Global Economic Uncertainty Remains Elevated For the Time Being
Economic data out the gate this week provided some clarity on how the economy fared through the remainder of 2018. The partial government shutdown, which began in December and lasted well into January, had continued to delay important data releases, clouding analysts’ assessments of the economy’s performance. Data on Q4-GDP, and housing starts and personal income and spending data now available through December, confirmed our expectation of a slowdown in growth to end 2018.
The U.S. Commerce Department released data on Thursday which showed that real GDP grew at an annualized rate of 2.6% in the fourth quarter. While this pace of growth still represents a step down from the strong growth rates experienced earlier last year, at 2.6% growth was above the market expectation of 2.2%.
Real personal consumption expenditures (PCE), grew only 2.8% in the fourth quarter, leading much of the deceleration in GDP growth. The weakness can be traced to the weak spending environment in December, with both personal spending and retail sales experiencing their largest declines since the recession year of 2009. Real PCE was in part boosted earlier last year by personal tax cuts, but these real income-boosting effects will likely fade this year. Personal income rose 1.0% in December, but fell 0.1% in January. Income growth should regain some strength this year, due to the robust labor market.
Consumer confidence data for February suggested consumers have regained some optimism. The present-situation component of the index improved to a cycle-high of 173.5, while the expectations component jumped 14 points. Expectations of job prospects and improvements in income have propelled the outlook, but fewer purchasing plans of autos, homes and major appliances weighed on overall optimism. Taking this anecdotal indication with recent hard data on durable goods orders suggests that growth in capital spending will likely be anemic in the first half of 2019.
After a slow pace of growth in the third quarter, business fixed investment (BFI) spending rebounded at a rate of 6.4% in the fourth quarter. But, the construction components of BFI remained weak. Non-residential construction fell 4.2%, while the residential side declined for the fourth consecutive quarter. A separate press release from the Commerce Department revealed that housing starts plunged 11.2% in December. Mortgage rates were up to a near 5% last year, which threatened to worsen the affordability crisis that has been dragging home sales and new home construction lower since March of last year. Rising home prices had only exacerbated weakness in residential construction last year. But, with mortgage rates now lower and building permits having risen in January, there may be some upside pressure to housing starts in 2019.
Despite the slowdown in the fourth quarter, the stronger-than expected GDP outturn should alleviate some concern that the economy is in serious trouble. As we look further ahead to 2019, our current forecast looks for a further deceleration in the first quarter but for a modest rebound starting in the second quarter.
Progress made in US-China trade talks, but nothing is done until everything is done
It appeared that sufficient progress were made in US-China trade negotiations to convince Trump to announce extension of trade truce indefinitely early last week. The news set a positive tone for the global financial markets, in particular in China. US Trade Representative is going to publish formal notice in the Federal Register next week, confirming that the rate of additional duty for the products covered by the September 2018 action will remain at 10 percent until further notice.”
Comments from the US official regarding the negotiation were generally positive even though USTR Robert Lighthizer sounded cautious. In his testimony to House Ways and Means Committee, Lighthizer said “real progress” were made and US could “turn the corner” in the economic relationship with China”. But “much still needs to be done” before an agreement is reached, and “more importantly, after it is reached.”
Treasury Secretary Steven Mnuchin, said the team is working on a 150-page, very detailed, document for “significant”, “structural” commitments from China. Mnuchin hoped to “make progress this month”. And, “if we do, there will be a summit of the Presidents”. National Economic Council Director Larry Kudlow hailed that “Lighthizer has worked miracles on this Chinese deal,” and “we’ve never come this far on China trade.”
However, as usual with any deal, it’s agreed only when everything’s agreed. Trump indicated in a tweet on Saturday that he made a sudden request to China to “immediately” remove all tariffs on American agricultural products. He claimed it’s “based on the fact that we are moving along nicely with Trade discussions”, and he didn’t increase the tariffs on March 1.
It’s uncertain what China’s response to Trump’s request would be. From China’s point of view, the logical equivalent response to Trump’s refrain from more tariffs is not to impose retaliation measures of their own. And China has already made some good-faith purchases of US soybeans since the start of trade truce. Chinese leaders could have their own rationales in rejecting Trump’s requests. The negotiation could turn down hill if China does say “no”.
And as a recap, Trump said after the summit with North Korean leader Kim Jong-un collapsed that “I am always prepared to walk,” and “I’m never afraid to walk from a deal, and I would do that with China, too, if it didn’t work out.” He walked away from a deal with Kim after traveling all the way to Vietnam. He can certainly walk away from a deal with China sitting in the Oval Office.
China’s response will be closely watched and this could be the turning point in whole US-China trade negotiations.
MSCI quadrupoles weighting of Chinese stocks, could translate into billions of inflow
Market sentiments were further lifted, in particular in China again, after MSCI announced to increase the weight of China A shares in MSCI indices. The weighting will be increased from 5%% to 20% in three steps:
- Step 1: MSCI will increase the index inclusion factor of all China A Large Cap shares in the MSCI Indexes from 5% to 10% and add ChiNext Large Cap shares with a 10% inclusion factor coinciding with the May 2019 Semi Annual Index Review.
- Step 2: MSCI will increase the inclusion factor of all China A Large Cap shares in the MSCI Indexes from 10% to 15% coinciding with the August 2019 Quarterly Index Review.
- Step 3: MSCI will increase the inclusion factor of all China A Large Cap shares in the MSCI Indexes from 15% to 20% and add China A Mid Cap shares, including eligible ChiNext shares, with a 20% inclusion factor to the MSCI Indexes coinciding with the November 2019 Semi-Annual Index Review.
After the process completes, there will be 253 large and 168 mid-cap China A shares, including 27 ChiNext shares, in the MSCI Emerging Markets Index, representing a weight of 3.3% in the pro forma index.
The decision was generally seen as symbolic acknowledgement of the growing importance of China’s stock markets. It could trigger increasing interest from US and European financial institutions in China A shares. On the other hand, it’s also an indication that China’s capital market are opening up much faster than anticipated. And foreign investors would pick up a much larger role in the Chinese markets.
Morgan Stanley said up to USD 3B of passive flows would be attracted, on top of USD 15B it highlighted previously. Harvest Global Investments said together with the opening policies, the decision would mean up to USD 100B of foreign inflows to A shares in 2019, more than double of USD 45B in 2018. T. Rowe Price said the decision would translate into USD 40B worth of inflows.
Chance of no-deal Brexit diminished after new arrangements
Diminishing chance of no-deal Brexit gave a strong boost to the Pound and also to general market sentiments. At this point, it uncertain how the EU and UK are going to solve the issue of Irish backstop yet. For the Commons to approve it, there must be legally binding that the backstop is temporary. EU is willing to offer further assurances, nothing more. With or without an updated Brexit deal, three votes are scheduled between March 12 and 14.
March 12 – Meaningful vote on a new Brexit deal. Prime Minister Theresa May promised to renegotiate with the EU, especially on the Irish backstop issue. As the EU has so far refused to reopen negotiations, the best PM May could do is to secure some “legal guarantees”.
March 13 – No-deal vote. If the “new” deal is again rejected on March 12, PM May would table a motion, asking if the MPs support to leave the EU without a deal on March 29. This is to get explicit consensus from the parliament as PM May affirmed that the UK “will only leave without a deal … if there is explicit consent in the House for that outcome”.
March 14 – Vote on Extension of Art. 50 (delaying the time to officially leave the EU from Mar 29, 2019). If the above motion is rejected, meaning the parliament rejects a no-deal Brexit with a majority, it would then have to vote on whether to “seek a short, limited extension to Article 50”. If the extension is approved, PM May would have to seek unanimous approval from the EU parliament on the extension.
Even with the arrangement, there is still some uncertainty left. In case of a delay, a short timeframe would unlikely be meaningful for any breakthrough. Some in the EU parliament instead propose a 21-month extension. A longer extension would increase the chance of a second referendum. And, while it is more likely that the majority would vote for an extension if no deal is approved, May has yet to reveal a contingency plan should the extension vote be rejected.
But after all for now, the stage is set that there will only be no-deal Brexit if there is “explicit consent” in the Parliament.