Twin Peaks: US Economy and EMU Inflation

<br /> Twin Peaks: US Economy and EMU Inflation – Marc to Market<br />


The US dollar has fallen against all the
major currencies but the Canadian dollar so far this year.  
 The euro is the primary beneficiary of the
greenback’s slide, appreciating 6.3% since the start of the year.  The
divergence driver has been superseded by
ideas that Europe has a turned the proverbial corner. 
Even before Macron
dispatched Le Pen, many investment houses and journalists were talking up
European equities and the euro. 
Sometimes it was offered as the counterpart to the unwind of the Trump trade.
 The apparent chaos of the White House, the clumsy and disorganized
efforts to replace the Affordable Care Act, and the prevarications,
 increased the skepticism over the Administration’s larger economic
The dollar also weakened in
the first part of last year.
  It bottomed against the euro in
early May 2016, and its rally was
primarily an H2 16 story.  Only
after Trump’s unexpected victory did the bullish dollar narrative include his
agenda.   The Federal Reserve’s removal of accommodation while the ECB and
BOJ were still easing and government bond yields were still negative throughout
the EMU, especially at short and intermediate term coupons, and Japan was the
heart of the bullish dollar narrative.  It is on top of the divergence of
monetary policy that the supply-side reforms and fiscal stimulus sat, like frosting on a cake.  
Ideas that the rising eurozone inflation and continued above-trend growth would prompt the ECB to
begin preparing the market for an exit from the unorthodox policies seems as
much if not a larger part of the story as the sluggish US growth.
  Before the weekend, Q1 GDP was
revised up from 0.7% to 1.2%, helped by a doubling of the contribution from
consumption.  Since 2010, growth in the first three months of the year has
averaged 1.1%.  
The two information peaks in
the week ahead address these issues head-on:  
The eurozone
reports a preliminary, though fairly reliable, the estimate for this month’s CPI.   The US reports May employment
data at the end of the week.  To cut to the
chase, with the Easter spike unwinding, eurozone
inflation likely fell back.  A series of economic reports in the coming
days, after the holiday at the start of the week, culminating with the
employment report are expected to show improving economic activity.  
Personal consumption
expenditure, a broader measure than retail sales, are expected to have risen by
0.4% in April. 
 It would be the best of the year,
after a Q1 average of 0.1% (subject to upward revision).  Pending home
sales, a leading indicator has been
alternating between monthly gains and falls.  April is expected to bounce
back from the 0.8% decline in March.  Construction spending is similarly
expected to have recovered from March weakness.  
Then there are the May auto
sales figures. 
 Sales likely continued the recovery
begun in April. Recall that December 2016 saw a strong 18.29 mln unit pace of
sales, which seemingly borrowed from Q1
when sales slowed each month.    The five-year monthly average is
16.43 mln, and during the slowdown in Q1,
sales remained above it.   
The jobs report should be
solid even if not spectacular. 
 Growth around the 12-month average
of 186k  is expected.  We
suspect that the risk is on the upside given the performance of weekly initial
jobless claims, the rise in withholding tax receipts point to a strong labor
market.  The unemployment rate fell from 4.8% in January to 4.4% in April.
 It probably did not fall further in May.   The participation rate
remains in the upper end of where it has
been for the past few years (~63%).  
Underemployment (U-6) has
continued to fall.
  It averaged 9.6% last year and was
9.4% at the start of the year.  It has since fallen to 8.6%.  It has
not spent much time below 8% since 2001.   Earnings growth remains modest.
 A 0.2% increase in May keep the year-over-year rate around 2.5%, which is
the lower end of where it has been over the past 12 months.  This is consistent with the likely
non-accelerating prices that will likely be signaled by the core PCE deflator
and the second monthly decline in the prices paid index of the ISM
Three forces have driven up
measured inflation in the eurozone,
raising the tenor of the persistent low-level murmur that the ECB policy is too
First, and
the most obvious, is higher energy prices.  Second, was the poor winter
crop that lifted the price of some vegetables.  Third are the distortions
caused by the calendar effect of Easter.  These forces are unwinding.
The recent gains in the
headline (from 1.1% at the end of 2016 to 2.0% in February and 1.9% in April)
could have been halved in May.
  The core rate had fallen to 0.7% in
March.  The cyclical low was 0.6% in Q1 2015.  It jumped to 1.2% in
April.  It can fall back to 0.9%-1.0% in May.  While eurozone
unemployment is expected to have edged lower in April (9.4% from 9.5%), wage
growth, including in full-employment Germany, remain subdued.   
This will be understood by the ECB’s staff as
they finalize their new forecasts for the ECB meeting June 8. 
  The rise in European rates and the strength of the
euro would suggest that the market has already discounted as a fact the kind of
risk assessment tweaks the central bank may offer.  Since the ECB will not
stop the asset purchases abruptly and the current purchases are projected through this year, purchases will
probably continue into next year, by which time, the Fed’s balance sheet would
have likely begun shrinking and a couple more interest rate hikes will probably
have been delivered.  
Besides the twin peaks of US
economy and eurozone inflation, there are a few other vistas for investors next
  In the UK, sterling ran out of
steam in front of what now seems like a formidable obstacle around $1.3055.
 The combination of tightening polls and soft economic data took a toll on
sterling and helped lift the FTSE 100 to new record highs.  
The June 8 election is approaching, and the polls suggest a tighter
race than anyone expected, including most
of all Prime Minister May.
  We suspect that if investors thought
that Labour’s Corbyn would be next Prime Minister, sterling would be
considerably lower.  Still, next week will suggest that after slowing more
than expected in Q1, the uptick in April
was a false spring.  The manufacturing and construction PMIs likely
resumed their downtrend.  
Japanese economic data will
suggest that growth has continued into Q2. 
 Industrial output likely recovered
the ground lost in March and more.  The year-over-year rate may rise to
its highest in three years.  However, weakness in household consumption
will remain evident.  The year-over-year rate has been negative with a few
exceptions since mid-2014.  
The last time it rose was in
February 2016.
 We note that Japanese investors have been
buyers of foreign bonds for the past three weeks.  This is the longest streak since last November.   Then it
coincided with yen weakness against both the euro and dollar.  
Lastly, we do not expect the
G7 statement to have much impact in the
capital markets
. There
can be no papering over the blatantly obvious fact that six of the G7 countries
are still reading from the imperfect playbook as they were prior and the US,
which helped forge that lose consensus on trade and the environment, appears to
be possibly balking.  

The inability of the US President to make a decision
on whether to continue to support the Paris Agreement on climate change, despite
knowing full well the issue and what was going to happen at the meeting, is a
bit disappointing and diplomatically awkward (must people talk about a G6?), but
a decision was promised in the week ahead.
 The indication is that President Trump will reject the Paris Agreement and the take away image from the G7 will not be the agreement to avoid protectionism, but of the other six heads of state walking while Trump followed in a golf cart.  


Twin Peaks: US Economy and EMU Inflation
Twin Peaks:  US Economy and EMU Inflation

Reviewed by Marc Chandler

May 28, 2017

Rating: 5

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