Eric Lascelles, chief economist at RBC Global Asset Management comments on the implications of weak economic data from China, dovish Fed minutes, the latest inflation data and the recent upward shift of oil prices.
Chinese economic data
China’s monthly cavalcade of economic data is upon us. The early releases show a broadly worse trade picture than anticipated, confirming both that China’s appetite for raw materials has waned and that it has lost some of the competitiveness that made it such an exporting powerhouse over the past few decades. Upcoming data will provide a window into how substantially China’s housing and credit markets are slowing, whether consumer spending is stepping up to fill the hole (unlikely, at least just yet), and how this all squares up in GDP. We remain mild pessimists on China, looking for underwhelming economic data but not disaster given the central government’s ability to mop up the country’s credit bubble. In the meantime, the Chinese stock market continues to soar. This confusing disconnect appears to be fuelled by the euphoria of monetary stimulus, a shift in savings behaviour away from the stumbling housing market and into equities, and the expectation that ongoing structural changes to China’s capital account will unleash a wave of international investor appetite.
The U.S. Federal Reserve Minutes were arguably a bit less dovish than expected in that they did not dwell excessively on international weakness or dollar strength, that domestic weakness was mostly transitory, and given confirmation that “several” Fed participants still favoured June lift-off for the fed funds rate. A June hike is unlikely given that the majority of Fed participants favoured somewhat later action, but a September tightening seems entirely plausible (and is arguably the single most likely date at this juncture). Another interesting titbit to emerge from the Minutes was that while two participants wished to signal a coming rate hike at the meeting before such an action, most preferred a more ambiguous approach (and two others were dead-set against it). As such, the Fed has very clearly entered an era of diminished forward guidance and markets will be left guessing.
This is an inflation-heavy week, with March CPI reports due for the U.S., Eurozone and Canada. On an annual basis, the inflation readings look likely to continue trundling along at very low levels – in the vicinity of 0.0% for the U.S. and Eurozone. Oil prices have since rebounded, but were no higher on average in March than in February. As we recently argued in an Economic Compass entitled “Dissecting Deflation”, the deflationary pressures currently on display are both less economically pernicious and less persistent than commonly imagined. This won’t particularly be evidence in the March figures, but from April on the inflation readings may manage to begin edging their way out of the cellar.
Oil prices have shown a slight upward trend over the past month, but broadly speaking they have failed to deliver the substantial gains we had expected to date. The rationale is a mix of weaker-than-expected emerging market growth, a slower-than-expected transmission of curtailed U.S. oil investment into curtailed oil production and an unhealthy U.S. oil inventory environment. The emerging-market slowdown is likely nearing an end, in part (ironically) to low oil prices. The U.S. oil rig count has fallen by more than half, and we calculate that this should remove a good one million barrels-plus from production growth over the next several quarters. Finally, U.S. oil inventories are not pretty, but should begin to accumulate less quickly now that oil refineries are re-engaging and given the expected production adjustment. In short, oil prices should manage some gains over the next few quarters, but it may take longer than this to fully normalize the price of oil.