Today will see give some further insight into the state of the UK and US economies as we will receive revisions on their respective first estimates for economic growth in the second quarter of 2010. When the UK first estimate was issued there was a lot of debate over the 1.1% growth rate and in particular the contribution of the construction sector which grew by 6.6% with discussion involving whether the cold snap in February shifted construction output into the second quarter from the first. The initial surprise has in fact turned to the possibility of it being revised upwards a little. But whilst I will be interested to see the revised estimate it is small fry to the revision of the first estimate of US economic growth that will appear at 1.30pm UK time. Not only is the economic status of the US a hotly debated subject but everyone is expecting a considerable downwards revision from the 2.4% that was initially issued, the only question is how much. Please also remember that the US annualisation of these figures usually works in their favour and makes the numbers look larger but today the revision will be exacerbated by it. Put on the same terms as UK growth figures then the US first estimate was 0.6%.
The real issue goes as follows in its “recovery phase” US growth per quarter has gone 5.0%,3.7%, and 2.4% which already worries people due to the obvious trend and this afternoon we are likely to get a number making this look somewhat worse. To do a ex-stimulus analysis then I would remind you from my update yesterday that the Congressional Budget Office estimated that stimulus efforts raised economic growth in the second quarter by between 1.7% and 4.5%.
If anybody wanted to know after the figures what the Chairman of the Federal Reserve Ben Bernanke thinks about the figures and the US economy then they will quickly get their chance as he will give a speech at an economic symposium at Jackson Hole in Wyoming. He will know the figures beforehand so do not be confused on that subject and he will expect his speech to be analysed down to the full stops! As to the media and analyst frenzy that will take place he and his colleagues on the FOMC fed that particular animal when they announced their QE-lite policy at their last meeting. Having (in my view) kowtowed to market pressure they will find that such pressure is only likely to be higher as time goes by and if the US economy continues to decline.
Market Response to yesterdays economic figures
Yesterday saw for the first time in a while better than expected figures for US initial weekly jobless claims. They came in at 473,000 which was lower than the expected 490,000. However after an attempted rally the Dow Jones industrial Average closed down some 74 points at 9985 and so it even fell below the psychologically important ten thousand level. This does I suppose at least correlate with the day before when it rose on bad figures but still shows the unpredictability of markets in the short-term! Looking deeper into the figures perhaps they were troubled by the fact that the four-week average for initial jobless claims rose again to 486,750 or that last weeks 500,000 was revised higher to 504,000. Perhaps also the fact that the number of people receiving extended or emergency benefits rose another 301,000 also concerned them.
As night turned to morning we saw a narrowing of the gap that has emerged between the Dow Jones and the Japanese Nikkei 225 index as the Nikkei rallied by 84 points to 8991 so in response to a big figure change in the Dow it nearly manged one itself in the opposite direction. The spread between the two indices accordingly dipped just below one thousand points to 994 which is a narrowing although it is still quite wide.
Japan deflation,disinflation and the Yen
The last few days have seen some signs of economic and political turmoil in Japan. The surge in the Yen exchange rate that took place earlier in the week has calmed down and reversed a little with it now trading at 107.63 versus the Euro and 84.61 versus the US dollar. So an improvement but still the Yen is at high levels. This led to a debate in Japan as to what she should do and now seems to have contributed to a challenge that has been made to the Prime Minister Mr.Kan who has only been in the job for a couple of months. So economic uncertainty has led to political uncertainty. No doubt the issue of the size of the national debt will be a factor as Mr.Kan had in his short tenure stated that reducing it was a policy objective but now he finds himself in discussions about increasing stimulus measures.
The talk of stimulus measure led to a reversal of the recent trend for Japanese Government Bonds where yields for the ten-year maturity which had recently been challenging 0.9% reversed and in fact hit 1%. So perhaps they actually believe the stimulus talk which is interesting as an announcement on this subject keeps being promised but has not in fact emerged.
One consistent trend throughout all this has been the fact that Japan is currently mired in disinflation. This morning the so-called core consumer price index (CPI), which includes oil products but excludes fresh food prices, fell 1.1 percent in July from a year earlier according to the internal affairs ministry, which was a further decline on the 1.0 percent fall in June. This is now the 17th month in a row of disinflation or falls in prices.The so-called core-core inflation index, which excludes food and energy prices and is similar to the core index used in the United States, fell 1.5 percent in July from a year earlier. So if we raise our minds from the somewhat inconsistent inflation nomenclature used here where core-core means what elsewhere is called core and think what core rates are used as a signal for we get the implication that things may be getting worse and not better. I say this because official forecasts invariably involve an end to disinflation after 12/18 months but current trends question that in my view.
One implication of the falling prices in Japan is that they may provide a reason why she has not been more adversely affected by the rise in her exchange rate. In other words the real or inflation-adjusted exchange-rate has risen by less than the nominal. Indeed there is some research which suggests Japan’s disinflation has been higher than the official estimates which if true would further improve her real exchange rate. To put the explanation of this in a nutshell Japan uses a different system for judging and measuring import price inflation and if you imply such methodology to her CPI measures then they would be lower or more negative.Of course, whilst this may have helped her exporters it only makes her domestic situation look even more difficult.
Ireland and her problems
Having discussed her position several times this week I just wanted to bring two strands together as I am not sure that I linked them as well as I would have liked. The sovereign downgrade of Ireland by Standard and Poors and her recent rise in government bond yields comes at a bad time. In addition to the issues of her property and finance sectors in the latter stages of this year quite a bit of bank debt needs to be renewed and some of it is state-supported either explicitly via the nationalised banks or implicitly via the support schemes she has provided for the banking sector. If the banks have to pay a higher rate of interest on their funding then this again weakens the sovereign nation which backs them so there is a danger of a downward spiral. I think the European Central Bank is likely to step in here with its Securities Markets Programme and we may also see Irish banks using the ECB for funding rather like their Iberian counterparts.
German Bund (government bond) Options
There has been some discussion this week in the Financial Times about some large purchases of call option spreads on the December 2010 German bund future. Now German bund yields have fallen a lot and the buying of such spreads will only make a profit if yields fall further. For those who do not follow such things 120,000 contracts is a very large amount and has led to a lot of speculation.As someone who worked in that market my opinion is that it is likely to be hedging of an over the counter transaction that someone has taken as if you were just looking for a further fall in yields why not simply buy the calls outright?
UK Growth surprises on the upside
Whilst I have been typing this article the revised figures for growth in the second quarter of 2010 for the UK have been issued by the Office for National Statistics and they indeed show a rise to 1.2% from the originally reported 1.1%. My suggestion is for UK readers to smile and enjoy the numbers for a moment and hope we can keep such growth going. As to the breakdown of the numbers they do rely on construction spending growth which was revised upwards from 6.6% to 8.5%. At the time of the initial estimate there were questions about the 6.6% growth rate which I suspect will be repeated with more force now. Should the numbers be true it hardly represents a rebalancing of our economy away from housing does it? But in these times we should be grateful for any scrap of growth and then enquire as to how such exceptional numbers for construction can be explained.
There is one further implication of today’s figures,further down the report we get figures for the annual implied GDP deflator which in many ways is the best indicator of price inflation that we get as it is a wider measure than just consumer or retail prices and according to the ONS.
The GDP implied deflator rose by 4.1 per cent compared with the second quarter of 2009, up from 2.9 per cent in the previous quarter
Perhaps someone at Jackson Hole will ask the Governor of the Bank of England about this move in inflation.
Update 1:45 pm UK time
According to the Bureau of Economic Analysis first revision just out US economic growth for the second quarter of 2010 fell from an annualised 2.4% to 1.6%. In terms used by most of the rest of the world that is from 0.6% to 0.4%. The reasons behind this are as follows.
The deceleration in real GDP in the second quarter primarily reflected a sharp acceleration in imports and a sharp deceleration in private inventory investment that were partly offset by an upturn in residential fixed investment, an acceleration in nonresidential fixed investment, an upturn in state and local government spending, and an acceleration in federal government spending.
These are figures which are better than many expectations so we should see relief in the short-term. However the downwards trend is even clearer now and without the stimulus measures the US economy would be shrinking.