USA:
• ISM manufacturing indicator jumps to two year high in December.
• December employment report with good news for wage earners.
In December, the most prominent leading indicator for the U.S. manufacturing sector – the ISM manufacturing survey – jumped to its highest level since two years. The index rose to 54.7 indicating expansion in the manufacturing industry in December and 1.5 points higher than in November. The forward-looking new orders index registered 60.2; a large increase of 7.2 points from the November reading of 53. Additionally, the production and employment survey increased in December, while the inventories index suggested contraction. The new orders, production and employment survey reached new highs for the year 2016. Resource and energy related sectors were mostly reporting expansion in December likely linked to higher oil prices.
The U. S. employment report for December was released last Friday. Total nonfarm payroll employment rose by 156.000 in December posting a disappointment against analyst’s expectations (175.000). Simultaneously, the November print was revised upwardly from 178.000 to 204.000 and thereby making up for the December disappointment. The services sector remained the U. S. employment engine: The highest job growth occurred in education and health, leisure and hospitality and trade and transport. Employment in mining has also been improving amid a rising number of oil-rigs and WTI oil price increases by more than 20 % in December. Growth in nonfarm payrolls averaged 165.000 and 189.000 over the last three and six months. The unemployment rate was little changed at 4.7 % in December (after 4.6 % previously). Average hourly earnings posted the most interesting number in the employment report by rising 2.9 % annually after 2.5 % in November (Bloomberg consensus expectation: 2.8 %). Similar indicators have been confirming slow though steadily accelerating labor costs; including for example the Atlanta Fed wage tracker which rose by 3.9 % (y/y) in November or the quarterly Economic Cost Index (2.3 % y/y in Q3). With the actual unemployment rate below its ‘natural’ level (~4.8 % according to the Fed’s Summary of Economic Projections), evidence for tightening labor market conditions and, hence, rising pressure on wages is finally firming (Figure 1).
The employment report keeps the U.S. central bank Fed on track for the rate hiking path which was suggested by the median projection among members of the federal open market committee (FOMC) in December (three rate hikes each 25 basis points in 2017, 2-3 hikes in 2018). The labor market figures also suggest a high level of capacity utilization and that the U.S. economy is running near its potential output. In this case, a further fiscal impulse on aggregate demand – as envisaged by the incoming administration (via tax cuts), would drive prices of goods and services higher. Higher expected inflation invokes speculation about a faster rate hiking cycle of the central bank and leads to higher nominal yields on treasury bonds.
Eurozone:
• Inflation rose in December, as expected, due to energy price base effects, and will likely do so in coming months.
• Survey data indicates cyclical momentum.
In December, Euro Area consumer price inflation accelerated from 0.6 % to 1.1 % (y/y). The inflation rise was widely expected (Bloomberg consensus expectation: 1.0 %) as it was driven a base effect. In December of 2015 the Brent oil price fell by more than 10 %, while in December 2016 the oil price rose by about 5 %. Energy and unprocessed food make up around 18 % of the consumer goods basket in the harmonized index of consumer prices (HICP). Housing, water, electricity, gas and other fuels sums up to 16 % of the total basket and transport makes up 14.8 % of the HICP basket; i. e. in total around 30 % of the basket. On average in the month of December, the housing index usually remains unchanged and transport increases by 0.2 % (compared to the previous month), while in December 2015 both components fell by 0.3 %. Sub-components of the headline index were not yet released for last month (with the flash estimate of last week), but assuming that prices behaved at least as on average during December, it implies large changes in the comparison to December 2015. Hence, these effects can be foreseen easily. Correspondingly, a rise in the headline inflation rate can be expected during January and February 2016 as both aforementioned segments fell in the corresponding months in 2016.
However, it seems premature to expect the European Central Bank (ECB) to make any changes to its monetary stance due to the pick-up in inflation.
First, base effects produce a transitory rise in inflation, while the core inflation rate has been very sticky at a sub inflation target level. According to the flash estimate, the core inflation rate rose to 0.9 % from 0.8 % previously, while it was 1.6 % on average between 2002 and 2012. This suggests that the headline inflation rate would revert to a lower level once base effects in the volatile index segments fade.
Second, estimates for capacity utilization in the Euro Area still suggest a very low use of capacity. Theoretical concepts – prone to measurement error – indicate a large, though gradually declining negative output gap, i. e. that actual GDP remained below potential GDP (at full utilization of productive factors). More intuitively, the actual Eurozone unemployment rate has slowly been declining (9.8 % in October) but remained above its average level before the 2008/09 financial crisis (~8.5 %) – the level which was associated with a stable price development around the central bank’s target (Figure 2).
Analysts are currently forecasting that inflation will average 1.3 % in 2017 and 1.5 % in 2018 (Bloomberg consensus forecast) equalling ECB staff projections. For 2019, the ECB forecast an inflation rate of 1.7 % in December.
Prominent economic sentiment indicators posted big gains in December implying rising economic momentum in the Euro Area. The composite purchase manager index (PMI) rose to a high at 54.4 indicating solid expansion in economic activity into the first quarter of 2017. The manufacturing sub-component was 54.9 (unchanged from November) and the servicing index rose to 53.7 (from 53.1). Country-specific details are mostly encouraging as Germany (55.6), Italy (53.2) and Spain (55.3) reported improving results for the manufacturing sector, while France manufacturing PMI (53.5) remained unchanged at a comfortable expansion level in December (Figure 3). The services PMI registered an increase in Germany (54.3) and France (52.9), but fell in Italy (52.3) and was nearly unchanged in Spain (55.0). The bottom line is that soft data surprised positively and was encouraging for the business cycle what has to be confirmed by lagging real activity indicators (for example, November industrial production to be released this week).
Author
Martin Ertl
Chief Economist
UNIQA Capital Markets GmbH
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