Sunday, 23 October 2011

Shocks and Surprises, Week Ending October 22nd

The shocks and surprises which will matter this week are all political – and if things go wrong, with a whiplash on the financial. Economists, like everyone else, wait to learn their fate.

As we wait for Armageddon, it's quiet – too quiet. Eurozone data continues to chug along much as expected. This week, the list of economic data coming in as expected included: new car registrations (up 0.7%), construction output (up 2.5% YoY), consumer confidence, Germany's IFO business climate surveys, and French business confidence. Outside the Eurozone, however, the UK both surprised and shocked: retail sales surprised on the upside, rising 0.7% MoM, whilst consumer confidence shocked on the downside, reflecting a sharp deterioration in expectations.

Over in the the US, the major necessary adjustments to expectations have already been made, even up to the point of economists modestly revising up 3Q GDP forecasts, whilst cutting forecasts for 4Q11 to 2Q12. This week brought more confirmation of the likely 3Q surprise, with unexpectedly strong readings from the Philadelphia Fed survey (though this was offset by a surprisingly weak Empire State Manufacturing survey. The keys to the medium term trajectory of the economy remain housing and employment. Currently, housing market data is arriving modestly stronger than expectations – the NAHB Housing Market Index, and housing starts numbers both surprised this week, but sales of existing homes were no better than expected, and the number of building permits granted actually disappointed.

The knee-jerk reaction to China's 3Q GDP (up 9.1%) was that it showed China's growth slowing. Which just goes to show that the headlines are written before even basic analysis is completed. Yes,  GDP growth did indeed slow, if you compare it to the 9.5% recorded in 2Q. However, when you adjust for movements in the trade surplus, which added 0.7pps to 2Q growth but stripped 0.2pps from 3Q growth, you find a snapshot of an economy at the apex of its inflationary cycle, and not yet quite over the hump. And this was confirmed by the monthly data for September released this week: industrial production accelerated to 13.8% YoY – although this seems like an acceleration from August's 13.5%, the truth is it was simply the reassertion of seasonal historic patterns. But the acceleration in retail sales growth, to 17.7% from the previous month's 16.9%, represented real sequential MoM acceleration.

We also had some trade data which was worth mentioning: Taiwan's export orders growth slowed to 2.7% in September from 5.3% in August, with the slowdown generated solely by a collapse in orders from Europe: demand from elsewhere in the world economy remained firm.

Inflation – Still Here
Finally, it is worth noticing that no section of the world economy seems to be tipping into deflation – rather, the last week has seen worse inflation numbers than expected in the US (PP1 rose 0.8% MoM), and the UK (CPI, which rose 0.6% MoM and 5.2% YoY). These are not the only unexpectedly strong readings on inflation we've seen in the last month: let's also remember that Eurozone CPI came in stronger than expected (3% YoY), Taiwan's WPI jumped to 5.1% YoY, and US import prices rose 0.3% MoM and 13.4% YoY. The only place where the inflation news is surprisingly good is now in China, where PPI slowed to 6.5% YoY in September, the lowest reading since Dec 2010, and confirmation that the PBOC's policies are finally beginning to find traction.

On reflection, the lack of deflationary pressure isn't surprising, since it's hard to point to overhangs of capacity or inventory anywhere in the world which might tend to trigger rapid price falls in the short term. In the US total business inventory/shipment ratios are at the low end of normal, with both retail and wholesale inventory ratios strikingly low, but offset by a rising inventory/shipment ratio in the manufacturing sector. In other words, whilst there is room for disappointment in manufacturers' situation, there is also room for a supply-chain squeeze afflicting wholesale and retail channels. I do not have comparable data for the Eurozone, but we do have capacity utilization data which shows that as of September, capacity utilization had recovered from 2009's lows of around 70% to around 81%. This remains only slightly lower (by around a 2 percentage points) from pre-crisis norms. In Japan inventory/shipment ratios are higher than normal, but this is plainly a reaction to the supply-chain disruptions following March 11th's catastrophes. It seems unlikely that corporate Japan would tolerate inventory/shipment ratios falling to pre-March 11 levels.

In other words, it's hard to find the ammunition for a deflationary shock in the short term. But, of course, a really shocking failure in the political sphere resulting in a second collapse of Western financial institutions could change all that in the longer term.  

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