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Current 'soft' economic data, consisting of surveys, appear to be overshadowing weaker 'hard' data, thereby allowing commentators and the markets to paint a rosier economic picture than might otherwise be the case. As a result, the potential for volatile market movements increases.
In the UK the data available would suggest that Q1 GDP growth was 0.5%, weaker than the 0.7% in Q4 but in line with BoE and OBR expectations. This modest slowdown comes as industrial and manufacturing output fell year on year by 0.9% in January and again by 0.1% in February. Service sector data for January also appears relatively disappointing along with retail sales figures for the three months to February which witnessed a 1.4% fall – the latter being particularly important given that household spending accounts for more than 60% of the UK economy. Yet in comparison, last week’s purchasing manager surveys (PMI) for March remained strong with the all-important service sector index rising from 53.3 to 55. This was a much better figure than forecast. The CBI has optimism amongst exporters at a 20 year high.
Should this upbeat sentiment translate into activity in the coming months, this could go some way towards offsetting the inevitable squeeze on consumer expenditure as we continue to witness sluggish real wage growth in the face of rising inflation. However, most commentators do not expect any pick-up in exports to be large enough in the short-term to compensate fully for the drag on growth. As a result, readers should not be distracted by Tuesday’s CPI figures which are expected to show a temporary halt in inflation at 2.3%. I expect this to continue up towards 3.0% by the end of the year, a rate with which wage growth will struggle to keep pace, even as the UK nears full employment (look to Wednesday’s labour figures).
A similar divergence between hard and soft data has arisen in the US since Trump’s election victory in November which coincided with a surge in the stock markets. Small business confidence surveys are particularly high, suggesting order books are full. However, industrial production in Q1 has been flat and business lending has witnessed a significant fall. Some surveys even have consumer confidence at its highest since December 2000, despite consumer expenditure in January and February actually contracting. As a result of this conflicting information, Q1 GDP growth predictions from regional Federal Reserves vary between 1.2% and 2.9% depending upon the weight they attribute to the soft data, with most economists coming in at the lower end of this estimate.
The relative strength of the stock markets and the dollar would also suggest a high reliance on sentiment over substance. Yet with doubts growing over Trump's ability to pass legislation resulting in his championed cuts to taxes or regulation, the possibility of a correction rises. We have arguably witnessed this over the course of this week as US stock funds witnessed their largest withdrawals in 18 months, much of which has gone into European stocks.
Yet any correction should not take away from the fact that the US economy has remained resilient, both pre and post Trump’s election. Furthermore, with unemployment at 4.5% there remains a very strong case for the normalisation of rates. This appears to be a sentiment supported in the Fed’s minutes, which openly raised the prospect of reducing its balance sheet by the end of 2017, something that received little attention from the markets, unlike the ‘taper tantrum’ of 2013. The markets continue to price in between two and three rate rises in 2017, with the next as early as June.
The divergence between 'hard' and 'soft' is arguably most evident in projections of GBP/USD over the coming year. As questions have surfaced around the Trump Trade in the face of ongoing resilience in the UK, many analysts have switched from bearish to bullish on the prospects for the pound, with an increasing number seeing it as undervalued. There is now a growing expectation that the pound could end the year at 1.3500 against the dollar, up from its current level of 1.2400. However, with the EU successfully presenting a united and resolved negotiating position on Brexit, there remain analysts who rightfully remain cautious about the possibility of the UK crashing out of the EU without a deal. These fears were raised again last week by Mark Carney and the Commons Select Committee on Brexit.
The fact that Draghi had to reaffirm his commitment to negative interest rates until the end of the ECB’s asset purchasing program is further evidence of the improving economic sentiment on the continent. He went as far as to say that a key driver behind any reversal of such strategy will be upward pay pressures. With spare capacity in the labour market there is little chance of this any time soon. Further good news came as Greece reached a deal on tax and pension reforms that took a large step towards satisfying the IMF’s requirements that would allow them to participate in any further bail-out.
All views expressed here are the author’s own and are based on information and data available at the time of writing.
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