another rate cut (100 bp).
After trading broadly sideways June-August, the lira’s downtrend resumed in early September as the central bank governor shifted focus for policy to the core rate of inflation rather than the headline. This signaled the rate cut that followed. Among a host of credibility issues, part of the problem now is that the one-week repo rate (16.00%) is below the core CPI (October 16.82%). The lira has fallen nearly 25% this year after falling 20% in 2020. In the two years before the pandemic, the lira depreciated by a little more than 40%. Arguably the maxi-deval is aggravating price pressures coming from more than doubling the price of its biggest imports (processed oil and gas, precious stones, and metals)., which are primarily traded in dollars.