This Week In The Economy: Global Economy Mired In The Dumps, Growing Risks From Middle East, Fed To The Fore Again, China’s Entrenched Slowdown
Welcome to a regular snapshot-review of U.S. and international economic news that aims to 1) provide a window into the challenges and decisions facing businesses today, 2) determine the direction of economic policy — such as the speed at which central banks decide to raise interest rates, and 3) assess what the impact will be for consumers.
OECD Sounds The Alarm Over Downward Path of Global Economy
The global economy is in danger of being bogged down for some time, resulting in weak growth for the foreseeable future, the OECD warned in its latest economic outlook report this week.
“Escalating trade conflicts are taking an increasing toll on confidence and investment, adding to policy uncertainty, aggravating risks in financial markets and endangering already weak growth prospects worldwide,” the OECD said.
The international organization representing a mix of advanced and emerging countries predicts the global economy will grow by 2.9% in 2019 and 3% next year — the weakest annual growth rates since the financial crisis, with downside risks continuing to mount. The OECD downgraded its outlook for almost all G20 economies, “particularly those most exposed to the decline in global trade and investment that has set in this year.”
“Solid consumer demand” has supported the service sector to date, the OECD noted, but sustained weakness in manufacturing and continuing trade tensions could weaken employment growth, household income and spending.
The report also pointed to “substantial uncertainty” from the drawn-out Brexit negotiations, with growing concerns about a possible no-deal exit which could push the UK into recession in 2020 and lead to disruptions in Europe. “Other risks — including the overall slowdown in the Chinese economy and significant financial market vulnerabilities from the tension between slowing growth, high debt and deteriorating credit quality — are also weighing on future growth,” it said.
Attacks On Saudi Oil Tankers Reintroduce Upside Risk To Oil Prices
The drone attacks this weekend on two major Saudi Arabia oil facilities roiled energy markets this week, as the prospect of escalating conflict in the Middle East raises the specter of higher oil prices.
The attack knocked 5.7 million barrels per day (around 5% of the world’s daily oil supply) out of production, but the Saudi energy minister allayed some fears regarding the potential length of the outages. Houthi rebels in Yemen claimed responsibility for the attack, although both the U.S. and Saudi Arabia have pointed the finger at Iran.
Oil prices have jumped as the risk of the ongoing proxy war between Iran and Saudi Arabia could morph into a direct confrontation. The U.S. has imposed harsher financial sanctions on Iran, including cutting off its central bank from the U.S. financial system, and is also said to be mulling over potential options for a military response. It remains to be seen what the Saudi response will be.
Given the current slow pace of global growth, a significant jump in oil prices would raise production costs (and consumer prices) in a weak demand environment — increasing the odds of a global recession.
Federal Reserve Cuts Interest Rates Again To Support Economy
The Federal Reserve this week announced another 25 basis point cut in its target interest rate, as the central bank provides more insurance against a possible economic downturn.
“In light of the implications of global developments for the economic outlook as well as muted inflation pressures the Committee decided to lower the target range for the federal funds rate to 1–3/4 to 2%,” the Federal Open Market Committee said in a statement.
The Fed noted that while the labor market has been “solid” and consumer spending growth has been strong, “business fixed investment and exports have weakened.”
In his press conference following the meeting, Fed Chair Jerome Powell said U.S. monetary policymakers acted to keep the economy ticking along “in the face of some notable developments and to provide insurance against ongoing risks.” He blamed slower global growth and the escalating trade war for the contraction in business spending and manufacturing activity.
“Since the middle of last year, the global growth outlook has weakened, notably in Europe and China. Additionally, a number of geopolitical risks, including Brexit, remain unresolved,” he noted. “Trade policy tensions have waxed and waned, and elevated uncertainty is weighing on U.S. investment and exports. Our business contacts around the country have been telling us that uncertainty about trade policy has discouraged them from investing in their businesses.”
Looking ahead, Powell said the future path of interest rates will depend on how the economy evolves and if there are any developments that pose risks to the outlook. “The Fed has no role in the formulation of trade policy, but we do take into account anything that could materially affect the economy relative to our employment and inflation goals,” he said.
Fed Injects Cash Into Financial System As Liquidity Dries Up
Money market rates spiked earlier this week, forcing the Federal Reserve to step for the first time since the 2008 financial crisis in an effort to drive rates down.
Many blame corporate tax payments to the IRS (September 15 was the due date) as the main driver of the jump in the federal funds rate above the Fed’s target range. Powell noted during his press conference that “this upward pressure emerged as funds flowed from the private sector to the Treasury to meet corporate tax payments and settle purchases of Treasury securities.”
Corporate tax payments generally result in less bank reserves/cash in the financial system available to be loaned out. In addition, the surge in bond issuance (both by the U.S. Treasury and corporations) likely exacerbated the funding squeeze by depleting banks’ reserves further.
In response, the New York Federal Reserve Bank (which handles financial market operations for the Fed) conducted operations on Tuesday, Thursday and Friday to buy up to $75 billion worth of Treasury debt and mortgage-backed securities from banks, thereby replenishing their reserves, lowering overnight borrowing costs, and injecting cash into the financial system.
Beyond that, the New York Fed announced it will conduct a series of repo operations until October 10 to help maintain interest rates within the target range. It will offer three 14-day term repo operations for an aggregate amount of at least $30 billion each, as well as daily overnight repo operations for an aggregate amount of at least $75 billion each.
“We will continue to monitor market developments and will conduct operations as necessary to foster trading in the federal funds market at rates within the target range. Consistent with our decision earlier this year to continue to implement monetary policy in an ample reserves regime, we will, over time, provide a sufficient supply of reserves so that frequent operations are not required,” Powell said.
China Factory Output Slows Again, Retail Sales Also Disappoint
The ongoing slowdown in the world’s second largest economy was evidenced in data released this week, as activity in China’s industrial and retail sectors slowed further in August.
Industrial production rose by 4.4% in August compared to the same month last year, a less than the 4.8% y/y rate reported in July.
Retail sales grew by 7.5% y/y in August, down from the 7.6% y/y growth rate in July.
U.S. CEOs Downgrade Their Outlook For Economic Activity
A survey of U.S. chief executives released this week showed the nation’s business leaders have a depressed outlook for the economy in the coming months in the face of growing trade policy uncertainty.
The Business Roundtable’s Q3 2019 CEO Economic Outlook Index fell to 79.2, below the Index’s historical average of 82.7. “This quarter, CEO plans waned likely due in part to growing geopolitical uncertainty, including U.S. trade policy and foreign retaliation, and slowing global economic growth,” BRT said.
CEOs’ plans for capital investment, hiring, and expectations for future sales all declined, while their forecast for economic growth this year came in at +2.3%, down from +2.6% in their previous forecast.
Finally, Some Positive News On The Housing Front
U.S. housing market activity has mostly struggled this year and contributed little to overall economic activity. This week finally saw some positive data, although it remains too soon to tell if this is a turning point for the sector.
New housing construction jumped by 12.3% in August compared to July, and is up 6.6% compared to August 2018. Single‐family housing unit construction was up 4.4% from July. Applications for building permits rose by 7.7% vs. July and are up 12% compared to the same month a year ago. Authorization to build single‐family homes were up 4.5% from July.
On the sales front, existing-home sales saw an uptick in August for the second straight month, according to the National Association of Realtors.
Total sales (completed transactions that include single-family homes, town houses, condos and co-ops) rose 1.3% from July to a seasonally adjusted annual rate of 5.49 million in August. Overall sales are up 2.6% from a year ago (5.35 million in August 2018).
The median existing-home price for all housing types in August was $278,200, up 4.7% from August 2018 ($265,600). The supply of housing for sale at the end of August decreased to 1.86 million, down from 1.90 million in July, and marking a 2.6% decrease from 1.91 million one year ago. Unsold housing inventory is at a 4.1-month supply at the current sales pace.
“Sales are up, but inventory numbers remain low and are thereby pushing up home prices,” the NAR warned in a statement. “Homebuilders need to ramp up new housing, as the failure to increase construction will put home prices in danger of increasing at a faster pace than income.”
Quickfire Round
German Economic Sentiment Bounces Back In September, But Still In Negative Territory — Expectations for growth in Europe’s largest economy improved in September, even as it remains mired at very low levels. In the ZEW September survey, respondents’ assessment of Germany’s economic situation worsened by 6.4 points, with the corresponding indicator falling to a current reading of minus 19.9 points. This has been the lowest reading since May 2010.
“The rise of the ZEW Indicator of Economic Sentiment is by no means an all-clear concerning the development of the German economy in the next six months. The outlook remains negative,” the group warned in a statement. “However, the rather strong fears that financial experts had in the previous month regarding a further intensification of the trade conflict between the USA and China did not come true.”
Bank of England Maintains Holding Pattern, Leaves Rates Unchanged — Senior Bank of England officials met this week and decided to leave interest rates unchanged, as the UK’s central bank awaits the outcome of the country’s negotiations to leave the European Union.
“Increased uncertainty about the nature of EU withdrawal means that the economy could follow a wide range of paths over coming years,” the BOE said in its statement. “The appropriate response of monetary policy will depend on the balance of the effects of Brexit on demand, supply and the sterling exchange rate.”
Bank of Japan Keeps Rates Unchanged, Expects Impact From Global Slowdown — The Bank of Japan’s board also met this week, and the decision was made to leave its target interest rate unchanged. “Japan’s economy has been on a moderate expanding trend, with a virtuous cycle from income to spending operating, although exports, production, and business sentiment have been affected by the slowdown in overseas economies,” the BOJ said.
“Downside risks concerning overseas economies seem to be increasing, and it also is necessary to pay close attention to their impact on firms’ and households’ sentiment in Japan,” it added.
South Africa Central Bank Stands Pat As Currency Drops Vs U.S. Dollar — A drop in the value of an emerging market country’s currency against the U.S. dollar is usually a sign of investor pessimism about that country’s prospects. Since July, South Africa’s rand has depreciated by 4.6% against the dollar, and by 3.0% against the euro. Nevertheless, the Reserve Bank of South Africa left interest rates unchanged at its policy meeting this week. It described the currency as “slightly undervalued,” adding that while the rand has benefited from improvements in global sentiment, investors remain concerned about domestic growth prospects and fiscal risks.
Economic activity in South Africa remains weak, it noted, with long-term weakness in most sectors a serious concern. “The MPC assesses the risks to the growth forecast to be balanced in the near term, but remains concerned about medium term growth and weak employment prospects. Escalation in global trade tensions, further domestic supply constraints and/or sustained higher oil prices could generate headwinds to growth,” the central bank warned.
