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What’s happening this week in economics? Deloitte’s team of economists examines news and trends from around the world.
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The number of infections has been increasing rapidly in the United States, putting stress on the health care system. Although the number of infections per capita had started to abate in mid-November, it sharply increased in the weeks following the Thanksgiving holiday during which millions of Americans traveled to be with family. Perhaps of greater importance than the number of reported infections is the number of people hospitalized and the number who die. As for hospitalizations, COVID-19 patients often occupy beds in intensive care units (ICUs). In many parts of the country, there is a growing shortage of ICU beds, creating a potential public health crisis if non-COVID-19 patients cannot be properly treated.
According to data from the Federal government, about one third of the US population lives in areas where fewer than 15% of ICU beds are currently available. In addition, about 10% of the population lives in areas where fewer than 5% of ICU beds are available. The number of COVID-19 patients in hospitals has suddenly increased rapidly. For example, the total number of hospitalized COVID-19 patients increased from 56,942 on November 8 to 104,600 on December 8. The number in ICUs increased from 11,223 to 20,483 over the same time frame. In addition, the number on ventilators increased from 2,977 to 7,245.
This situation has led to various responses from state governments. In my home state of California, where less than 15% of ICU beds are available, the governor has ordered a partial lockdown, but not as severe as the one implemented in March and April. In only two states (California and Ohio) has a stay-at-home order been implemented. Only nine states have ordered that most businesses close. In contrast, 35 states have a mandatory mask wearing order, although enforcement seems weak in many places.
As for deaths, the number of deaths per capita has increased to the highest level since the crisis began. The good news is that survival rates for those infected have improved, likely due to medical professionals having learned a great deal about what works and doesn’t work.
What are the economic implications of this outbreak? We already know that there was a sharp deceleration in consumer spending in October and a sharp deceleration in employment growth in November. Given that the outbreak appears to be worsening as December progresses, it seems likely that economic indicators will worsen during this month. Deloitte forecast is that, in the fourth quarter, real GDP will be up from the third quarter at a moderate pace. However, we expect a downturn in economic activity in the first quarter of 2021. After that, there are two major factors that will determine the path of the economy—the path of the virus and the policy response. The incoming administration intends to encourage widespread wearing of masks. In addition, it intends to boost funding for testing and tracing so that asymptomatic sufferers of the virus can be identified and encouraged to self-isolate so as not to transmit the virus. The hope is that these measures could help to quickly suppress the outbreak and allow the removal of economic restrictions. The second factor is the policy response, which is currently the source of debate in Washington.
Until a week ago, it seemed likely that another stimulus bill would be passed, but timing is currently up in the air. While there are discussions on providing direct support to the unemployed and to distressed businesses, there are disagreements over the amount and the restrictions on providing money to distressed state and local governments. There is also disagreement about the degree to which businesses should be protected from liabilities stemming from infections of employees or customers. The bipartisan proposal that was the original basis for recent optimism about passing a bill included money for the unemployed but no stimulus money for households.
In any event, passage of a bill before the new administration takes office on January 20 remains unclear. One problem is that a special government program of pandemic-related unemployment insurance benefits is set to expire at the end of this month, potentially leading to a serious cash shortfall in January for roughly 14 million unemployed workers. For many of those people, this will mean a complete loss of income, setting the stage for a surge in evictions, foreclosures, and personal bankruptcies. This is one reason why quick passage of a new bill is seen as critical.
China continues to outperform the world’s major economies, this time with extraordinary growth of exports. Specifically, Chinese exports (evaluated in US dollars) increased 21.1% in November versus a year earlier, the fastest growth in nearly three years. This was up from 14.1% growth in October. Exports hit a record high level in November, fueled in part by strong exports of personal protective equipment (more commonly known as PPE) and technology related to online interactions. Both categories have been in high demand throughout the pandemic. Moreover, should the outbreak in the United States worsen, it will probably have a positive impact on Chinese export growth. Plus, the soaring US housing market has contributed to strong growth of Chinese exports of household appliances. Notably, exports to the United States were up 46.1% in November. Meanwhile, exports to the European Union (EU) were up 8.6%, to Japan 5.6%, to ASEAN 8.8%, to South Korea 9.5%, and to Taiwan 18.1%.
Imports rose a more modest 4.5% in November versus a year earlier. The result was that China’s trade surplus soared to a record level. All this has happened despite a sharp rise in the value of the renminbi in the past year. However, currency movements tend to influence trade flows with a lag. Thus, it could be that the negative impact on exports from a rising renminbi will not be felt until 2021. Moreover, if a vaccine is widely introduced in the coming year, it could lead to a deceleration or decline in demand for pandemic related goods. Thus, the surge in China’s exports might abate. Plus, a post-virus world will likely entail a shift in consumer spending away from goods and more toward the kinds of services that consumers have avoided over the past year. Tourism, for example, could surge in 2022. A return to global travel will likely lead to a big increase in Chinese tourism, thus reducing the country’s trade surplus.
With the Eurozone economy likely to contract in the current quarter due to the second wave of the virus, the European Central Bank (ECB) has chosen to provide the economy with additional stimulus through a further easing of monetary policy. The ECB increased its bond buying program, known as the Pandemic Emergency Purchase Program (PEPP), from 1.35 trillion euros to 1.84 trillion euros. It said that this program will be extended to March 2022 rather than the previously planned ending of June 2021. Moreover, it said it will reinvest maturing securities until the end of 2023. This means that the asset base of the ECB will continue to increase until 2022 and will not start to decline until at least 2023. Christine Lagarde, president of the ECB, said that if the economy recovers more quickly than now anticipated, full implementation of the PEPP might not be necessary.
In addition, in order to maintain a steady stream of credit market activity, the ECB will offer banks the ability to borrow directly from the ECB at rates as low as –1.0%, provided that the banks use the funds for loans to households and businesses. In other words, the ECB will effectively pay banks to lend money to the private sector. The idea is to keep credit-market activity growing. The ECB also announced other measures aimed at boosting liquidity and retaining an easy monetary policy for a prolonged period. For example, it extended the time frame during which collateral requirements for loans are reduced. The ECB said that “the monetary policy measures taken today will contribute to preserving favorable financing conditions over the pandemic period, thereby supporting the flow of credit to all sectors of the economy, underpinning economic activity and safeguarding medium-term price stability.” It noted that there remains considerable uncertainty regarding the path of the virus and the timing of the full implementation of a vaccine.
In response to the ECB’s announcement, the value of the euro increased against the US dollar. Normally, a more aggressive monetary policy, in which borrowing costs are suppressed and liquidity is expanded, would presage a decline in the value of a currency. Yet investors evidently expect that, with this change in policy, the outlook for economic growth will improve, thus putting upward pressure on the value of the currency. Still, given the current outbreak of the virus, the ECB downgraded its forecast for economic growth in 2021. However, the recent restrictions on economic activity during the outbreak have already resulted in a decline in the number of daily infections. If this continues, it could lead to a robust economic recovery in 2021—even before full implementation of the vaccine.
British Prime Minister Boris Johnson had a number of discussions with European Commission President Ursula von der Leyen last week in an attempt to avoid the United Kingdom leaving the transition period without an agreement on the future relationship between the United Kingdom and the EU. Although another deadline has been missed, the two sides have agreed to continue talking. Despite some frosty interactions between Johnson and von der Leyen earlier in the week, things have improved marginally with the two able to agree a joint statement following their most recent call—albeit one that offered little sign of a breakthrough on the big sticking points.
In any event, what would a no-deal Brexit entail? It would mean that both sides will revert to World Trade Organization (WTO) rules. What are WTO rules? To keep global trade fair and as open as possible, all WTO members are bound by the most-favored nation principle, which requires them to offer all trading partners the same tariffs without discrimination. Any advantage given to one country must be also made available to others. The exception to the rule is where a free trade agreement (FTA) has been put in place. This will mean the erection of tariff barriers in both directions and some services suppliers will no longer be automatically eligible to trade cross-border.
Because of this, the pound is likely to further decline in value, thus boosting the competitiveness of British exports, increasing the cost of imports into the United Kingdom, increasing the value of the vast amount of overseas assets held by Britons.
Many of the changes faced by businesses on January 1, 2021 will come into play regardless of whether a free trade agreement (FTA) is in place. Outside of the EU’s Single Market and Customs Union, the freedom of movement of goods, services, people and capital ends, leading to changes in a number of areas. For example, the implementation of full border controls (such as, customs declarations and compliance with animal and plant health measures) will create additional compliance requirements for businesses irrespective of whether there is an FTA. It is, therefore, possible that costs will increase and there could be delays to the movement of goods as businesses adjust to new processes.
In the absence of an FTA, there would also be tariff costs. The UK goods sold into the EU will be subject to the Common External Tariff, which on average is fairly low, although it can vary greatly on individual products. Goods originating in the EU sold into the United Kingdom would be subject to the UK Global Tariff, which has the effect of maintaining the EU’s tariffs on some goods and reducing or eliminating them on others.
There will be changes to the United Kingdom’s immigration system, with the United Kingdom’s new points-based immigration system taking effect on January 1, 2021. This new immigration system will set the eligibility criteria for entering the country to work, live, or study, and the same principles will apply to both UK and EU nationals. UK nationals will also be subject to EU member state immigration rules for third-country nationals. An FTA would include some provisions around international travel to provide services, so in the absence of a FTA, there will be greater restrictions, such as on “fly-in fly-out” services and secondments.
Britain will not be alone in facing negative economic consequences from a no-deal Brexit. Several countries in Northern Europe, especially Ireland, Germany, the Netherlands, Belgium, and the Nordic countries, are expected to be hit. The German automotive industry is very concerned, given that it will face a 10% British tariff on the importation of autos and automotive parts. Furthermore, often automotive parts move between the United Kingdom and the EU multiple times in the course of manufacturing a finished vehicle, which would mean significant tariff costs arising. For Germany’s automotive industry, Britain is the largest export market. While there are other countries with larger sales of German cars (the United States and China), German cars are mostly assembled in these countries. Meanwhile, 1.5 million cars are imported into the United Kingdom each year, many of them from Germany. If Britain adopts different standards than the EU regarding safety and environmental protections, it will also increase the cost for automotive companies to do business in the United Kingdom, potentially leading to higher-priced automobiles.
Aside from automotive, there are other important industries that will potentially face disruption. These include aerospace, air travel, pharmaceuticals, information technology, and financial services. Once the COVID-19 crisis ends and tourists resume travel, a cheaper pound might boost the British tourist industry. In contrast, British tourists could face higher costs in traveling to the continent.
In discussions with clients and Deloitte partners recently, the question that came up most often concerned the behavior of equity prices. Specifically, I was asked how it could be that central bankers and economists (like me) keep warning about significant dangers to the economy while investors continue to push up equity values into the stratosphere? My answer is that there are four possible explanations.
First, good news about vaccines and their imminent distribution has likely convinced some investors that a robust recovery is just around the corner. They reasonably assume that, once the vaccine is widely distributed in rich countries, herd immunity will quickly be achieved, setting the stage for consumers to return to economic activity in droves. Indeed, consumers in the United States are sitting on a large pile of cash that could be used once pent-up demand is unleashed. This, in turn, could lead to upward pressure on prices, which would be good for corporate profitability. Moreover, the so-called “breakeven” rate, which is an excellent proxy for investor expectations of long-term inflation, has risen lately. The 10year breakeven rate has hit its highest level since May, suggesting that investors have upwardly revised their inflation expectations based on the potential impact of a vaccine. Still, the breakeven rate remains below the level seen before the crisis struck. This means that many investors expect that, over the next 10 years, inflation will be lower than they had expected prior to the crisis.
Second, based on comments made by central bank leaders, investors expect central banks to continue injecting large amounts of liquidity into financial markets. Historically, low yields amidst lots of cash mean that investors are likely eager to put funds into riskier assets, such as equities. The result is a continued rise in equity prices.
Third, a disproportionate share of the increase in equity prices this year stemmed from the performance of technology companies. Investors have bet that, in the aftermath of this crisis, the transition to more remote interaction will continue. Thus, if large numbers of people continue to work, shop, and be entertained remotely, then technology companies will be the principal beneficiaries. Thus, their high share prices might make sense.
Finally, one could make the argument that the surge in equity prices is not rational. That is, perhaps it is a speculative bubble, driven by excess liquidity and irrational exuberance on the part of investors. There have been countless bubbles in history, during which people often say that “this time is different.” It never is. And it always ends in tears. Bubbles are often driven by investors who might even see trouble brewing but decide to jump in lest they miss out on making a killing. One way to spot a bubble is to look at the price/earnings ratio, which currently is quite high. At the least, this suggests the need for caution. However, Nobel Laureate Robert Shiller says that, despite the high price/earnings ratio, today’s valuations might make sense. He says that an equity’s value should be the discounted value of expected future earnings. He notes that the rate at which equities are discounted is now historically low, thereby suggesting that a high valuation is warranted.
The latest employment reports from the US government confirm that the economy is likely facing headwinds stemming from the current outbreak of the virus. Job growth in November was significantly slower than in October. In addition, although the unemployment rate fell modestly, it was entirely due to the fact that a large number of people departed the labor force, likely discouraged by the paucity of available jobs. It can also be argued that the slowdown in job growth was influenced by the end of government stimulus. Indeed, we already know that consumer spending decelerated sharply in October, possibly influencing the hiring decisions of businesses in November.
The US government publishes two employment reports: one based on a survey of establishments; the other based on a survey of households. First, let’s consider the establishment survey. The government reports that, in November, there were 245,000 new jobs created, a sharp decline from the 610,000 created in October and the 711,000 created in September. This was the smallest job gain since the big decline in employment in April. Keep in mind that, in November, government employment declined by 99,000, mostly due to the dismissal of temporary census workers. Excluding this, job growth was a more respectable 344,000. Still, private sector job growth clearly decelerated sharply. Despite the slowdown, there were pockets of strong job growth. For example, there was a significant increase in jobs in residential construction and real estate services, both reflecting the strength of the US housing market. Employment in automotive manufacturing increased as consumer demand for cars continued to strengthen. Employment in warehousing and storage increased as online shopping services continued to grow at the expense of retail stores, which saw a sharp decline in employment. Employment also grew at couriers and messenger services, temporary employment services, health care, and leisure and hospitality services, such as amusement parks and spectator sports. In addition, there was a decline in employment at nursing homes, which have been disrupted by the virus.
The separate survey of households revealed that the labor force contracted by 400,000 people in November, leading to a decline in the rate of participation. In addition, participation fell sharply for those with a high-school education while participation increased for those with a university education. The result was that the unemployment rate fell from 6.9% in October to 6.7% in November. While the number of people reporting that they were unemployed (actively seeking but not finding work) fell sharply, the number of people reporting that they were unemployed for more than six months increased sharply once again. This suggests that many businesses are either shutting down or permanently downsizing. That, in turn, is a reflection of the economic scarring taking place due to the pandemic. That is, as personal behavior changes in response to the pandemic, certain businesses in key industries are becoming unviable, leading to an increase in permanent unemployment. Moreover, the longer people are unemployed, the greater the difficulty in returning to the labor force. Meanwhile, the lion’s share of job losses involved less-skilled, lower-wage individuals working in service-providing industries. These are people who most likely lack the skills needed for the kinds of jobs that are presently being created. Thus, a mismatch in the job market is developing, with potentially negative consequences for the economy.
The second wave of the virus in Europe is starting to abate. For example, the number of new infections in France peaked at 823 per million population on November 8. By November 29, it had fallen to 174 per million. Similarly, large reductions took place in Spain, Italy, and the United Kingdom. In Germany, the rate of infection remained steady and below that of the other countries. Evidently, governmental efforts to keep people apart by stifling economic interaction has been a success. The issue now is what this will mean for the economic situation. It is already likely that real GDP will decline in the fourth quarter. After that, suppression of the virus, combined with a removal of economic restrictions, should set the stage for a robust recovery. However, there is concern that, with a prolonged rollout of the vaccine likely, the European economy will remain at risk for much of 2021. Indeed, the International Monetary Fund (IMF) says that many businesses in the Eurozone face the risk of insolvency without further government support. As such, the IMF called on the European Central Bank (ECB) to provide direct financial support to troubled businesses in order to prevent mass failure.
However, it would be counterproductive to provide support to those businesses that are not likely to remain in business after the crisis ends. Consequently, the IMF suggested that support only be given to viable businesses “while facilitating the exit of unviable companies.” Doing this will be challenging, not least because of the political controversies that are likely to arise. In addition to monetary policy support, the IMF also said that fiscal support will be needed “for longer than initially envisioned.” It suggested that the EU’s restrictive fiscal rules should only be reactivated once the economic recovery is well under way. The IMF has long been a strong advocate of fiscal probity. For it to suggest that fiscal rules be set aside is unusual and notable. Meanwhile, the EU has still not disbursed the EUR750 billion of support to member states that had been agreed upon because there remain disagreements about how the money should be spent. The IMF said that this source of funding could ultimately play a significant role in supporting Europe’s recovery.
Interestingly, as the second wave of the virus began to soar, retail sales in the Eurozone performed surprisingly well in October. This was before governments across Europe imposed new economic restrictions thereby leading to a decline in consumer mobility. Still, the strong numbers for October suggest underlying strength in the regional economy. After all, the increased household saving of the last several months set the stage for consumers to spend at a healthy pace. While we are forecasting a sharp decline in real GDP in the fourth quarter due to the policy response to the second wave, we also believe that, provided the virus is suppressed by early 2021, a robust economic rebound can potentially take place.
The EU reported that, in October, real (inflation-adjusted) retail sales in the 19-member Eurozone were up 1.5% from September after having fallen 1.7% in the previous month. In addition, real retail sales were up 4.2% from a year earlier. The figures for the larger EU were nearly identical to the Eurozone figures.
The most notable trends were the sharp decline in retail sales of apparel and textiles, and the continued rapid growth of spending online. By country there were divergences. From September to October, real retail sales increased 2.6% in Germany, 2.8% in France, 0.6% in Spain, and fell 0.7% in the Netherlands. Data was not available for Italy.
During this crisis, the greatest disruption occurred in the broad services sector, especially consumer-facing services, such as hospitality and leisure businesses. Thus, the state of the services sector is, in part, a good indication of the health of the overall economy. Last week, IHS Markit released its latest purchasing managers’ indices (PMIs) for services and the results indicate a modest deceleration of global services activity in November. The deceleration is largely due to a sharp decline in activity in Europe and a moderate decline in Japan. In the United States, China, and India, however, activity increased, accelerating in both the United States and China. The weakness in Europe reflected the negative impact of governments imposing new economic restrictions in response to the virus outbreak. In the United States instead the outbreak did not evidently have a negative economic impact—at least not yet. The United States did not impose major restrictions and data on consumer mobility suggests that consumers continued to patronize service businesses.
PMIs are forward-looking indicators meant to signal the direction of activity. They are based on such sub-indices as output, new orders, export orders, employment, pricing, and sentiment. Services encompasses tourism and hospitality, retail, wholesale, transportation, telecoms, finance, professional services, education, and health care. A reading above 50 indicates growing activity; the higher the number, the faster the growth.
Let’s consider the details: first, the global PMI for services fell slightly from 52.9 in October to 52.2 in November, a level indicating moderate growth in activity. In the United States, the PMI increased to 58.4, the highest level since 2015 and indicating very rapid growth. There was strong growth of output and new orders. In addition, business sentiment improved significantly in response to the news about potential vaccines. This, in turn, likely contributed to increased employment.
In Europe, however, the situation was very different. The services PMI for the United Kingdom slipped to 47.6, indicating a significant decline in activity amidst renewed economic restrictions. Likewise, the PMI for the Eurozone also fell sharply, hitting 41.7 in November, indicating a very rapid decline. The PMI in Germany, at 46.0, was the best among large European economies, indicating a moderate decline in activity. The PMIs were far worse in France (38.8), Italy (39.4), and Spain (39.5), indicating a very rapid decline in activity. The good news is that the economic restrictions in Europe have led to a sharp reduction in the daily number of new infections. This sets the stage for a robust recovery of activity in 2021.
Finally, in Asia Pacific, PMIs were in favorable territory in China (57.8), India (53.7), and Australia (55.1), but not in Japan (47.8). Most notable and impactful was the very strong number for China. There, new orders grew at the fastest rate in a decade. However, export orders remained muted. Thus, it appears that China’s domestic demand is strong, a fact that will likely stimulate activity in other countries. In Japan, however, domestic demand was weakened by the renewed surge in the virus. The decline in new orders accelerated and employment declined as businesses prepared for a period of muted activity.
Meanwhile, the global manufacturing sector performed exceptionally well in November. The global manufacturing PMI increased to 53.7, a 33-month high and one of the highest levels in the past decade. It was driven by strong growth of output, new orders, and favorable sentiment. Export orders increased, but only modestly. The countries that had strong manufacturing PMIs were the United States (56.7, a six-year high), Canada (55.8), Brazil (64.0), United Kingdom (55.6, a three-year high), Germany (57.8), India (56.3), China (54.9, a 10-year high), and Taiwan (56.9, a nine-year high). However, some countries continued to have stagnant manufacturing sectors. These included Mexico (43.7), Japan (49.0), and ASEAN (50.0). The most notable aspect of the report is the strength of China’s manufacturing sector, driven in part by very strong new orders, disproportionately due to domestic rather than export orders. This indicates strong domestic demand, a factor that could help to drive global exports to China.
Around the world, governments are increasingly setting rules or goals aimed at ending the sale of new gasoline and diesel-powered vehicles. Japan intends to ban the sale of traditional vehicles by the mid-2030s. The United Kingdom intends to ban traditional vehicle sales by 2030 and ban hybrid vehicles by 2035. The result would be that only electric vehicles would be sold thereafter. In my home state of California, the government will ban gasoline powered vehicles by 2035. Although the Trump administration has attempted to prevent California from implementing such rules, it is highly likely that California’s efforts will be supported by the incoming Biden administration. In France, the government intends to implement a similar rule by 2040. Finally, China is considering new rules aimed at reducing the sale of traditional vehicles.
If fully implemented, the hope is that these efforts will contribute to the larger goal of having economies become carbon neutral by mid-century. In any event, a dramatic shift away from gasoline-powered vehicles will likely have a negative impact on global demand for petroleum. All other things being equal, this will likely lead to much lower prices for carbon-based fuels. Meanwhile, the production cutting agreement of OPEC and Russia (known as OPEC+1) is set to expire. The member states have agreed to gradually ease the production ceilings so as not to generate a sharp drop in prices. The hope is that, with a vaccine soon to be introduced, traders will expect stronger demand and thereby elevate energy prices. For countries that are highly dependent on the export of carbon-based fuels, there will be a need to diversify. The recent rapprochement between Israel and several Arab oil-producing countries, although likely related to their mutual concerns about Iran, might also be reflect a need for the oil producers to diversify and embrace technology related industries. The latter is where Israel has competitive strength.
Also, a dramatic shift toward electric vehicles will likely have disruptive effects beyond the oil industry. Gasoline (petrol) stations will have to become electric charging stations. Yet they will have to continue selling gasoline until the fleet of traditional vehicles dies out. Automotive repair shops will have to dramatically re-tool and their employees will have to be retrained. Materials used for battery production will see a sharp rise in demand and, possibly, prices. Globally, there is already a race under way to secure materials and production capacity. Electric power generation will have to rise accordingly and there will be debates about the optimal source of power. There will likely be efforts to encourage more use of nonrenewables, possibly including nuclear power. Yet, in many countries, the existing power grid remains highly dependent on carbon-based fuels.
The latest outbreak of the virus in Europe and the United States has resulted in very different economic outcomes. In Europe, the implementation of significant economic restrictions has led to a sharp decline in consumer mobility and a decline in economic activity. In the United States, in contrast, state governments have only undertaken limited restrictions while consumer mobility has barely changed. The result is that the economy appears to be doing quite well this month, based on the latest purchasing managers’ indices (PMIs). Meanwhile, economic activity in Japan continues to decline, but at a decelerating pace. Let’s consider the PMIs for each region. First, keep in mind that PMIs are forward-looking indicators meant to signal the direction of activity in the broad manufacturing or services sectors. They are based on sub-indices, such as output, new orders, export orders, employment, pricing, pipelines, and sentiment. A reading above 50 indicates growing activity, and vice versa. The farther the reading from 50, the bigger the increase/decrease in activity.
In the Eurozone, the economy is clearly bifurcating, with manufacturing doing well and services declining. Services encompasses retail, wholesale, telecoms, travel, distribution, hospitality, finance, professional services, education, and health care. The weakness in services reflects the large-scale aversion to consumer-facing services. Here is the data: The manufacturing PMI for the Eurozone fell from 54.8 in October to 53.6 in November, a level indicating continued moderate growth of activity. Still, the deceleration was significant and reflected a marked slowdown in output and growth of new orders. The services PMI, however, fell sharply from 46.9 in October to 41.3 in November, a six-month low. This was due to an especially sharp slowdown in activity in the hospitality and travel industries. The authors of the report indicate that the numbers suggest a strong likelihood that real GDP in the Eurozone will decline in the fourth quarter, which is precisely what Deloitte’s economists are forecasting. Nevertheless, the survey revealed that business sentiment has improved as companies increasingly expect the crisis to abate sometime in 2021. Perhaps their optimism reflects the news about vaccines.
Performance varied by country. In Germany, the manufacturing PMI, at 57.9, suggests strong growth. It is likely driven by strong demand for Germany’s capital goods exports, especially in China. The strength of manufacturing is expected to limit the downward movement of German GDP in the fourth quarter. The services PMI, at 46.2, indicates decline, but at a slower rate than in the rest of Europe. The decline in services activity likely reflects the impact of recently implemented restrictions meant to suppress the outbreak. Separately, the PMIs for France suggest a far greater decline in overall economic activity. The manufacturing PMI, at 49.1, indicates a modest decline in activity. France’s manufacturing sector is more closely driven by domestic demand and exports of consumer-facing industries than Germany’s. The French PMI for services fell to 38.0, a six-month low and a level indicating a rapid decline in activity. France has imposed stringent restrictions in response to a severe outbreak. Markit reports considerable weakness in the rest of the Eurozone as well.
Also, the PMIs for the United Kingdom moved in opposite directions in November. On the one hand, the PMI for manufacturing improved, rising to 55.2, a level indicating strong growth in activity. The strength of manufacturing reflected, in part, strong export demand, especially in other parts of Europe. The fear of an imminent no-deal Brexit could be spurring precautionary purchases to avoid disruption once the new year begins. On the other hand, the services PMI fell from positive territory to a six-month low of 45.8, a level indicating a rapid decline in activity. This likely reflects the impact of recent economic restrictions, which have especially hit the hospitality industry.
The situation is highly different in the United States. There, both PMIs improved in November. The manufacturing PMI increased from 53.4 in October to 56.7, the highest in 74 months and a level indicating strong growth. This was driven, in part, by very strong new domestic orders. Export orders were not especially strong. The domestic orders reflected strong demand by US consumers and businesses. In addition, sentiment improved substantially owing to vaccine news and the end of the election cycle. The separate services PMI increased from 56.9 in October to 57.7 in November, the highest in 68 months and a level reflecting strong growth. The sub-indices for new orders, employment, and sentiment were strong. Prices were up as demand evidently exceeded supply. The strength of services is somewhat surprising given the surge in the virus. However, recent mobility data indicates that many consumers are not responding significantly to the virus in terms of their behavior. Plus, state governments are mostly not implementing significant restrictions. If, however, the virus continues to spiral out of control, the situation could change.
Finally, the PMIs for Japan remain below 50 and are not improving, indicating a continued decline in economic activity. Specifically, the manufacturing output index, at 47.6, and the services PMI, at 46.7, both indicate activity declining at a moderate pace. Both numbers are marginally worse than in October. The Japanese economy has been in decline all year, despite the lack of a serious outbreak. However, the outbreak is currently worsening. Consumers are responding. Evidently, businesses are responding as well. The weakness of Japan’s economy reflects not only weak domestic demand, but the impact on exports from weak global demand.
A decline in government support for unemployed workers led to a decline in personal income in the United States in October. Although consumer spending continued to increase, it decelerated sharply, adding to concerns about a slowing economy at a time when the virus is spiraling out of control.
In October, personal income declined at an annualized rate of US$130 billion after rising at a rate of US$147 billion in September. The reversal was mainly due to a sharp decline in the amount of government support for unemployed workers. For many workers, extended unemployment insurance expired in October, leading to a sharp decline in income. Moreover, although wage income grew, it decelerated from September, almost entirely due to a sharp drop in wages paid in the trade, transportation, and utilities sectors. These sectors had seen a strong increase in September. Why the reversal? It might be related to the worsening pandemic. In any event, real (inflation-adjusted) disposable personal income fell 0.8% from September to October. Interestingly, if the sharp decline in government transfers were to be excluded, real disposable income would have grown 0.8%.
Meanwhile, real consumer spending increased 0.5% from September to October after having increased 1.1% in the previous month. The deceleration was largely due to a sharp decline in the growth of spending on nondurable goods. In nominal terms (not adjusted for inflation), spending grew at an annual rate of US$71 billion in October after rising at a rate of US$176 billion in September. After growing US$45 billion in September, spending on nondurable goods fell US$9 billion in October. And, after growing US$113 billion in September, spending on services grew only US$69 billion in October. As income fell and spending grew modestly, personal saving declined at an annual rate of US$202 billion. The personal savings rate fell from 14.6% in September to 13.6% in October. The report signals that consumers continued to boost spending in October but at a slower pace, likely due to declining government support and potentially an increased aversion to social interaction because of the outbreak of the virus. We are past November and the infection rate is much higher than it was in October. it is likely that spending is suffering as people further avoid social interaction, especially in those states that have implemented modest economic restrictions. Overall, our expectation is for positive but modest economic growth in the fourth quarter.
Global trade has bounced back after a sharp decline earlier this year, but it decelerated in September. The data for global trade comes from the Netherlands government’s Central Planning Bureau. The overall volume of global trade grew 7.9% in June, 4.8% in July, 2.4% in August, and 2.1% in September. The volume of trade remains roughly 4% below the level from a year ago. For the third quarter, however, trade volume was up 12.5% from the previous quarter, almost reversing the 12.2% decline in the second quarter.
In September, the volume of exports was up 2.5% in the Eurozone, 2.6% in the United States, 5.3% in Japan, and down 3.8% in China. However, Chinese exports had grown strongly in the previous two months. Exports increased strongly in emerging countries other than China. For all these countries, export volume decelerated in September versus August. It is important to note that growth of export volume is measured as the growth in nominal exports adjusted for changes in prices. In the case of China, nominal exports increased modestly in September, but this was due to a rise in prices. The volume declined, indicating a worsening of China’s export prowess.
Meanwhile, global industrial production increased only 0.9% in September, a deceleration from the previous two months. Industrial production declined in both the Eurozone and the United States but increased in Japan and China. It increased in emerging Asia excluding China as well as in Latin America. Industrial production declined in Central Europe, Africa, and the Middle East.
The problem with the latest data on global trade is that it reflects the world before the current surge in infections took place. Thus, it is hard to say what to expect going forward. The damage from the virus directly has a negative impact on consumer-facing services, not necessarily on demand for traded goods. However, the weakness of consumer-facing service industries can have a spillover effect on other industries, thereby dampening global demand.
In China, there has been a spate of defaults on loans to state-owned enterprises. This has alarmed the government and drawn new attention to the surge in debt that has taken place in the past year. In one case, a large company defaulted on AAA-rated commercial paper, suggesting that ratings agencies have been lax. Although the volume of defaults remains low by global standards, the Chinese government promised to “avoid a financial system crisis” and expressed “zero tolerance” for misconduct by companies. The inference is that the defaults reflect a lack of financial probity and possible corruption. A committee of the State Council said that “fraudulent issuance, disclosure of false information, malicious transfer of assets, and misappropriation of issuance funds will be strictly investigated.” While corruption should be investigated, the reality is that China has probably not had a sufficient number of defaults. That is, bad debts have been rolled over and companies have not often been disciplined for bad decisions. This discourages more efficient investment and rewards inefficient investments. In a US$13 trillion bond market, there have only been defaults on about US$24 billion in corporate bonds during the past year.
While the world waits to see what US President-elect Biden will do regarding trade policy, especially in Asia, China’s president said that China would consider joining the Trans-Pacific Partnership (TPP), the trade agreement from which the United States withdrew nearly four years ago. Some analysts expect Biden to seek US reentry into the organization. Meanwhile, the Regional Comprehensive Economic Partnership (RCEP), that China is seen as leading, is up and running. Neither organization involves US membership at this time, which potentially offers an opening for China to boost its geopolitical footprint. Last week, China’s president said, “Mounting unilateralism, protectionism and bullying as well as backlash against economic globalization have added to risks and uncertainties in the world economy.” It was likely meant as a critique of the current US policy. However, it is expected that policy will shift with the new Biden administration to some degree. China’s suggestion about entering the TPP, from which it had initially been excluded, signals possible anxiety about how the TPP, with future US membership, might threaten China’s dominance in the region. It is notable that the TPP goes much farther than the RCEP in liberalizing economic relations in the region. It not only involves reductions in tariffs on traded goods, but also focuses on services trade and other issues. Whether China would be welcomed into the TPP without structural changes to its economy is remains to be seen.
Meanwhile, there will soon be negotiations to create free trade between China, Japan, and South Korea, three countries that dominate the economy of east Asia. Such an agreement could make it more difficult for the United States to encourage Japan and South Korea to avoid economic interaction with China. China and Japan have committed to strengthening a rules-based multilateral trading system. Thus, it appears that a peaceful conflict is underway between China and the United States over who will lead the regional economy.