Daily Macro: China’s December GDP and more

In this briefing:

1. China’s December GDP
2. The Bull Case for 2019: If Household Spending Stands Out (And Funding Finally Flows In)
3. UK Cycle: BoE Should See a Tightening Labour Market
4. Fed Policy Outlook Gets Even More Complex Due to Multiple Factors
5. 2019 Equity Market Outlook

1. China’s December GDP

China’s quarterly numbers are in and China’s economic growth decreased to 6.4%. We are reviewing the most recent numbers and examining some inconsistencies.We believe there are pronounced weak spots in China’s GDP growth and expect to see that downward pressure in the Chinese economy going forward.

2. The Bull Case for 2019: If Household Spending Stands Out (And Funding Finally Flows In)

There is a certain scenario in which the Indonesian market in 2019 could outperform on relative basis.  If global growth slows while the resilient household sector holds up, capital inflows coud prove sufficient to cover the current account and avert yet more depreciation. 

An adverse policy framework is depressing key sectors and hampering investment – at a time when the current account deficit (Cad) is jeopardizing stability.  The administration of President Joko Widodo, who is cruising to re-election, shows little urgency about rectifying recent declines in Foreign Direct Investment (FDI).  These concerns have underpinned our bearish outlook for the market in 2019 (see Indonesia: The Year of Dithering Dangerously).  But in the event of a sharp global slowdown this year, Indonesia has potential – on a relative basis – to outperform. 

Indonesia’s economy is poorly integrated with the international arena, and this ‘decoupling’ can offer insulation from global turbulence under certain conditions.  And the key driver of GDP is household consumption, which has shown resiliency by sustaining a 4.9‑5.1 percent pace of annual growth over the past five years.  As global growth deteriorates, Indonesia’s stalwart consumer‑growth engine may stand out and garner attention; if so, this may attract the capital inflows needed to cover the Cad. 

However, risks remain high due to a background context that features policy flaws and institutional dysfunctions.  Reforms to address the investment climate could bring about a substantial upward re‑rating – but prospects for Widodo to move assertively in this direction seem poor.  In the continued absence of meaningful reforms, macro-economic stability will remain fragile, vulnerable to abrupt reversals in short‑term portfolio flows.  Given Indonesia’s weak export performance and growing dependence on imported oil, the currency would face renewed pressure in the event of excessive Federal Reserve hikes or global shocks.  However, in a scenario of global deceleration without undue turbulence, Indonesia has potential to outperform. 

3. UK Cycle: BoE Should See a Tightening Labour Market

• Faster employment growth lowered the unemployment rate to 4.0% in Nov-18, contrary to expectations. The labour market still looks to be tightening.
• The BoE will provide its annual update of supply-side conditions in its 7-Feb Inflation Report. I expect it to maintain its 4.25% NAIRU estimate.
• Stronger wage growth suggests an effective tightening of the labour market. Excess demand and inflation provide hawkish pressure, albeit neutered by Brexit.

4. Fed Policy Outlook Gets Even More Complex Due to Multiple Factors

The Fed’s new patient approach to raising the federal funds rate will hinge critically on co-operative incoming economic data, notably subdued inflation signals.

Measures of US inflationary expectations remain well-anchored, thereby providing the Federal Open Market Committee (FOMC) with policy breathing space, while labour market conditions will continue to be closely monitored for overheating risks.

US monetary policy requires both nimbleness and flexibility, analogous to the conduct of the 1990s, although the advanced age of the current cycle raises the risks of a policy mistake.

The Fed has effectively been forced by excessive financial market volatility to return to issuing forward guidance, as investors struggle to envisage the return to a normal environment where short-term interest rate volatility is higher compared to long-term yields.

Fed policy adjustment is being complicated by further declines in the term premium demanded by bond investors that simultaneously boosts financial accommodation, supports the real economy and flattens the yield curve.

5. 2019 Equity Market Outlook

• The equity market in the fourth quarter of 2018 was throwing off recession-like signals with the 19.8% drop in equity prices from the S&P 500’s all-time high through the near-term trough of December 24, 2018.  We see the decline as a correction from an overvalued position in late September rather than as point to an impending recession.
• Key to the outlook for equities and the economy are economy-wide profit margins (share of nonfinancial corporate profits in output).  It appears the balance between price increases and productivity-adjusted labor costs has improved as productivity has accelerated despite a pickup in the growth of labor compensation.  The corporate tax cut has spurred post-tax margins close to record highs.
• We expect nonfinancial corporate profit growth of 7% on average over the next two years, which should support equity prices.   However, the scope for a strong further rebound in equity prices is challenged by our outlook for rising corporate bond yields (our valuation model suggests rising profits and higher yields roughly cancel each other out in our valuation model).