Global Economic Perspective: February by Franklin Templeton Investments
Perspective From the Franklin Templeton Fixed Income Group®
Strong Jobs and Consumer Spending Data Point to a Resilient US Economy
Recent data released in the United States appear to vindicate the relatively upbeat assessment of the economy contained in the Federal Reserve’s (Fed’s) January 28 statement, which stated that “economic activity has been expanding at a solid pace.” The Fed highlighted continued gains in employment, and another big rise occurred in the January nonfarm payroll figure alongside a drop in initial jobless claims. Already-strong nonfarm payroll numbers for November and December were also revised upward. The pickup in employment is contributing to a healthy rise in consumer spending, which accounts for almost 70% of US gross domestic product (GDP). Americans’ spending power has also benefited from the 43% fall in oil prices in US-dollar terms between June and the end of 2014. Helped by easier credit, Americans have been using some of the extra money in their pockets to buy new cars, with January auto sales up almost 14% on a year earlier, according to Autodata. As a consequence, personal consumption rose by 4.3% in the fourth quarter, the biggest gain since the beginning of 2006, and much higher than the 3.2% rise in consumer spending seen in the third quarter. Consumer confidence has surged, with The Conference Board’s consumer confidence indicator reaching its highest level in eight years in January.
We are also beginning to see wages rising, albeit tentatively. The latest Bureau of Labor Statistics’ employment cost index revealed that wages and salaries increased by 2.1% in 2014, compared with a rise of 1.9% in 2013, and there were some signs that wage growth accelerated in the final quarter of the year. The January nonfarm payrolls report offered further evidence that slack in the labor market is being absorbed, with average hourly earnings 2.2% higher than a year earlier. In spite of the concerns about hourly wage growth, the total US wage bill is now well in excess of prerecession levels.
US economic growth did slip from an annual rate of 5.0% in the third quarter to 2.6% in the fourth, according to a first estimate released by the Bureau of Economic Analysis. On balance, however, in light of strong consumer and labor data, we continue to believe that growth prospects look good for the coming months, and we continue to think the Fed will move to normalize its interest-rate policy in the months ahead, although it undoubtedly faces a dilemma as a result of recent disinflation and international developments.
Many commentators focused on the Fed’s addition of concerns about “international developments” to its January 28 statement. Indeed, global growth estimates for this year have been revised downward by both the World Bank and the International Monetary Fund, while there is a risk of further eurozone instability associated with the election of a radical left-wing government in Greece. The persistent rise in the US dollar on a trade-weighted basis since the middle of last year is generally weighing on the competitiveness of US firms and hurting export performance. Perhaps reflecting the overseas challenge, the pace of expansion in America’s manufacturing sector slowed in both December and January, according to the Institute for Supply Management’s purchasing manager index survey, while durable goods orders fell steeply in December from a month earlier, according to the Commerce Department, as business investment in the United States remains uneven and many firms appear reluctant to spend until they see further signs of strong long-term growth.
The weakness in business investment may also stem in part from the sharp cuts in oil-related capital expenditure in recent months. Yet cuts in oil-related investment allow for redeployment of corporate resources to other areas such as those catering to rising consumer spending. Such redeployment may take a couple of quarters to filter through into GDP reports.
Price rises have been running below the Fed’s long-run inflation objective of about 2%. However, the Fed believes that tumbling inflation and inflation expectations are temporary, “largely reflecting declines in energy prices.” And since it seems highly unlikely that we will see a further 43% decline in oil prices in the coming six months, we think it is reasonable to expect that inflation expectations will stabilize and, under the influence of rising wages, begin to increase somewhat. In short, we believe the disinflation engendered by the fall in oil prices will prove to be a one-off effect that may be giving a false sense of security to some investors who persist in believing that recent inflation data are symptomatic of a weak recovery that requires further, long, drawn-out Fed support.
All in all, we believe the slowdown in US GDP growth seen in the fourth quarter (compared with the two previous exceptionally strong quarters) is likely to be short-lived given the enormous tailwind provided by the fall in oil prices plus strong employment gains. We further believe the fundamentals of the US economy are strong enough to cushion the blow to growth from any economic weakness elsewhere in the world.
Global Markets Contend with Shifting Growth and Inflation Signals
The opening weeks of 2015 have been marked by interest-rate cuts in a number of important economies, including Australia, India, Canada, Singapore and, most surprisingly, Russia. China and South Korea have also cut rates in recent weeks. Others, most notably the United Kingdom, seem to be in the process of pushing back previously signaled rate hikes. Canada, Australia and Russia are currently undergoing income shocks due to falling commodity prices, which could well give way to asset price shocks, thus forcing central banks to act. By contrast, rate cuts in places like India and Singapore are perhaps more reflective of the increased room for policy maneuvering afforded by falling oil prices.
More generally, while monetary policymakers in Asia have to contend with declining headline growth in China, the reorientation of Chinese development toward domestic consumption should actually continue to stimulate these countries’ exports, even as liquidity continues to filter into Asian countries courtesy of quantitative easing (QE) in Japan and the eurozone. A further stimulus to growth should come from new governments in countries like India and Indonesia that seem intent on overhauling their economies. For all the talk of slowdown and for all the volatility that might be expected to come with speculation about rate tightening in the United States, emerging markets as a whole are still expected to grow at a faster clip than developed ones.
Importantly, we see the decline in oil prices since mid-2014 as having a one-off effect on inflation. Unless we see further significant drops in oil prices from their current levels, we believe the impact on headline inflation will progressively fade, and the real underlying inflationary pressures from stronger growth should play out. Given the anticipated transitory impact of falling oil price on inflation rates, together with the stimulus provided by the price declines that have already occurred, central banks may well approach monetary easing more cautiously in the months ahead. It is perhaps noteworthy that the central bank of India, where growth has slowed in the past two quarters of fiscal 2014 and which has a history of high inflation, did not