*Economic Recovery Remains on Solid Foundation*
* The U.S. economy continues to generate solid economic growth. The
December retail sales and industrial production reports released
last Friday revealed a consumer that is spending a little more
readily and a manufacturing sector that is being re-energized by
growing end demand.
* The outlook also appears fairly bright. The December leading
indicators report released by the Conference Board has jumped more
than 2.0 percentage points over the past two months and has been
gaining ground since last June when the economy hit its summer
lull.
*Strong Economic Data Where It Counts*
The December readings on retail sales and industrial production
painted an increasingly bright picture of sustained economic growth.
While retail sales growth slowed to a 0.6 percent monthly rate in
December from a 0.8 percent gain in November, the threemonth moving
average of retail sales improved to a 14.0 percent annualized growth
rate, showing a clear acceleration in consumer spending in the fourth
quarter. These numbers are strong enough to ensure real consumer
spending growth of nearly 4.0 percent in the fourth quarter. And, it
is not just autos and gas that consumers are springing for. December
also saw solid sales gains in furniture, building materials and
healthcare.
Manufacturing is also getting its mojo back. The manufacturing
component of December industrial production increased another 0.4
percent in December despite a modest deceleration in auto production.
Strong increases in production were noted in information processing,
computer and electronics, consumer goods, materials and energy.
Stronger consumer spending growth, if sustained, could help ignite
another round of business spending growth and more hiring, especially
from smaller businesses that have largely been left behind so far in
this economic expansion. This will help strengthen the virtuous cycle
that often takes shape during economic expansions and help wean the
United States off of government support.
The Conference Board's index of leading indicators for December,
released this week, confirms a sustainable U.S. economic recovery over
the near term. Many of the components that make up the index continue
to support solid economic activity. The December reading got
additional support from an improvement in initial jobless claims,
nondefense capital goods orders, building permits, stock prices,
consumer expectations and the interest rate spread.
Initial jobless claims continue to move lower, slipping to 404,000 for
the second week of January, suggesting labor market conditions
continue to improve in the new year. Jobless claims are now 50,000
below their trend level over the past 52 weeks.
Even the U.S. housing market got a modest dose of good news this week.
December existing home sales jumped to 5.28 million on an annualized
basis in December, a 12.3 percent gain that followed a large 6.1
percent increase in November. This was strong enough to reduce the
months' supply of existing homes to 8.1 months, a marked improvement
in the supply-and-demand balance for the existing home market. The
homebuilders didn't see much improvement in the housing outlook from
their perspective, however. The Wells Fargo/NAHB housing market index
for January held at a low 16.0, and housing starts for December sank
again, down 4.3 percent on the month. Weather could be a contributing
factor to the drop in starts, though residential building remains weak
nonetheless.
!! Consumer Confidence • Tuesday !!
After two consecutive increases, consumer confidence fell 1.8 points
to 52.5 in December as the weak labor market continues to weigh on
consumers' psyche. While confidence is well above its record low of
25.6 reached in early 2009, it was little changed in 2010 and remains
at depressed levels. Both the present situation and expectations
indices fell on the month. With confidence more closely correlated to
the labor market, the stubbornly high unemployment rate will likely
continue to keep confidence low. In fact, the percentage of those who
reported that jobs were "hard to get" continued to climb in December,
while the percentage of those who cited "jobs were plentiful"
declined. Until we see acceleration in the pace of private sector job
growth, we will not see much improvement in consumer confidence.
Previous: 52.5 Wells Fargo: 53.7 Consensus: 54.3
!! New Home Sales • Wednesday !!
New home sales are beginning to gain momentum. Sales have risen in two
of the last three months, but are increasing from very depressed
levels. Consequently, any true recovery in new home sales will be
gradual and will likely not pick up significant traction until next
homebuying season. Moreover, foreclosures and short sales will largely
keep builders on the sidelines until they have a better idea as to
where prices will settle and the oversupply of existing homes whittles
down. According to the Wells Fargo/NAHB Housing Market Index, builders
continue to report little to no improvement in buyer traffic and
expectations for future conditions also remain low. The inventory of
unsold homes continues to slide and remains at a four-decade low. We
expect new home sales to increase 4.8 percent to 304,000 in December.
Previous: 290K Wells Fargo: 304K Consensus: 300K
!! Durable Goods • Thursday !!
Orders for durable goods fell 1.3 percent in November relative to the
previous month. Excluding transportation, durable goods orders were up
2.4 percent in November. Outside of the transportation sector, the
rise in orders in November was broad based, which continues to show
the recovery in the factory sector is becoming self-sustaining.
Moreover, over the past three months, unfilled orders rose at an
annualized rate of 12.8 percent, suggesting that the production
pipeline is filling up. Consistent with the new orders component of
the ISM manufacturing index and regional manufacturing reports, we
expect durable goods orders to increase 1.7 percent in December.
Production in the factory sector should continue to expand further in
the months ahead, which reinforces our expectation that the U.S.
economy will continue to grow in 2011.
Previous: -1.3% Wells Fargo: 1.7% Consensus: 1.5%
*Inflation Becoming More of an Issue for China*
* Following a modest slowdown earlier in 2010, Chinese real GDP
growth stabilized at a high rate in the fourth quarter.
* Unacceptably high inflation is replacing insufficient growth as
the most important risk facing Chinese policymakers today. The
underlying inflation rate rose to a two-year high in December.
* In our "Topic of the Week," we place the U.S.-Chinese trade deals
announced in Washington this week into context.
*Robust Growth Continues in China*
China was very much in the headlines this week. Not only did Chinese
President Hu visit President Obama in Washington, but economic data
showed that the Chinese economy continues to grow at a rapid rate. As
shown on the graph on the front page, real GDP in China rose 9.8
percent on a year-ago basis in the fourth quarter. Following a modest
slowdown over most of 2010, which was due, at least in part, to
increasingly more difficult year-over-year comparisons, it appears
that the growth rate is stabilizing at a high level.
A breakdown of the GDP data into its underlying demand components is
not readily available. However, monthly data suggest that most
spending categories continued to grow at strong rates in the fourth
quarter. Retail spending continued to grow at a year-over-year rate
approaching 19 percent in the fourth quarter, indicating that Chinese
consumers are alive and well. The value of exports was up 25 percent
in the fourth quarter, which is consistent with other indicators of
solid global growth. Loan growth, which slowed sharply after the
Chinese government directed banks to rein in excessive lending,
stabilized in the fourth quarter. Solid loan growth of 20 percent in
the quarter helped to finance the 25-percent growth rate in investment
spending that occurred during that three-month period.
*Inflation Is Priority No. 1*
The inflation data that printed this week brought good news and bad
news. The good news is that the overall rate of CPI inflation dropped
from 5.1 percent in November to 4.6 percent in December as food
prices, which constitute one-third of the Chinese CPI, stabilized (top
chart). The bad news is that nonfood price inflation rose to 2.1
percent, nearing the highs that were reached in 2008. This underlying
inflation rate fell sharply two years ago as the global financial
crisis caused the global economy to careen into recession. If, as we
project, the global economy continues to grow at a solid rate, then a
significant slowdown in the underlying rate of Chinese CPI inflation
does not seem likely. Although the Chinese economy may not be
"overheating," unacceptably high inflation has replaced insufficient
growth as the biggest problem facing the Chinese economy today.
In that regard, Chinese economic policy is tightening. Not only has
the central bank raised its benchmark lending rate by 50 bps since
mid-October, but it has also raised reserve requirements for banks to
record highs (middle chart). The latter step is intended to help
sterilize the country's balance of payments surpluses that contribute
to strong growth in the money supply. In addition, authorities have
allowed modest appreciation of the currency - the renminbi has risen
about 3 percent versus the U.S. dollar since September - that also
helps to tamp down inflation (bottom chart). Although authorities will
probably not allow runaway appreciation of the currency, further
renminbi gains against the greenback are likely in the coming year.
(The currency strategy team looks for the renminbi to strengthen more
than 5 percent against the dollar between now and the end of the
year.)
!! Eurozone PMIs • Monday !!
The 16-member Eurozone economy expanded at a 1.4-percent pace in the
third quarter, marking the fifth consecutive quarterly expansion.
Still, the level of GDP remains roughly 3 percent below the
pre-recession peak.
We expect the Eurozone grew at a slightly faster pace in the fourth
quarter of the year. In addition to decent growth in industrial
production in the fourth quarter, the various purchasing managers'
surveys also remained firmly in expansion territory.
That said, the Eurozone is not without its share of problems at the
moment. The ongoing challenge of the sovereign debt crisis certainly
is not a positive for the outlook in Europe. On Monday (Jan. 24),
January readings for the PMIs will tell us whether the fiscal problems
in a few member countries will be enough to dampen sentiment across
the Eurozone.
Previous: 57.1 (Man.) 54.2 (Services) Consensus: 57.1 (Man.) 54.3
(Services)
!! U.K. GDP • Tuesday !!
The U.K. economy expanded at a 2.9-percent annualized pace in the
third quarter. Available monthly indicators, including the
manufacturing and service sector PMIs, suggest that the recovery
continued in the fourth quarter of 2010, although the pace of growth
may have slowed somewhat. Official numbers are due out on Tuesday.
Consumer sentiment deteriorated in the fourth quarter, though most
analysts still expected only a modest slip in retail sales for
December, thinking that an increase in the value-added tax in January
would bring sales forward into December, softening the decline. The
dip in sales was larger than expected, falling 0.8 percent in
December. Combined with weaker-than-expected industrial production
growth in the quarter, we expect U.K. GDP growth likely slowed to a
2.2-percent annualized pace in Q4.
Previous: 2.9% Wells Fargo: 2.2% Consensus: 2.6% (CAGR)
!! Canadian CPI • Tuesday !!
In 2010 as the Canadian economy outpaced the recoveries in other large
developed economies, the Bank of Canada (BoC) was among the few
central banks in the world raising its key lending rate. The BoC's
primary consideration in setting monetary policy is targeting a core
inflation rate between 1 percent and 3 percent. So when a 0.4-percent
jump in core consumer prices in October lifted the year-over-year
inflation rate to 1.8 percent, some market-watchers became concerned
that rising inflation might force the BoC to raise rates again to
combat rising prices. November data revealed that prices were
essentially unchanged for the month, which allowed the annual measure
to settle to a 1.4-percent rate. Headline inflation for December will
most likely show an increase as food and gasoline prices across Canada
were higher in December. The core rate of inflation will likely stay
near the midpoint of the BoC's target range.
Previous: 2.0% Wells Fargo: 2.1% Consensus: 2.5% (Year-over-Year)
!! Interest Rate Watch !!
Rising Rates: Fundamental Drivers
Treasury benchmark rates have risen in line with the changing
fundamentals and investor and business confidence. Better than
consensus economic releases, the outlook for rising inflation over
time and the renewal of the Bush tax cuts all suggest the case for
rising rates to continue ahead. Moreover, capital markets are also
seeing strength in bond issuance and loan finance - another sign that
economic strength is being financed despite the rise in benchmark
Treasury rates. Higher interest rates often accompany better economic
growth and are not a recoverykiller as some commentators are claiming.
Fundamentals Matter
Declining jobless claims filled in their usual role as an indicator of
an improving economy. Then, along came the continued gains in the
Institute for Supply Management (ISM), better retail sales, better
regional supply management surveys and even the upturn in
architectural billings, which all supported the better growth outlook.
Then, throw in the trade data and estimates of fourth quarter GDP
approached 4 percent and the outlook for 2011 improved in many
surveys.
On the policy front, the Fed is committed to further growth and the
goal of raising the core inflation rate. The commodity notes in the
ISM report also revealed a broader set of increases in basic
commodities, including corn and wheat. According to the University of
Michigan Consumer survey, the one-year inflation expectations measure
jumped to 3.3 percent in early January from 3.0 percent in December.
This is the highest reading since 3.9 percent back in October 2008.
Confidence Shown in Bond Issuance
Renewal of the Bush tax cuts were viewed, by your trusty interest rate
watcher at least, as positive for the economy and, more important, as
a signal policymakers in Washington can get beyond the petty politics.
This confidence is reflected in the strength of high-grade and
high-yield bond issuance. We view this strength as confidence in the
recovery and that the recent rise in rates is not a recovery-killer.
!! Consumer Credit Insights !!
Mortgage Market Activity Update
Mortgage applications for the purchase of a home have faltered
recently, declining in five of the past six weeks likely due to
increasing mortgage rates and tighter credit qualifications.
Application activity, however, is still up over 11 percent since
August. Refinancing activity, on the other hand, has improved in
recent weeks, up over 17 percent since the end of December.
Since bottoming back in November, mortgage rates have risen 13
percent. The rate on a 30-year fixed mortgage is currently around 4.74
percent. Adjustable rate mortgages (ARMs) have not risen as much as
fixed-rate mortgages over the past few months and remain relatively
low. The rate on a one-year ARM is around 3.25 percent.
While many have speculated that the recent rise in mortgage rates
threatens to derail the nascent housing recovery, we believe these
views are overblown. First, mortgage rates are still very low - the
average 30-year fixed mortgage rate from 1990 to 2005 was around 7.50
percent. And second, access to credit remains a much bigger issue than
cost of credit for homebuyers. With nearly 23 percent of homeowners
having negative equity on their home mortgages and tighter
underwriting standards on the part of lenders, many prospective buyers
- or those simply looking to refinance - just do not qualify in
today's credit environment despite the fact that housing affordability
is still near all-time highs.
Deng to Hu: "To Get Rich Is Glorious"
Chinese President Hu's first visit to the United States in five years
was marked by great pomp and circumstance as well as sober
acknowledgements of the challenges to bilateral political relations.
Few expected Hu to follow in Deng Xiaoping's footsteps and don a
cowboy hat and make his way down to Texas for a rodeo. Since the
beginning of Deng's liberalization of the Chinese economy in 1979, the
U.S.-Chinese bilateral trade balance has been on a steep slide in
China's favor, but the imbalance accelerated greatly circa 2002 (about
the time Hu succeeded Ziang Jemin).
Although the bilateral trade deficit with China continues to widen,
the overall U.S. trade deficit has narrowed in recent years to levels
seen in the early 2000s. This pattern reflects China's continued
expansion as an industrial center for consumer goods. Today, many of
the goods Americans imported from Europe or Latin America are instead
being assembled and exported from China. As China's industrial prowess
rises and the yuan remains undervalued, we are likely to see the
bilateral trade deficit continue to widen, especially if China
maintains a weak yuan policy. However, headline trade numbers often
reflect goods that are simply assembled in China, while the parts are
sourced from third-party countries and profits flow to foreign
corporations.
During the summit, Presidents Hu and Obama announced a $45 billion
export deal, but nearly half the value of the deal represents a
"final" approval from Chinese officials for a planned purchase from
Boeing. American companies, such as Boeing and Coca Cola, have had
longstanding relationships with China, beginning with President Deng's
visits to Seattle and Atlanta in the 1970s. While America's largest
companies may benefit marginally from one-off trade deals, the
bilateral trade deficit with China likely will remain large,
especially if the yuan remains undervalued. Therefore, trade tensions
with China probably will remain an issue in U.S.-Sino relations for
some time.
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