Weekly global economic update
What’s happening this week in economics? Deloitte’s team of economists examines news and trends from around the world.
China: Weak domestic demand, strong exports
- While most major economies worry that inflation remains above central bank targets, many investors worry that China’s inflation is too low and that the risk of deflation has not disappeared. Here are the numbers.
In China, consumer prices were up only 0.2% in June from a year earlier. This is down from 0.3% inflation in April and May. Prices were down 0.2% from May to June. In fact, in three of the last four months, prices fell from the previous month. Thus, deflation remains an issue. When volatile food and energy prices are excluded, core prices were up 0.6% in June from a year earlier.
What is driving very low inflation? It helps to look at the details. In June, food prices were down 2% from a year earlier. This included a 7.3% drop in the prices of fresh vegetables and an 8.7% drop for fresh fruit. On the other hand, prices were up 1.5% for clothing and up 1.5% for health care. Also, the government reported that factory gate prices (producer prices) in China were down 0.8% in June from a year earlier. This is the slowest decline since December 2022. Still, on an annual basis, factory gate prices have been falling in every month since September 2022. This likely reflects excess capacity as well as the impact of declining commodity prices.
China’s continuing weak inflation is, in part, a reflection of weak domestic demand. Chinese consumers have been hurt by the crisis in the residential property market, which has led a decline in property prices and, therefore, perceived wealth. In addition, weak activity in property seems to have stifled purchases related to new homes. Also, the job market is relatively weak, while private sector business investment has been stagnant. Plus, household savings has been high owing to consumer uncertainty about the economic environment.
At a time of weak domestic demand, the government has relied on exports to drive economic growth, especially exports related to information technology and clean energy. Yet China has faced a backlash from its trading partners who claim that China is competing unfairly through subsidies, a charge China denies. Yet the backlash is hurting China’s ability to boost exports. In fact, Chinese exports of electric vehicles (EVs) fell 13.2% from May to June. This follows action by both the European Union (EU) and the United States to restrict imports of Chinese EVs. Moreover, Chinese producers of lithium batteries are reported to be suffering financial losses.
Thus, stimulating domestic demand will likely be important to generate economic growth and reduce the risk of deflation. The government has taken modest steps including subsidies to complete unfinished home construction and modest declines in some interest rates. Yet more action is likely needed. This could entail strengthening the social-safety net to encourage less savings.
- At a time when the Chinese economy is growing too slowly, the central bank has gradually eased monetary policy with the goal of stimulating more credit activity. Yet the latest data indicates that the growth of bank lending has declined the slowest rate on record. Specifically, in June, bank lending was up 8.1% from a year earlier, the slowest rate ever. The growth of bank lending has been declining steadily for several years, but the decline has accelerated in the past year.
There are two ways this can be interpreted. One interpretation is that the central bank needs to ease monetary policy further and that current monetary conditions are not conducive to credit creation. The other is that monetary policy is simply not working because China is in a liquidity trap. That is, despite lower borrowing costs, potential borrowers are not responding and, instead, are hoarding cash. This could reflect weakness in domestic demand and poor sentiment on the part of potential borrowers.
What is the solution to a liquidity trap? The answer is often fiscal stimulus. That is, what might be needed is for the government to boost spending, funded by borrowing, and directly stimulate aggregate demand. Another solution is deregulation of the market economy aimed at removing bottlenecks to economic activity.
- An important part of the growth strategy for China is to boost investment and exports in key technologies such as information technology, EVs, and batteries. Based on the latest data, the strategy shows signs of success. That is, exports grew rapidly in June, rising at the fastest rate in almost two years. However, China faces a growing protectionist policy against some of its exports, coming from Europe and North America as well as other locations. The risk is that such restrictions on trade will inhibit China’s ability to boost exports, thereby slowing economic growth.
Let’s look at the details. In June, Chinese exports (measured in US dollars) were up 8.6% from a year earlier, the fastest rate of growth in 21 months. It’s possible that some companies are frontloading exports in anticipation of higher tariffs. In fact, imports declined 2.3% in June versus a year earlier, the steepest decline since February. Given that a large share of imports are inputs used to produce export-oriented products, the drop in imports bodes poorly for future exports. The drop in imports might also reflect weak domestic demand.
For the first six months of 2024, exports were up 3.6% from a year earlier. By industry, this included an increase of 21.6% for integrated circuits, 18.9% for automobiles, and 85% for ships. On the other hand, steel exports were down 9.3%. Also, in the first six months of 2024 imports were up 2%. This included a 54% increase in imports of automatic data processing equipment and an 11% increase for high-tech products.
By country, exports in the first six months were up 1.5% for the United States and down 2.6% for the European Union (EU) and down 6.3% for Japan. However, exports grew more strongly for Southeast Asia and Latin America. Specifically, exports were up 10.7% for Southeast Asia and up 11.3% for Latin America. Meanwhile, imports were down 4.9% from the United States, down 5.7% from the EU, and down 3.9% from Japan. Imports were up from other parts of the world, including India, Russia, and Southeast Asia.
The shifting trade landscape is likely a reflection of the impact of trade restrictions as well as the shift in supply chain investment by large global companies. Going forward there is a risk of further trade restrictions by the United States and EU, thereby encouraging companies to reduce supply chain exposure to China and obtain more imports from other locations. For China, this would mean more exports of inputs to Southeast and more final assembly taking place in Southeast for export to the rest of the world. This process is already under way and is likely to accelerate.
The big question for China, given its massive investment in export-oriented production of high technology and clean energy technology, is whether export growth will be sufficient to justify that investment. Already officials in the United States and EU are complaining that China is subsidizing exports and selling products below cost. China denies this, but the result has been more restrictions on trade. If China’s exports do not continue to rise rapidly, it is not clear that China’s domestic market will be able to absorb the added output.
US inflation decelerates, Fed signals amenability to easing
- In the United States, bond yields declined while the value of the dollar fell against major currencies following news that inflation in June was lower than expected. In the futures market, the implied probability of a September rate cut by the Federal Reserve increased from 72% yesterday to 92% today. Let’s look at the data.
The US consumer price index (CPI) was up 3% in June versus a year earlier, the smallest increase in 12 months. Prices were down 0.1% from May to June. This follows no change in the CPI from April to May. Thus, on a monthly basis, inflation has evidently halted. Of course, weak food and energy prices played a role. When volatile food and energy prices are excluded, core prices were up 3.3% in June from a year earlier, the lowest core inflation since April 2021. Core prices were up 0.1% from the previous month.
These numbers were better than expected, leading to revised expectations about Federal Reserve behavior. The details were interesting as well. For example, prices of durable goods continued to decline at an accelerated pace, falling 4.1% in June versus a year earlier. This included a decline of 4.6% for furniture, 3.6% for appliances, 10.1% for used vehicles, 5.6% for televisions, 6% for toys, 3.9% for computers, and 10.3% for smartphones.
Meanwhile, prices of non-durable goods increased a modest 1.3% in June versus a year earlier. This was mainly driven by the 2.2% increase in food prices. Excluding food, non-durables prices were up only 0.3%. On the other hand, prices of services continued to rise rapidly, up 5% from a year earlier. This included a 5.2% rise in the price of shelter (housing) and a 6.9% rise in the price of hospital services. On the other hand, the price of renting a car fell 6.3% and airline fares fell 5.1%.
In any event, many services are labor intensive, and labor costs are rising—albeit at a slower pace than previously. In his latest testimony, Federal Reserve Chair Powell said that the labor market is no longer a concern regarding inflation. This implies that inflation in services is likely to recede in the coming months. That, in turn, suggests the Fed is ready to start cutting interest rates.
Although the latest inflation data suggests an increasing likelihood that bond yields will decline in the coming months, risk spreads on junk (high-yield) bonds have been rising amid an increase in corporate bankruptcies. The gap in yields between low- and high-rated corporate bonds has risen to the highest level in more than a year. The recent rise likely also reflects concern that the Fed’s previous delays in cutting rates will lead to even more bankruptcies. However, the latest inflation data suggests a higher likelihood of an imminent rate cut. Moreover, in his testimony recently, Fed Chair Powell indicated that keeping rates high creates risk to the financial system. Thus, there is reason to expect that spreads will decline in the near term.
- One of the biggest uncertainties in the world of finance concerns the timing of an easing of monetary policy by the Federal Reserve. Investors hang on every word uttered by Fed Chair Powell to gain insight into his thinking. It was no different recently when Powell offered testimony to a Congressional committee. And his words were well received. Specifically, Powell said that there has been “considerable progress” in the fight against inflation, and that the Fed will wait a bit longer to cut rates. He added that “more good data would strengthen our confidence that inflation is moving sustainably toward 2%.”
In recent months, the biggest impediment to an easing of monetary policy by the Fed has been concern about the labor market. A tight labor market was generating big wage increases, which have an inflationary impact on labor-intensive services. Yet recently, Powell said that labor market conditions “have cooled while remaining strong.” He added that the labor market is “not a source of broad inflationary pressures for the economy now.” Powell said that this was not his view as recently as two months ago.
While the Fed is mandated by Congress to target minimal inflation combined with maximum employment, the reality is that, in the past year, the Fed has been almost exclusively focused on fighting inflation. That may be changing. In his testimony, Powell said that “elevated inflation is not the only risk we face.” Rather, he said that sustained high borrowing costs could “unduly” damage the economy. Thus, he is evidently becoming more concerned about trade-offs in monetary policy. Indeed, he said that “we’re very much aware that we have two-sided risks now.”
The Fed’s favorite measure of inflation (the personal consumption expenditure deflator) is now at 2.6%, very close to the 2% target. Moreover, the Fed has previously emphasized that the target is not meant to be a ceiling, but rather an average. As such, 2.6% appears to be benign. Meanwhile, the unemployment rate has risen while the so-called Sahm Rule has been activated. Thus, from the Fed’s perspective, inflation is tame while the labor market is weakening. That seems like a good time to cut interest rates. Investors have been anticipating that the Fed will start to cut rates at its September meeting, the last meeting before the election in early November.
US job market signals possible recession
- Could a US recession be under way? That question arises because the Sahm Rule has been activated. The Sahm Rule, named for former Federal Reserve economist Claudia Sahm, is not so much a rule as a consistent pattern for more than 60 years. It says that when the three-month moving average of the unemployment rate exceeds the lowest unemployment of the last 12 months by more than 50 basis points, a recession has begun. Recently, the US government reported that, in June, the unemployment rate rose to 4.1%. The three-month moving average is 4%. The lowest unemployment rate of the last 12 months was 3.5%. Hence, the Sahm Rule now prevails.
Claudia Sahm herself has said that the rule named for her is not a law of physics. Rather, it is a pattern that has been consistent, but might not continue. Thus, it ought to be taken with a grain of salt. Still, the unemployment rate has risen rapidly in recent months. In fact, Dr. Sahm recently said that now is a good time for the Federal Reserve to cut interest rates. She said: “My baseline is not recession. But it’s a real risk, and I do not understand why the Fed is pushing that risk. The worst possible outcome at this point is for the Fed to cause an unnecessary recession.” She appears to be saying that the ball is in the Fed’s court.
In any event, let’s consider the latest jobs report. The US government releases a jobs report based on two surveys: One is a survey of establishments; the other a survey of households. The establishment survey found that 206,000 new jobs were created in June—a very strong number, but the second slowest job growth in the past seven months. In other words, the job market appears to be slowing while remaining relatively strong.
By industry, there was strong growth in construction but a decline in employment in the manufacturing sector. In addition, employment declined in retailing and increased only marginally in financial services, information, and wholesale trade. Moreover, employment fell sharply in professional and business services, largely reflecting a big decline in employment in temporary job services. In addition, there was a very small increase in employment in leisure and hospitality. On the other hand, there was a big increase in employment in health care and social assistance as well as in state and local government. Overall, job growth was relatively concentrated in a small number of industries.
Meanwhile, the establishment survey also included data on wages. The government reported that average hourly earnings were up only 3.9% in June versus a year earlier, the smallest increase since June 2021. This suggests that the tightness in the job market is easing. That bodes well for a continued deceleration in inflation. Indeed, the principal worry of the Federal Reserve in the past year has been the tightness of the job market and its impact on wages.
Finally, the household survey, which includes data on self-employment, found that the size of the labor force increased considerably faster than the working-age population. That is, the participation rate increased. Yet employment increased more slowly than the labor force, resulting in a slight increase in the unemployment rate from 4% in May to 4.1% in June.
What will the Federal Reserve make of this report? First, they might take note that the Sahm Rule has been activated. Second, they may note that, although employment grew at a healthy pace, it grew more slowly than in recent months and the growth was concentrated in only a few industries. Third, they may note that wage inflation has decelerated to the lowest level in three years. Given that the Fed’s Congressional mandate is to minimize inflation and maximize employment, this data suggests that an easing of monetary policy could come soon. Of course, much will depend on what the next set of inflation numbers indicate.
Data signals strong US consumer sector and declining inflation
- In May, US real (inflation-adjusted) disposable personal income increased from the previous month. In addition, real consumer spending increased. Thus, the consumer side of the US economy appears to be relatively healthy. Moreover, the government’s report on income and spending also included data on the Federal Reserve’s favorite measure of inflation, the personal consumption expenditure deflator, or PCE-deflator. It indicated that inflation receded further in May, with core inflation hitting the lowest level in three years. This combination of economic strength and weakening inflation suggests the possibility that the Fed may start cutting rates sometime soon.
Let’s look at the details: In May, real disposable personal income (income after inflation and taxes) was up 0.5% from the previous month, reflecting strong increases in wages after inflation. In addition, real personal consumption expenditures were up 0.3% from the previous month. The latter included a 1.1% real increase in spending on durable goods, a 0.3% gain for non-durable goods, and a 0.1% increase for services.
Regarding the PCE-deflator, overall prices were up 2.6% from a year earlier. When volatile food and energy prices are excluded, core prices were also up 2.6% from a year earlier, the lowest rate of core inflation since March 2021. By category, prices were down a sharp 3.2% for durable goods, up 1.6% for non-durable goods, and up 3.9% for services. While the latter number is one of the lowest in three years, it remains too high for the Fed’s comfort. Services are labor-intensive and wages continue to rise sharply amid a tight labor market.
Economists are divided as to when the Fed may start to cut rates. Some argue that the very low level of core inflation means that the Fed has largely achieved its goal. Others worry, however, that persistent services inflation will not abate until the economy softens. They suggest that sustained tight monetary policy will be needed to facilitate such an outcome.
Eurozone inflation down considerably
- While inflation in the 20-member Eurozone is now relatively low, it remains above the European Central Bank’s (ECB’s) target of 2%. Moreover, after receding rapidly, both headline and core inflation appear to have stabilized in recent months at a level too high for the ECB to be complacent. This suggests that the job of the ECB is not finished and that it might ease monetary policy slowly in the coming months. Moreover, ECB deliberations could be disrupted by financial market volatility.
Let’s look at the data: In June, Eurozone consumer prices were up 2.5% from a year earlier, down from a rate of 2.6% in May but higher than the 2.4% inflation recorded in both March and April. When volatile food and energy prices are excluded, core prices were up 2.9% in June versus a year earlier, the same rate as in March and May and higher than the 2.7% rate recorded in April. In other words, core inflation has stabilized above the ECB target.
One factor that explains the relatively low headline inflation rate is the 0.2% rate of inflation for energy. Food prices, meanwhile, were up 2.5% in June from a year earlier. Prices of non-energy industrial products were up a mere 0.7% in June from a year earlier while prices of services were up 4.1%. The latter number has barely moved in the last six months. This persistence of service inflation likely reflects the labor-intensive nature of services and the fact that tight labor markets are generating big wage increases. This is the principal concern of the ECB. Meanwhile, the European Union (EU) released data on employment in the Eurozone. It found that the Eurozone unemployment rate remained unchanged in May at an historically low 6.4%.
The recent persistence of service inflation could be attributable, in part, to the start of the tourism season and to the intense demand for major sporting and entertainment events (think Taylor Swift). Still, the ECB will closely watch the labor market for signs of rising or falling demand. It will also look at other factors such as labor productivity and migration, both of which can have a big impact on wages. ECB President Lagarde said that the policy committee will closely watch data, noting that it will “take time” to determine the direction of things.
BIS warns central banks against complacency
- The Bank for International Settlements (BIS), which is the central bankers’ central bank, has warned central banks not to loosen monetary policy too soon. In its annual report, the BIS noted considerable progress for the global economy in terms of inflation and growth, but said that serious risks remain, including the risk of policy failure. While inflation in major jurisdictions has declined, “the recent stickiness of inflation in some key jurisdictions reminds us that central banks’ job is not yet done.” It noted that, in major economies, inflation remains above central-bank targets. It expressed particular concern about persistent inflation in services. It said that “premature easing could reignite inflationary pressures and force a costly policy reversal—all the costlier because credibility would be undermined.”
Interestingly, BIS research indicates that the ratio of service prices to goods prices remains below the pre-pandemic level. This reflects the impact of the spurt in goods prices early in the pandemic. The BIS suggested that the current high inflation in services reflects a trend toward restoring the traditional relationship between the prices of services and goods. Unless there is further goods price deflation, it is likely that this process will entail overall inflation remaining above pre-pandemic levels for some time.
In addition, the BIS said that the global financial system is at risk from persistent high fiscal deficits as well as troubles in the commercial property market. Regarding fiscal policy, it noted that the trajectory of fiscal policy in major economies is unsustainable. Although investors have not yet reacted adversely to current fiscal trends, this could change, thereby wreaking havoc in financial markets and creating difficult choices for central banks. A top BIS official said that “we know that things look sustainable until suddenly they no longer do—that is how markets work.” Fiscal expansion played a role in the post-pandemic rebound of major economies. Yet, when policy tightens, it could cause a slowdown in growth.
PMIs indicate modest growth for global manufacturing industry
- The latest purchasing managers’ indices (PMIs) for manufacturing indicate that the global industry continues to grow at a modest pace after having contracted last year. PMIs are forward-looking indicators meant to signal the direction of activity in the manufacturing industry. They are based on sub-indices such as output, new orders, export orders, employment, input and output pricing, pipelines, inventories, and sentiment. A reading above 50 indicates growing activity. The higher the number, the faster the growth. The figures are compiled by S&P Global.
The global PMI for manufacturing was nearly unchanged in June at 50.9, indicating modest growth of activity. The survey found that output and new orders continued growing but at a slower pace. Export orders declined. However, employment and input and output pricing all accelerated. The acceleration in prices raises questions about inflationary trends. The PMI for manufacturers of consumer goods was relatively high while that of capital goods producers was relatively low. The latter potentially bodes poorly for investment spending.
The countries with the highest manufacturing PMIs were India, Russia, Vietnam, Greece, and Taiwan. The lowest were Germany, Austria, Poland, and Czechia. Of the 31 countries analyzed, 19 had PMIs above 50, indicating growth, while 10 had PMIs below 50. Two countries had PMIs at 50. The countries of Asia as well as the United States had relatively strong growth while Europe excluding the United Kingdom saw a sizable decline in activity.
Here are a couple of key points inferred from the PMI data. First, the German manufacturing sector PMI fell to 43.5 in June, indicating very rapid decline. This led S&P Global to ask, “Will this downturn in manufacturing never end? It will, but apparently it is going to take longer than expected.” S&P noted that there was a sharp decline in new orders and export orders. However, sentiment improved, suggesting that companies see light at the end of the tunnel. The sharp decline in export orders is especially concerning and might reflect increased competition from Chinese companies.
Another interesting aspect of the global data concerns Taiwan. It’s manufacturing PMI increased sharply from 50.9 in May to 53.2 in June, hitting a two-year high. This dramatic improvement reflected a surge in demand for Taiwan’s globally competitive IT products, a reflection of the surge in AI investment. Companies were able to boost output without boosting employment because of substantial improvements in labor productivity. Still, facing labor constraints, companies have been forced to increase prices. Also, the manufacturing PMI in Vietnam surged, rising from 50.3 in May to 54.7 in June. This likely reflects an acceleration in supply chain shifts from China to Southeast Asia.