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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.