On May 17, 2017
Rothschild May Monthly Letter
If the consensus still anticipates in 2017 the first real acceleration of global growth since 2010, Q1 (1st quarter) GDP in many countries show a rather modest start to the year. What’s more, April’s downturn in commodity price indices – particularly base metals that historically have been highly correlated with industrial activity – might be calling into question this scenario of global growth acceleration.
In China, business confidence indicators in both the manufacturing and services sectors have slowed, and recent statistics show that the effects of support measures introduced in 2016 are waning. Moreover, new measures introduced in the real estate sector and the tightening of monetary policy could weigh on domestic demand. Indeed, large Chinese cities have once again tightened restrictions on the purchase of apartments, whereas previous measures have not really paid off as house price growth remains robust. For its part, the central bank has recently begun to tighten financial conditions as high level of private sector indebtedness remains a major concern for the country's financial stability.
In the UK, GDP growth fell more than expected to 0.3% q/q (quarter over quarter) in Q1 2017 from 0.7% in Q4 (4th quarter) 2016, a reminder that the UK economy’s resilience in the wake of the Brexit vote might be waning. The economic slowdown was led by consumers, whose incomes are under pressure from slowing employment and wage growth as well as rising inflation. Indeed, the rebound in energy prices combined with the depreciation of the pound – down -10% since the June 2016 referendum – has lifted inflation to its highest level for more than three years, thus eroding households’ purchasing power. Also, the marked slowdown in property prices could become an additional challenge as increasing house prices in recent years increased homeowners' wealth, which in turn supported consumption. Lastly, the negotiations regarding Brexit will be very complex. At the latest European Union (EU) Summit, the remaining EU 27 members have formed a rare united front on Brexit as they try to preserve regional stability and ensure others don’t try to follow Britain out of the bloc. As German Chancellor Angela Merkel mentioned recently, third-party states can’t and won’t be able to have the same rights, let alone a better position than a member of the European Union.
In the United States, economic activity stalled in Q1 2017, up a mere 0.2% q/q, which is far from what could have been anticipated given the size of the rebound of the various confidence indices. The slowdown was mainly due to a near-stagnation in household spending which was held down by a drop back in motor vehicle sales and the unseasonably warm winter weather, which depressed utilities spending. The other drags came from inventories and government to growth expenditure. The good news is that business investment increased markedly, driven by a strong rebound in mining structures investment. The consensus expects this dynamic to continue, and even to accelerate, by the end of the year as more details are given by President Trump regarding his investment plan and, more broadly, his tax reform. However, uncertainty remains.
At the end of April, the Trump Administration presented the main lines of its fiscal proposal, including deep cuts to corporate and individual tax rates, although infrastructure spending was notably absent. Yet, nearly six months after the election, the administration’s proposals amounted to a single-page statement filled with bullet points. The plan contrasts starkly with the one championed by House Republicans, who proposed new revenues in an effort to ensure that the measure would not swell the deficit. In fact, the introduction of a border-adjustment tax seems to have been rejected by the Trump Administration and more broadly there was no indication as to how the plan would be financed. Overall, neither the Democrats nor Republican deficit hawks will likely support these proposals nor is the plan highly likely to get approved by Congress through a budget reconciliation that requires 10-year revenue neutrality. Accordingly, the plan would require a super-majority of 60 votes in the Senate, which is also unlikely.
While many countries have had a shaky start to the year, the Eurozone has distinguished itself. Not only has business confidence continued to rise, but GDP growth reached 0.5% q/q in Q1 2017 according to preliminary results. As it was the case last year, Spain and Germany contributed significantly to this good performance. While French macroeconomic data have been rather disappointing, lower political uncertainty could spur economic activity in the second half of the year. The results of the June legislative elections and consequently the capacity of the new French President Emmanuel Macron to put in place a coherent political project will be an important factor in the extent of the economic improvement.
Chart source: Rothschild Asset Management
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