In the United States, the economic surprise index stands near a two-year low on the back of disappointing data. ISM non-manufacturing PMI is also near a two-year low, job creation is declining in small businesses, JOLTS job opening are plunging and real retail sales in Q1 are down 0.7% after a negative print in Q4 2018. There is probably some seasonality here, but it also indicates the US cycle is showing signs of fatigue, and the cyclical slowdown should extent in the rest of the year, though avoiding outright recession.
In the euro area, potential growth is lower than in the United States, leading to lower real growth, but the economic situation is in fact not as bad as many investors think. Though starting from a very low point, the euro area economic surprise index is moving north, currently at minus 38.7.
Concern is mostly concentrated on Germany which has revised its growth forecast to 0.5% this year, versus a preliminary estimate of 1% three months ago. Recent soft data seem to signal that Germany’s economy has bottomed. ZEW economic sentiment is weak but there are indications of stabilisation in the car industry, which represents roughly 14% of the country’s GDP. Sentiment in construction and services is improving, respectively at 47.6, the highest level since May 2018, and 34.7.
The expectations of German investors are on the rise again and are back in positive territory at 3.1. In terms of exports, the country was hit hard in Q1 by China’s slowdown and very much by Turkey’s economic drop, but we expect a slow improvement of data in coming months as the euro area REER is finally falling and China’s stimulus will start to have noticeable ripple effect on the rest of the world. In Q2, Germany’s economy should still be driven by positive domestic demand and higher performance of the service sector. Trade war talks and inflation on the agenda in May
Looking ahead, there will be two dominant macro themes in May: trade war talks and the return of inflation.
Next week, a new round of US-China trade talks will start in Beijing then Vice Premier Liu He will lead a Chinese delegation for additional discussion in Washington starting on May 8. The likelihood of an imminent trade agreement has been reduced over the past days following the strengthening of US sanctions against Iran that will primarily affect China. This may be only a new episode in the US-China wrestling match, but it may be counterproductive in the short-term by making ongoing negotiations even more complicated. From a market perspective, this new round of negotiations is a non-event.
The expected agreement has already been priced into the market. The main risk ahead now concerns US auto tariffs against the euro area. A recent European Central Bank economic bulletin article
assesses the impact of 25% tariff on cars could lead to a loss of 4% added value in the euro area car sector. So far, most of the trade war has impacted China and the United States, with little effect on the euro area (estimated to be about USD 5.5 billion of euro area added value in 2018).
The other emerging risk is the comeback of inflation. Average inflation in the G7 countries was still subdued in March, at 14%, but we have noticed over the past weeks rising inflationary pressures related to energy prices. US gasoline prices are back to where they were for most of 2018, before going down at the end of 2018, and oil prices have jumped 18% over the past six weeks. The market has not repriced inflation yet, especially the bond market, but it might not be necessary because the trend may be short-lived. Using the CAD as a proxy of oil inflationary pressures, we observe it has largely sat out the rally in oil prices and even moved lower versus the dollar in April. It may be the signal that investors are betting that oil prices will lose momentum. We are all waiting for Trump’s next tweet shouting out at Opec and Saudi Arabia…