Whilst May retail sales came in lower than expected (though April’s numbers were revised higher), US economic data released during the week was positive. As the US economy improves and with the FED continuing to taper, the US$ is strengthening, in particular against the Euro, a trend I expect will continue. I also expect Sterling to strengthen further against the Euro, as the UK economy outperforms the Eurozone (EZ) and expectations of an interest rate rise by the BoE are brought forward. Indeed, the governor of the BoE, Mr Carney admitted that a rise in interest rates may come earlier than anticipated by markets. It is likely that the BoE will be the 1st major central bank to raise rates.

Subject to geopolitical risks, US bond yields will, I believe, rise further as the US economy improves and as the FED continues with its tapering programme. The 10 year yield increased to the mid 2.60’s during the week, though dropped following the threat to oil production posed by the insurgents in Iraq. The amount of bonds that will be issued is expected to increase from current levels, which should also increase yields. However, the differential between US and German yields may well slow both the pace and the absolute yield of US bonds.

I continue to believe that markets will gradually trend higher. However, problems in the Middle East, which have impacted oil prices, needs to be watched carefully as they pose a potentially material threat to markets. Brent, which had been stable, has risen to over US$113.

The central authorities in Beijing are ratcheting up their stimulus programme and the Central Bank is increasing liquidity. However, the response suggests to me that the authorities are deeply concerned about the economy, which is likely to have slowed far more than suggested by the official data. I continue to believe that China faces significant problems, though the measures taken by the authorities will buy it time.

US
US May retail sales rose by just +0.3% M/M, below the rise of +0.6% expected. However, the April data was revised higher to +0.5%, from just +0.1% reported initially. Core sales (which are used to calculate GDP) were unchanged, lower than the upwardly revised increase of +0.2% in April, which was initially reported a decline of -0.1%.

US consumer credit surged by US$26.8bn in April, the largest rise since January 2011. The March data was also revised higher to US$19.5bn, from US$17.5bn previously. The data confirms that the US consumer is increasing spending, which is a major positive for the economy.

The US May small business optimism index rose to 96.6, above the rise to 95.8 expected and the reading of 95.2 in April. Once again, small businesses reported difficulty in finding skilled workers and stated that they were increasing prices. The index has reached the highest level since September 2007. Yet more positive news in respect of the US economy.

Wholesale inventories rose by +1.1% in April, well above the rise of +0.5% expected. The increase in inventories suggests that Q2 GDP will be significantly higher than that in Q1.
Job openings rose to 4.5mn in April, as opposed to 4.2mn in March – yet another positive data point.

The import price index rose by +0.1% M/M (+0.4% Y/Y) in May, below the rise of +0.2% expected, though higher than the -0.5% in April.

Initial jobless claims came in at 317k, somewhat higher than the 310k expected and the 313k in the previous week. The 4 week moving average came in at 315.3k, from 310.5k in the previous week.

US producer prices declined by -0.2% in May, lower than the rise of +0.1% expected and April’s +0.6% increase. Y/Y, prices rose by +2.0%, lower than the rise of +2.1% in April. Core prices (excluding food and energy) declined by -0.1%, as opposed to the rise of +0.1% expected and April’s +0.5% increase.

Europe
EZ April industrial production rose by +0.8% M/M, better than the rise of +0.5% expected and the decline of -0.3% in March
Italian April industrial production rose by +0.7% in April, much better than the unchanged expected and the decline of -0.4% in March.
French industrial production rose by +0.3%, slightly lower than the increase of +0.4% expected.

UK industrial production rose by +0.4% M/M in April, in line with expectations and by +3.0% Y/Y, the largest increase since 2011. The better data confirms that the UK economic recovery is more broadly based than has been the case in the past.

UK unemployment continues to decline. The unemployment rate fell to 6.6% in the 3 months to April, the lowest level in 5 years. Employment rose by 345k. However wage growth slowed. Jobless claims declined by 27.4k in May, better than the decline of 25k expected. Sterling continues to strengthen, in particular against the Euro.

The sharp rise in property prices is causing concern for the BoE and the government. The Chancellor has promised to provide new powers to the BoE to curb mortgage lending.

Japan
Q1 GDP was revised higher to an annualised rate of +6.7%, up from +5.9% previously. Business investment was higher than estimated initially as was consumer spending. However, Aprils current a/c surplus fell to Yen 187.4 bn, below the forecast of Yen 287.7bn.

The Japanese government announced that corporate tax rates would be cut next year. However, the government will need to raise revenues from other sources given the large budget deficit.

As expected, the BoJ announced that it would continue to expand the monetary base by between Yen 60 tr and Yen 70 tr per month. It also kept its assessment of the economy unchanged. Analysts expect that the BoJ will have to increase its asset purchase programme later this year to achieve its inflation target of 2.0%.

China
Chinese exports rose by +7.0% Y/Y in May, above the rise of +6.7% expected. Imports declined by -1.6%, well below the rise of +6.0% expected, resulting in a trade surplus of US$35.92bn, the largest in 5 years. Recent data suggests that the domestic economy is weakening, though exports have picked up. Premier Li is urging local governments to help meet the government’s growth target this year. Additional capital expenditure projects, in respect of railways, highways and waterways have been announced. Furthermore, Reuters reports that the central authorities have instructed the provinces to spend their entire 2014 budget by the end of June. It is unclear as to what the provinces will do for the rest of the year. The Finance Ministry announced that spending by local and central government rose by nearly +25% in May Y/Y, far higher than the rise of +9.6% in the 1st 4 months of the year. The actions by the central authorities suggest strongly that they are deeply concerned about the economy.

S&P forecasts that Chinese home prices will decline by -5.0% this year, as opposed to the rise of +11.5% last year. There has been a wave of discounting to generate interest in property sales. The problems of the property sector remain a major threat to the Chinese economy.

To enable further lending and help to stem the downturn in the economy, the PBoC has cut the reserve requirement ratio by 50 bps for a large number, but not all, banks.

May CPI rose to +2.5% Y/Y, slightly higher than the +2.4% expected and above the +1.8% in April. Higher food prices contributed to the increase. However, the inflation rate remains below the governments 3.5% target, which could allow for further monetary easing by the central bank, the PBoC. The producer price index declined by -1.4% Y/Y, though by not as much as the -2.0% decline in April and the -1.5% expected.

New loans amounted to Yuan 870.8bn in May, above the Yuan 750bn expected. Total aggregate financing was Yuan 1.4tr, in line with estimates, though below the Yuan 1.55tr in April. Money supply (M2) rose by 13.4% in May Y/Y, exceeding the forecast of arise of 13.1%. The Central Bank continues to inject liquidity into the system.

Chinese industrial output increased by +8.8% in May Y/Y, above the rate of +8.7% in April, though in line with estimates. Retail sales rose by +12.5% (+12.1% expected) and fixed asset investment between January and May came in at +17.2%, roughly in line with the +17.3% rise in the 1st 4 months of the year. However, home sales remain a problem, declining by -11.0% Y/Y in May. The property sector remains a material problem.

Other
The World Bank has reduced its growth forecast for the current year to +2.8%, down from its January forecast of +3.2%. US growth was downgraded to +2.1% (+2.8% previously), with growth of the BRICs (mainly Brazil and Russia) also revised lower. Growth in the EZ was left unchanged at +1.1%.

The oil price has been relatively stable for many months. However, problems in the Middle East (in Iraq, Libya, and possibly Iran in particular), could disrupt supplies. Supply is relatively tight and OPEC decided to maintain and not to increase supply at its recent meeting. However, demand has increased, as China has decided to increase its strategic reserve.  There is a possibility that oil prices will spike, which clearly will be negative for the markets.

 

Kiron Sarkar
14th June 2014

Category: Markets, Think Tank

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