Weekly global economic update
What’s happening this week in economics? Deloitte’s team of economists examines news and trends from around the world.
Week of July 29, 2024
US economy remains resilient
- There have been some indications of economic weakening in the United States recently. Employment growth, while still strong, has receded; the unemployment rate has risen; high borrowing costs are starting to influence many consumers; and some consumer-focused companies are reporting weaker results as consumers trade down to lower priced products. And the latest report on real GDP growth in the second quarter was surprisingly good. The US economy evidently has remained resilient.
Why do we care about the GDP data? After all, the second quarter was April through June. The data is a look at the past, not the present or future. The reason we care is that it is a good snapshot of the entire economy. It tells us not only how fast the economy grew, but how fast many of the components of the economy grew. Moreover, it is the last major piece of information that the Federal Reserve will process before it makes its next set of decisions. So, with that in mind, let’s look at the data.
In the second quarter, real GDP grew at an annualized rate of 2.8%. Notably, in seven of the last eight quarters, the economy grew faster than 2%. Keep in mind, that most economists believe that, in the long term, the US economy is likely to grow in the range of 1.5% to 2%. Thus, one could argue that the economy was on fire in the second quarter.
Let’s look at the details: In the second quarter, real consumer spending grew at a rate of 2.3%. This included growth of 4.7% for durable goods, 1.4% for non-durable goods, and 2.2% for services. Yet real disposable personal income only grew at a rate of 1%. This means that households reduced their saving in the second quarter. It also suggests that spending growth might weaken in the third quarter.
In addition, non-residential fixed investment grew at a rate of 5.2%, the fastest since the second quarter of 2023. This included growth of 11.6% for business equipment (computers, telecoms, transport goods), the fastest since the first quarter of 2022. Equipment investment accounted for 0.6 percentage points of GDP growth. In fact, until now, investment in equipment had stagnated since late 2022. That partly explained weakness in demand for consultative services. Thus, the strong rebound in the second quarter likely bodes well for our business. Meanwhile, investment in structures (office buildings, shopping centers, factories, warehouses) fell at a rate of 3.3% while investment in intellectual property (software, R&D) grew at a rate of 4.5%. Residential investment fell 1.4%. Finally, inventory accumulation contributed 0.8 percentage points to GDP growth.
Lastly, foreign trade had a net negative impact on GDP, with exports growing 2% while imports grew 6.9%. In addition, government purchases increased at a rate of 3.1%, led by defense purchases at 5.2%. Excluding the impact of foreign trade, grows domestic purchases were up at a rate of 3.5%. This is the final value of purchases made by US residents. It is a strong number, suggesting healthy domestic demand.
Although the economy was strong in the second quarter, there are signals of potential weakening. As such, this likely implies that the Fed will start to cut interest rates in September.
- In addition to GDP, the US government reported on consumer income and spending in June, the last month of the second quarter. As was true in May, real (inflation-adjusted) consumer spending grew faster in June than real disposable income. For this to happen, the savings rate fell in June. Going forward, if the deceleration in job growth leads to slower income growth, it could mean a slowdown in consumer spending once households stop reducing their saving. Meanwhile, the Federal Reserve’s favorite measure of inflation continued to improve in June.
In June, real disposable personal income (income after inflation and after taxes) increased 0.1% from the previous month. The personal savings rate (the share of disposable income that is saved) fell from 3.5% in May to 3.4% in June. It was the fifth consecutive month in which the amount of money saved fell from the previous month.
Consequently, real consumer spending increased 0.2% from May to June. This included a 0.2% decline in real spending on durable goods, a 0.5% increase for non-durable goods, and a 0.2% increase for services.
From a year earlier, real disposable income was up 1% in June while real consumer spending was up 2.6%. The latter included a gain of 2.9% for durable goods, 2% for non-durable goods, and 2.8% for services. The bottom line is that consumer demand has been stronger than income growth. The question is how long can this go on? As the late economist Herbert Stein once said, “If something cannot go on forever, it will stop.”
Yet this can continue for a while if households are willing to reduce their savings rate, dip into existing savings, and take on more debt. And, indeed, debt has been rising, leading some observers to worry about the probity of household finances. On the other hand, household debt service payments as a share of disposable income remain below the pre-pandemic level and dramatically below the level seen prior to the global financial crisis of 2008–09. Thus, it appears that households can continue to spend at a healthy pace.
Meanwhile, the government’s report on income and spending included data on the Federal Reserve’s favorite measure of inflation, the personal consumption expenditure deflator, or PCE-deflator. This measure was up 2.5% in June versus a year earlier, down from 2.6% in the previous month. More importantly, when volatile food and energy prices are excluded, core prices were up 2.6% in June versus a year earlier, the same as in May and the lowest seen since March 2021.
These numbers are close to the Fed’s 2% target. Moreover, it is worth recalling that the target is not meant to be a ceiling. Rather, it is meant to be an average. As such, the current inflation numbers are well within the Fed’s target range. Still, the details offer cause for concern. While prices of durable goods fell 2.9%, prices of services were up 3.9%, likely reflecting the impact of rising wages given that services tend to be labor-intensive.
For the Fed, the favorable inflation data, combined with evidence that labor market tightness is abating, bodes well for a rate cut in September. Indeed, this is what investors now expect. The futures market is now pricing in a 90% chance of a 25-basis-point cut in September. Investors think there is a 7% chance that the Fed will cut rates next week. Once the Fed starts to cut, it is likely that bond yields will follow, thereby leading to lower mortgage interest rates. This would probably boost activity in the housing market, creating a positive spillover effect on consumer spending on durable household products.
China cuts interest rates
- China’s central bank has only increased its one-year loan rate one time since 2014. Rather, it has steadily cut the rate. Recently, it cut that rate once again. In addition, it cut other rates commensurately. However, the cut was only 10 basis points. The People’s Bank of China (PBOC), China’s central bank, has followed a policy of caution in the past two and a half years, cutting the one-year loan rate by a total of only 50 basis points since late 2021.
The latest move comes at a time when the Chinese economy is evidently growing slower than desired. Second-quarter GDP growth was significantly slower than in the first quarter. Plus, retail sales grew slowly in June. There is a widespread concern that, while output and exports grow strongly, domestic demand is weak, thereby generating excess capacity and contributing to deflationary pressure.
The PBOC has periodically undertaken interest rate cuts over the past decade, attempting to boost credit creation in the face of structural weaknesses such as the property crisis and the challenges from abroad. Yet easing monetary policy has so far failed to revitalize the economy. Rather, many analysts are calling for more focus on fiscal and regulatory policy as tools for boosting domestic demand.
Moreover, the cautious approach to monetary policy is likely due, in part, to concerns that excessive interest rate cutting will put further downward pressure on the value of the currency. Although a weakened currency can boost export competitiveness, it can also have negative consequences. For example, a weakening of the renminbi hurts the ability to service foreign currency debts. In addition, it invites further protectionist measures by trading partners, especially the United States. Finally, a weaker currency goes against the Chinese goal of boosting the global role and status of the renminbi.
If there is downward pressure on the renminbi, managing a steady value of the currency becomes more difficult. It might require even tighter capital controls than are already in place. Or it could require more central-bank intervention in currency markets to support the renminbi. That, in turn, would offset the impact of cutting interest rates.
- Following the initial reduction in key interest rates, China’s central bank surprised investors late last week and cut a key interest rate by 20 basis points. Moreover, the central bank will provide the equivalent of US$27.5 billion in new loans at the new interest rate. It is likely that the central bank is becoming more comfortable in cutting rates because there is strong anticipation that the US Federal Reserve will soon start cutting its benchmark interest rate. When the Fed does this, it could remove some of the downward pressure on the Chinese renminbi.
Meanwhile, there is a widespread view that monetary loosening alone will not be sufficient to boost Chinese growth, and that fiscal stimulus is needed. As such, it is interesting that the government announced a plan to provide the equivalent of US$41.5 billion in subsidies for households to purchase automobiles and consumer electronics. This will be funded by about a third of the money raised through the issuance of special purpose bonds. A senior government official noted that “consumption has not been sufficiently invigorated while competition in the marketplace has intensified.” The problem is that excess capacity, combined with severe competition, has led to deflationary pressure and declining company margins. The subsidies might help to kickstart domestic demand.
The impact of shipping disruption
- With inflation having decelerated in Europe, goods prices are barely moving while inflation in services has remained sticky, creating a headache for central banks such as the European Central Bank (ECB) and the Bank of England (BOE). Yet there is now concern that a surge in shipping costs, due to continued attacks on shipping by Houthi rebels in Yemen, could reverse progress in stabilizing the prices of goods. This, in turn, could create yet another headache for central banks. Indeed, Christine Lagarde, president of the ECB, said she is worried about geopolitical risks that could “push energy prices and freight costs higher in the near term.”
Yet is this worry warranted? Perhaps. The concern stems from the fact that, after a brief lull earlier this year, the cost of shipping a container from East Asia to Europe has surged as Houthi attacks have increased substantially. In fact, the cost of shipping a container from East Asia to Northern Europe has roughly doubled since May. In addition, the European economy has shown signs of renewal, with real wages rising and interest rates starting to come down. Thus, a rebound in consumer demand, along with stress in supply chains, might ultimately lead to higher consumer prices. This situation is different from earlier this year when weakness in European demand suggested that higher shipping costs would not be passed on to consumers. Now, however, there is a perception that the crisis in the Red Sea will likely boost European inflation, thereby stifling the ability of central banks to cut interest rates further.
On the other hand, it might not be that much of an issue. After all, the cost of shipping, albeit important, is but a small part of the prices paid by consumers. By one estimate, the recent rise in shipping costs would only increase the consumer price index by 0.1–0.2 percentage points, especially given that such costs are not likely to be fully passed on to consumers. Still, even a modest rebound in goods prices, combined with continued sticky service prices, could upend the calculus of the ECB and the BOE.
- It is reported that US retailers are frontloading overseas orders for merchandise. This is happening because of two concerns: First, retailers are worried about potential further disruption of shipping, especially given the surge in attacks on shipping in the Red Sea; second, they are concerned that there could be new trade restrictions involving China in the aftermath of the upcoming US presidential election.
Consequently, the number of containers with consumer goods arriving at US ports has surged. For example, the number of containers arriving in Seattle/Tacoma in June was up 43% from a year earlier. The number arriving at Los Angeles/Long Beach was up 15% from May to June, hitting the highest number since July 2022.
The risk, however, is that retailers could wind up stuck with excess inventory if demand does not meet expectations. On the other hand, failure to purchase in advance could lead to a shortage of desired goods. The fact that retailers are frontloading orders indicates optimism about demand. Meanwhile, the ratio of retail inventories to sales has surged to the highest level since May 2020.
Aside from the risk to shipping from the attacks in the Red Sea (which disproportionately affect the shipment of goods to Europe and not the United States), there is concern about the persistent drought that is limiting the capacity of the Panama Canal. In addition, there is fear that dockworkers on both the US East and West coasts might go on strike in the Autumn. Also, the disruption in the Red Sea has led global shipping companies to move ships to the Asia-Europe route to offset the need to send ships around Africa rather than through the Suez Canal. This, in turn, limits the supply of ships available on other routes, including the Asia-US route.
Chinese weak demand persists, more talk about stimulus
- A plethora of data released last week indicates that China’s economy has decelerated. This came at the same time as the Chinese Communist Party’s Third Plenum, a four-day meeting often used to launch new economic reforms. The weak economic data is expected to increase pressure on the government to take steps aimed at revitalizing the economy. Notably, the data indicates relatively strong growth of output combined with weak demand. Economic policy has lately focused on boosting output while many pundits have urged more effort to stimulate domestic demand rather than rely on exports to absorb increased output. Exports have lately grown rapidly, but there is concern that the United States and the European Union (EU) may introduce further restrictions on trade with China, thereby hurting China’s ability to grow through exports. Thus, domestic demand becomes more critical.
Let’s look at the data. In the second quarter of 2024, China’s real GDP was up 4.7% from a year earlier. This was down from growth of 5.3% in the first quarter of 2024 and was the slowest rate of growth since the first quarter of 2023. In addition, real GDP was up 0.7% from the previous quarter, down from growth of 1.5% in the first quarter. Among the possible explanations for slower growth are the continuing problems in the residential property market, weak household demand, and stagnant private sector investment. The weakness of domestic demand has likely contributed to the very low inflation recently reported.
As for domestic demand, the Chinese government reported that, in June, retail sales were up only 2% from a year earlier. This was down from 3.7% in the previous month and was the slowest rate of growth since December 2022. If the period since the start of the pandemic is excluded, this was the slowest increase in retail sales on record. Moreover, retail sales declined 0.12% from May to June. Among possible explanations for the weakness of retail sales are declining property values, thereby hurting household wealth and encouraging increases saving, and a weak labor market.
By category, retail sales were down 1.9% for clothing, shoes, and textiles; down 14.6% for cosmetics; down 7.6% for appliances and audio/visual equipment; down 8.5% for cultural and office equipment; and down 6.2% for automobiles. The latter is despite a government-funded trade-in subsidy. On the other hand, spending was up 5.2% for tobacco and alcohol, up 2.9% for communications equipment, and up 4.6% for petroleum products.
On the supply side, things were a bit better. The Chinese government reported that, in June, industrial production was up 5.3% from a year earlier. Although this was the second slowest growth in the last seven months, it remains stronger than growth in most months of the last year and a half. The manufacturing component was up 5.5%, a slowdown from the 6% growth in May. Growth was especially strong for chemicals (up 9.9%), non-ferrous metals (up 10.2%), non-auto transportation equipment (up 13.1%), and automobiles (up 6.6%). Growth was a more modest 4.4% for production of computers, communication, and other electronic equipment.
China’s fixed asset investment was up 3.9% in the first six months of 2024 versus a year earlier. This was slower than the 4% growth recorded in the previous month. Also, investment increased only 0.2% from May to June. The growth of investment in the first six months included rapid growth of 23.7% for aviation transportation, 18.5% for railway transportation, and 24.2% for water production and supply. In other words, infrastructure investment is driving much of the growth of overall investment. Most of this is government-funded. Indeed, private sector investment grew only 0.1% in the first six months of 2024 versus a year earlier.
In addition, manufacturing investment was up 9.5%, likely fueled by government incentives for investment in high tech and clean energy. On the other hand, property investment declined 10.1% from a year earlier, weakened by the crisis in the residential sector. In fact, it has been reported that new home prices fell in June in 64 of 70 major cities. It was the 13th consecutive month in which a majority of cities saw a decline in home prices. Prices of new homes in the 70 cities were down an average of 0.7% from the previous month. Meanwhile, prices of existing homes fell in 66 of the 70 cities. The decline in home values seems to be affecting household wealth, thereby having an impact on the willingness to spend. This partly explains the weakness in retail sales.
In response to the data release, a Chinese government spokesman said that favorable factors “are stronger than the unfavorable factors.” However, he said that “looking ahead to the second half of the year, the external environment is becoming more unstable and uncertain, and there are still many difficulties and challenges at home.” Already there is a vigorous debate among economists about the best path forward for Chinese economic policy.
Explaining US economic resilience
- For much of the past two years, many economists, business leaders, and pundits argued that a US recession was imminent. It never came. Why? Below are a few thoughts as to why the US economy has been surprisingly resilient in the face of a significant tightening of monetary policy.
o One reason people thought a recession was coming was that the yield curve inverted. That is, short-term interest rates exceeded long-term rates. Historically, such an inversion usually presages a recession. It’s not that inversion causes a recession. Rather, it often reflects conditions that lead to a recession. Inversion often leads to a decline in credit growth due to worsened bank margins, thereby hurting interest-sensitive sectors of the economy. Yet in the post-pandemic era, both households and businesses were flush with cash. As a result, they were less sensitive to credit conditions than usual. Consequently, the yield curve inversion might have been a false positive. On the other hand, it could be that a recession will come, but with a longer lag following the inversion than usual. Indeed, Fed Chair Powell has expressed concern that prolonged high interest rates might undermine financial conditions.
o Some analysts were convinced of imminent recession because the manufacturing sector of the US economy was clearly in recession in 2022. Given the large spillover effect of manufacturing on the rest of the economy, this was a reasonable viewpoint. However, there was unusually strong growth of the services sector following the pandemic, perhaps reflecting pent-up demand. Historically, it is unusual for there to be a significant downturn in manufacturing without a recession.
o Immigration helped to ease inflationary pressure while boosting capacity. The surge in US immigration in the past two years helped to ease wage pressure and, consequently, contributed to receding inflation. That, in turn, probably led the Federal Reserve to halt monetary tightening earlier than would otherwise have been the case. Plus, immigration boosted labor supply, thereby contributing to stronger growth of output. And immigration also boosted demand for goods and services. As such, one could view the immigration as a positive supply shock to the economy.
In any event, the possibility that a recession could come in the coming year remains. Meanwhile, data on consumer confidence indicates that US households are not convinced that the economy is strong. In fact, I am still asked by friends when this recession will end. There is clearly a disconnect between what the data shows and what many people feel they are experiencing.
One reason for this disconnect might be that food prices rose rapidly in the past two years, causing food to increase as a share of household expenditures. Thus, for people on modest incomes, this makes them feel poorer, less able to afford non-food discretionary items. Another reason might be that most of the increase in employment in the United States in the past two years was in part-time work while full-time employment stagnated. Plus, most of the increase in employment accrued to foreign-born workers. Native-born Americans did not see any increase in employment in the past two years. That partly reflects demographics. There has been no increase in the number of working-age native-born Americans.
US retail demand remains healthy
- The headlines indicate that, in the United States, retail sales stopped growing in June. Yet stagnant retail sales were entirely due to a decline in spending on automobiles and gasoline. Excluding these categories, retail spending grew at a healthy pace. Plus, the decline in gasoline spending was due to lower prices. As such, the US consumer sector appears to remain strong.
Let’s look at the details. In June, retail sales in the United States were unchanged from the previous month. The retail sales data are not adjusted for inflation but are adjusted for seasonal variation. However, sales at motor vehicle and parts dealers fell 2% from May to June. This might have been due to a cyberattack on automotive dealerships, thereby slowing the process of selling cars. In addition, sales at gasoline stations fell 3%, mainly due to declining gasoline prices. When motor vehicles and gasoline are excluded, retail sales were up 0.8% from May to June.
Some categories of retail spending did especially well. For example, sales at non-store retailers (principally online venues) were up 1.9% from May to June. In addition, sales were up 0.6% at furniture stores, up 1.4% at home improvement retailers, up 0.9% at drugstores, up 0.6% at clothing retailers, and up 0.4% at department stores.
While the retail sales report suggests continued strength of consumer spending on goods, the fact that the headline number was unchanged possibly contributed to further expectations for a rate cut by the Federal Reserve.
ECB keeps rates steady. Uncertainty looms about next moves
- Not surprisingly, the European Central Bank (ECB) left its benchmark interest rates unchanged recently, with analysts now wondering whether the ECB will cut rates again in September. The ECB initiated its first rate cut in many years at the last meeting. This came following a swifter than anticipated reduction in inflation. Moreover, it’s likely that the ECB was concerned about the stagnant Eurozone economy.
On the other hand, the persistence of inflation in services, likely related to a tight labor market and rising wages, is a factor that might inhibit further easing of monetary policy by the ECB. The ECB statement said that “domestic price pressures are still high, services inflation is elevated, and headline inflation is likely to remain above the target well into next year.” On the other hand, the ECB noted that, while wages are rising, profits are taking a hit as companies are not fully passing on their higher costs to consumers in the form of higher prices. Weaker profits could have a negative impact on investment.
Meanwhile, ECB President Christine Lagarde said, “We are determined to ensure that inflation returns to our two per cent medium-term target in a timely manner. We will keep policy rates sufficiently restrictive for as long as necessary to achieve this aim.” This hints at a very gradual, or even delayed, easing of monetary policy. The ECB predicts that inflation will revert to the 2% goal by the second half of 2025—a very gradual decline indeed, given that inflation hit 2.5% in June.
Ms. Lagarde also noted areas of strength and weakness for the Eurozone economy. She said most growth is coming from services, driven by rising consumer spending, itself related to increases in real (inflation-adjusted) wages. She noted that manufacturing remains weak. Investment and exports are, commensurately, weak. She also noted that rising real wages are not being offset by rising productivity. The result is an increase in unit labor costs, thereby damaging the competitiveness of industry. On the other hand, she expects export growth to pick up speed as the global economy recovers.
Finally, Ms. Lagarde noted that monetary policy remains tight, thereby having a dampening effect on credit creation. The ECB will have to balance a desire to avoid economic harm with a desire to further reduce inflation. She said that “the risks to economic growth are tilted to the downside,” implying that the ECB will be careful to avoid an excessively tight policy. She also said that “growth could be higher if inflation comes down more quickly than expected,” implying that a focus on inflation remains important. Thus, the ECB likely faces a challenging balancing act going forward.
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.