Volume 61 | Number 2
Once again this week, the story appears to be a data correction changed the market’s direction. Retail sales were much stronger than expected, rising 1.1% in September, with sizable upward revisions adding 0.4% to the growth rates for the two previous months. As retail goods activity accounts for roughly one third of GDP, this recent outperformance has lifted estimates for real growth in the third quarter above 2.5% — and, given the strong jumping off point for the fourth quarter, it has raised expectations to over 2% for that quarter as well. So no more fear of a double dip recession and a strong rally in equities markets and a rise in ten year note rates ensued. Both are now roughly back to the levels of early September – just before the report of zero new jobs in August and sharp downward revisions of the previous two months caused economists to scramble and ramp down their forecasts for the third and fourth quarters. Hmmm…
Has much really changed? No. Home prices still look like they are dropping in the US and there is still a threat to the viability of the collateral for the US banking system. European leaders have promised yet another fix to the Greek problem, now focused on recapitalizing the banks. However, even the newly expanded European Financial Stability Fund is woefully inadequate for carrying out the task. That is why Angela Merkel is calling for changes to the Euro Treaty – by the end of the month – which will then entail a long process that must be validated by seventeen countries. As the recent EFSF process has shown, that makes even fourth parties in small governments like Slovakia powerful enough to rattle markets. With the US Congressional super-committee apparently no closer to a solution that does not derail the defense industry; and the risk of a sizable tax increases on both January 1 when the FICA holiday ends and again in 2013 when the Bush tax cuts expire, we see no reason for business to jump for joy and start expanding. Bottom line, recent good news on the economy – if you can call 2% growth good news — is unlikely to spark a self-fulfilling up cycle. All it does is eliminate for now a double dip and leaves us back in the muddle through.
Recent data from the employment and retail sales reports – collected from two different sources – suggest 4% nominal growth is here to stay. Note that at a 4.5% annual growth rate over the past six months, retail sales are near the bottom of the range seen in expansions – but above the 3% level seen during the 2001-2003 jobless recovery or at the late 2006-2007 slide into recession. As noted last week, retail activity has benefitted from a decline in financing costs allowing consumers to spend slightly more than they earn. Last week, the employment report confirmed that wage based income was rising at about a 4% annual rate – half from an increase in hours worked and half from wage gains. With both wages and spending creeping along at 4%-4.5% the only question is what is the inflation rate? At roughly 2%-2.5% for the third and fourth quarters – because energy prices are still not coming down on a seasonally adjusted basis – we see sustained 2%-2.5% real GDP growth. Not exciting, and still susceptible to downside shocks which remain aplenty.
Still No Help from China
The G-20 met again this weekend with high hopes, but the only result was a dictate that the Eurozone should solve their own problems – soon. The US blocked calls for more money from the IMF. The Chinese rejected a US call for faster yuan appreciation. Seems the only thing everyone agrees on is that each party should solve their own problems before commenting on others.
The most beneficial contribution to the world economy from China is not likely to be from yuan appreciation, but from a return to easier monetary policy. The tightening of the reserve requirement, higher interest rates, and — most importantly — the reining in the shadow lending markets has cooled real estate appreciation and is starting to slow inflation. However, signals indicate that China is not yet ready to step off the brake. Premier Wen Jiabao travelled to Wenzhou in Zhejiang Province, one of the areas hardest hit by cutbacks to small and medium sized enterprises. However, despite a nice speech, conditions remain tight. Wenzhou has benefitted more than any other city from the real estate boom, and it is suffering as leveraged players are getting squeezed by sky high private lending rates. One city in Guangdong caved in this week and announced it was easing real estate restriction – only to reverse its course the next day. Seems the central government is not yet ready to release real estate from its credit constraints.
Inflation has cooled a bit in China over the last few months, but it remains too high headed into 2012– the year of transition in Party leadership. September CPI was reported up 6.1% from a year ago, slightly below the 6.5% peak two months back. Food inflation remains the main culprit, up 13.4% from a year ago in September – but it is up just 1.5% (a 9% annualized rate) over the past two months. Nonfood inflation was up 2.9% in September from a year ago – but up just 0.3% (a 0.9% annual rate) over the past four months and unchanged in September. It seems likely – in fact it seems designed – that headline inflation will be falling below the 5% maximum now targeted as we move into 2012.
Only if growth falters badly are we likely to see the Chinese step off the monetary brake. Monday, China will report third quarter real GDP – which is widely expected to be up at a 9.5% annual rate. Over the week long October 1st-7th National Holiday, retail sales were up 17% from a year ago, well in line with expectations. Traffic numbers also confirmed that everyday Chinese workers were not scrimping on this second most heavily travelled holiday week. The rich may be suffering from a credit squeeze, but the average wage earner still appears to be spending. A decline in inflation – especially in pork prices – could translate into stronger spending in real terms. Foreign businesses continue to report rapidly rising wages, even away from the coast in China. It is hard to see a sharp slowdown in economic activity that would require an unexpectedly rapid injection of credit – barring renewed problems in the developed world.