US April producer prices higher, economic activity slower

Stock markets around the world took a beating yesterday and the US economic data didn't help. Reuters reports the latter.

The Labor Department said the Producer Price Index rose 0.2 percent last month as food prices took a respite from their march upward and as gasoline costs, which usually climb sharply in April, fell after adjustment for seasonal swings.

However, core producer prices, which strip out volatile energy and food costs, increased by 0.4 percent -- twice the rate forecast on Wall Street.

Over the past 12 months, core prices have risen 3 percent, the largest gain since December 1991. Overall producer prices were up an even stiffer 6.5 percent.

U.S. stock prices fell as investors, already alarmed by a fresh record oil price notched on Tuesday near $130 per barrel, took further fright over the high core price gauge.

The Dow Jones Industrial Average closed down almost 200 points or more than 1.5 percent in New York...

The report suggested price pressures further back in the chain of production, with core crude goods up 7.9 percent...

A report from the Chicago Federal Reserve Bank showed weaker economic activity in April across a range of sectors. Its National Activity Index, compiled from an array of economic data, moved down to -1.17 from -0.98 in March.

However, Monday had provided some hopeful signs for the US economy. From Bloomberg:

The index of leading U.S. economic indicators rose in April for a second month, the first back-to- back gain since October 2006, signaling that the current slowdown will be short-lived.

The Conference Board's gauge increased 0.1 percent, better than forecast and matching the gain in March, the New York-based research group said today. The measure points to the direction of the economy over the next three to six months.

Japan's interest rates left unchanged, leading index revised down

There was no change in interest rates from the Bank of Japan today. Bloomberg reports:

The Bank of Japan kept interest rates on hold at the first meeting after slashing its growth estimate and shelving a two-year policy of seeking higher borrowing costs.

Governor Masaaki Shirakawa and his six colleagues unanimously voted to leave the overnight lending rate at 0.5 percent in the quickest decision in three years, the central bank said in Tokyo. The rate is the lowest among major economies.

The world's second-largest economy is slowing, the central bank said in its monthly report released after the meeting...

Among economic data released today, there was good news in the form of a 0.3-percent increase in the tertiary index in March.

The bad news, however, is that Japan's index of leading economic indicators for March has been revised down from 20.0 to 18.2.

Fall in US industrial production raises recession probability

While employment in the US has been declining, leading many economists to declare that the economy has tipped into recession, industrial production had been one of those indicators that had merely stagnated but not shown a clear decline. This changed in April.

On 15 May, the Federal Reserve released data showing that industrial production fell 0.7 percent in April. Industrial output in April was also the lowest since May last year. The decline in industrial production raises the probability of a US recession.

The fall in industrial production was not surprising. The Institute for Supply Management's manufacturing PMI has been below the 50 mark for the past few months.

Retail sales is the other indicator that has been weak for some time and the latest report proved no exception. On 13 May, the Commerce Department reported that retail sales fell another 0.2 percent in April.

Elsewhere in the world, though, economies have been somewhat more resilient.

On 15 May, Eurostat reported that gross domestic product in the euro area grew by 0.7 percent in the first quarter, accelerating from 0.4 percent growth in the fourth quarter of 2007.

On 16 May, Japan's Cabinet Office reported that the economy grew 0.8 percent in the first quarter, also accelerating from the downwardly-revised fourth-quarter growth of 0.6 percent.

However, the composite leading indicators released by the Organisation for Economic Co-operation and Development last week showed that the major economies remain headed for a slowdown.

A consolation for the global economy perhaps is that the expected slowdown is likely to cool inflation around the world.

There are already signs that inflation has peaked in the US. Last week, the Labor Department reported that headline CPI in the US increased 0.2 percent in April, less than the 0.3 percent gain in March. Consumer prices excluding food and energy climbed 0.1 percent, down from a 0.2 percent gain a month earlier.

The declines helped bring the 12-month rate of increase in headline CPI to 3.9 percent in April, slightly down from 4.0 percent in the previous two months. Excluding food and energy, the index was 2.3 percent higher than a year ago, down from 2.4 percent in March although only back to the rate in February.

In the euro area, Eurostat last week confirmed consumer price inflation at 3.3 percent in April, down from 3.6 percent in March.

However, other data released last week show that inflation is still accelerating in many parts of the world.

In China, consumer price inflation rose from an annual rate of 8.3 percent in March to 8.5 percent in April, inducing the People's Bank of China to increase the reserve requirement ratio for commercial banks by half a percentage point to 16.5 percent.

In the UK, the inflation rate rose from 2.5 percent in March to 3.0 percent April. The Bank of England's latest inflation forecast is that it is likely to stay above 3 percent for several quarters.

Moderation in global inflation, especially towards the respective central banks' target or comfort ranges, will probably have to wait until after the slowdown becomes more evident globally.

With yet another US economic indicator moving into recession territory last month though, clear evidence of such a global slowdown may not take too long to come.

US consumer confidence down, other data mixed

US consumer confidence fell in May. Reuters reports:

The Reuters/University of Michigan index of consumer confidence certainly highlighted the threat to economic growth, dropping to 59.5 in May -- the lowest level since June 1980...

Meanwhile, the Michigan report's gauge of one-year inflation expectations surged to 5.2 percent -- the highest since February 1982 -- from 4.8 percent in April.

Also worrying for policy-makers at the Federal Reserve, five-year inflation expectations were the highest since August 1996, edging up to 3.3 percent from April's 3.2 percent.

But housing data released yesterday were mixed.

... [S]tarts on new U.S. homes rose by a surprisingly strong 8.2 percent in April, the biggest monthly increase in more than two years. The bounce, however, came entirely from multiple-unit dwellings such as apartments and condominiums.

Applications for new building permits also turned up for the first time in five months, presenting another rare bit of good news for the beleaguered U.S. housing market, the original source of the economy's current troubles.

In a sign that housing's woes were not yet over, groundbreaking on single-family homes in the United States dropped to the slowest pace since 1991.

Still, the ECRI's leading index continues to give hopeful signs. Reuters reports:

The Economic Cycle Research Institute...said its Weekly Leading Index slipped to 133.5 in the week to May 9 from 133.6 in the prior period, revised from 133.5...

The index's annualized growth rate improved to negative 7.2 percent from minus 8.0 percent, its highest since the week to March 28, according to ECRI data.

US economy looking weak but other economies holding up better

The US economic data released yesterday were negative. Reuters reports:

... [N]ationwide industrial production tumbled a bigger-than-expected 0.7 percent in April due to the most severe contraction in the manufacturing sector in nearly three years, the Federal Reserve said...

The Philadelphia Federal Reserve Bank said its business activity index was at minus 15.6 this month, improving from minus 24.9 in April...

On the labor market front, a government report showed the number of people who remained on jobless benefit rolls after drawing an initial week of aid increased 28,000 to 3.06 million in the week ended May 3...

The New York Fed's "Empire State" general business conditions index fell to minus 3.23 in May from positive 0.63 in April...

The National Association of Home Builders said its preliminary NAHB/Wells Fargo Housing Market Index fell to 19 from 20, within one point of the record low of 18 set in December 2007...

However, the data were not weak enough to disturb investors and stocks easily shrugged them off. From Bloomberg:

U.S. stocks climbed, sending the Standard & Poor's 500 Index to a four-month high, as analysts said chipmakers will benefit from rising global demand and energy shares are cheap relative to crude prices...

The S&P 500 added 14.91, or 1.1 percent, to 1,423.57. The Dow Jones Industrial Average increased 94.28, or 0.7 percent, to 12,992.66. The Nasdaq Composite Index gained 37.03, or 1.5 percent, to 2,533.73... More than five stocks rose for every two that fell on the New York Stock Exchange.

Other data out yesterday showed the eurozone economy doing well in the first quarter, but the strength may not last. Reuters reports:

... [T]he European Union's statistics office said growth for the euro zone as a whole beat forecasts, up 0.7 percent from the last quarter of 2007...

European Central Bank President Jean-Claude Trichet said the European news, while positive, merely confirmed what he had been saying for some time, namely that the first quarter would be good and the ensuing period slower...

European Statistics office Eurostat confirmed that annual inflation in the euro zone was 3.3 percent in April, below the record 3.6 percent of March but well above the ECB's goal of just below two percent...

British growth slowed in the first quarter to 0.4 percent from 0.6 percent...

Data out from Japan today also showed strong growth in the first quarter. Bloomberg reports:

Gross domestic product expanded an annualized 3.3 percent in the three months ended March 31, better than the 2.5 percent median estimate of 32 economists surveyed by Bloomberg News, the Cabinet office said today in Tokyo. Japan's fourth-quarter GDP growth was revised to 2.6 percent from 3.5 percent.

UK faces stagflation threat, US gets better inflation news

As if the previous day's UK inflation number was not bad enough, yesterday saw the Bank of England's inflation report providing a gloomy set of forecasts. Reuters reports:

The economy could shrink for a quarter or two and inflation may near 4 percent this year, the Bank of England said on Wednesday in its bleakest forecasts since the Labour government took power in 1997.

Economists said the expected spike in inflation even further above the central bank's 2 percent target meant that interest rates won't come down quickly, even with news on the housing market downturn getting nastier by the day...

The Bank report shows inflation could hit 3.7 percent this year and still be clearly above its 2 percent target if interest rates come down by half a percentage point over the next year, as many analysts had previously expected...

Economic growth was expected to slow to around 1 percent at the end of this year before picking up to around 2.3 percent in two years -- still below the long-term trend rate.

If the forecasts look worrying, Mervyn King made little effort to ameliorate their impact.

"The Monetary Policy Committee is facing its most difficult challenge yet," said Bank Governor Mervyn King. "We are travelling along a bumpy road as the economy rebalances. Monetary policy cannot, and should not try to, prevent that adjustment."

"Inflation will return to the target and growth will eventually recover to a sustainable rate. But we will need to be patient."

The diverging inflation and growth trends appear to be making themselves felt in the labour market simultaneously. From another Reuters report:

The number of Britons claiming jobless benefits rose for the third successive month in April, official data showed on Wednesday, suggesting a slowing economy is starting to hit the job market.

Figures from the Office for National Statistics showed the claimant count rose 7,200 in April to 806,300. That was the biggest increase since April 2006 and the first time it has risen in three consecutive months for almost two years...

Average earnings in the three months to March rose 4.0 percent, above forecasts and the highest since last November. In March alone, wages rose 4.7 percent, the highest single monthly rise since January 2007.

There was some good news, however, on the inflation front in the US. Bloomberg reports:

U.S. consumer prices rose less than forecast in April, reflecting cheaper furniture and lodging costs that offset the biggest jump in food expenses in 18 years.

The consumer price index increased 0.2 percent after a 0.3 percent gain in March, the Labor Department said today in Washington. So-called core prices, which exclude food and energy costs, climbed 0.1 percent, compared with a 0.2 percent advance a month earlier...

Prices rose 3.9 percent in the 12 months ended in April, down from a 4 percent year-over-year gain in March. The core rate increased 2.3 percent from April 2007, after increasing 2.4 percent in the 12 months ended in March.

Even as inflation slowed though, it continues to weigh on real spending. From Asha Bangalore:

... The good news is that the April report showed a moderation in inflation. At the same time, inflation adjusted retail sales fell 0.3% in April, following a string of declines... [I]nflation adjusted retail sales have dropped for four consecutive quarters at mostly an accelerating pace. The weakness seen in April and forecasts of consumer spending should translate into another quarterly decline in inflation adjusted retail sales...

But the deceleration in inflation should take a bit of sting out of Willem Buiter's post yesterday, which criticised the Fed for having "let inflation get away from it even more than the ECB and the Bank of England".

Nevertheless, Buiter's overall point appears valid. He wrote that inflation "is rising just about everywhere", and that ultimately, central banks are responsible. Notwithstanding the deceleration in April, headline inflation in the US is already "way above what should be the Fed’s comfort zone" while core inflation, though lower, has ceased to be a superior predictor of future headline inflation (see also my take on the latter).

Indeed, the global nature of rising inflation has become apparent in recent months. Even Japan could be facing rising inflation as wholesale prices rose in April at close to the fastest pace in almost three decades.

Fund managers also think that global inflation is rising. From MarketWatch:

A rising number of fund managers say inflation is set to accelerate over the next 12 months, according to Merrill Lynch's monthly survey for May.

According to the report, a net 25% of fund managers believe that global core inflation will be higher in a year's time, up from 7% who held this position in April and 17% in March...

The number of asset allocators who believe bond markets are currently overvalued nudged up to 48% in May, up from 47% in April, while the number of managers that think global equity markets are undervalued fell to 15% in May, down from 26% in April.

Slower growth and higher inflation in the US and UK, malaise for risky assets

Signs of a slowing US economy continue to show up. From Reuters:

The Commerce Department said retail sales declined 0.2 percent, but excluding cars, sales rose 0.5 percent...

Separately, the National Association of Realtors said median values of previously owned single-family homes in metropolitan areas fell 7.7 percent from year-ago levels.

But the expectation for a pause in the Federal Reserve's rate cutting remains, to a large extent because inflation remains a concern.

The Labor Department said U.S. import prices climbed 1.8 percent in April as prices for petroleum and non-petroleum products climbed, feeding worries about the potential for inflation...

Analysts said the retail sales numbers might increase chances that Fed policy-makers will pause their rate-cutting campaign and focus more closely on controlling inflation.

A survey by the Philadelphia Federal Reserve sees economists acknowledging both slower growth and higher inflation in the US. Reuters reports:

The U.S. economy will barely expand in the second quarter and the chances of it shrinking have risen, following sluggish growth early in the year, said a Philadelphia Federal Reserve survey released on Tuesday.

The 50 economists surveyed by the regional Fed also forecast a sizable pickup in overall inflation in the next several months as a result of surging oil and food prices...

They forecast U.S. gross domestic product in the current quarter would expand at an annualized rate of 0.2 percent, sharply below their prior forecast of 1.3 percent...

Forecasters revised upward the prospects of a contraction in the second quarter to 49.1 percent from their earlier projection of a 42.9 percent risk...

Core inflation will likely stay just above the top end of the Fed's perceived comfort zone of 2 percent in coming months. Forecasters raised their second-quarter estimate for the Consumer Price Index, the government's broadest inflation measure, to a 3.5 percent increase from their previous estimate of 2.4 percent.

Unlike the Federal Reserve, the Bank of England is early in its interest rate cutting cycle but it might already have to consider a pause.

There is little doubt that the UK economy is decelerating. From Reuters:

House prices suffered their most widespread decline across Britain for 30 years and retail sales fell for a second consecutive month in April, surveys showed on Tuesday, in a sign the economic slowdown is worsening...

The Royal Institution of Chartered Surveyors said its house price balance fell to -95.1 in the three months to April from -79.4 in March -- the weakest since the series began in January 1978 and well below forecasts for a reading of -80.0.

The balance fell in every region compared with March...

The British Retail Consortium said the value of like-for-like retail sales fell by an annual 1.5 percent last month.

Total sales, which include new floor-space, rose by 1.0 percent, the weakest annual rise in three years.

And from another Reuters report:

Property services firm Savills said its Total Commercial Development Activity Index showed a net balance of minus 20.8 percent last month -- the lowest level recorded in the monthly survey's five-year history and evidence that the country's property downturn has further to run.

But inflation is still headed in the wrong direction. Again from Reuters:

Soaring food and fuel bills pushed up the inflation rate by its biggest amount in nearly six years, further denting expectations of interest rate cuts despite a slowing economy.

The Office for National Statistics said consumer prices leapt 0.8 percent last month from March, pushing the annual rate up by half a percentage point to 3.0 percent. Analysts had expected a rate of only 2.6 percent.

The pound jumped more than half a cent and interest rate futures tumbled as dealers ratcheted down the probability of further interest rate cuts soon.

Morgan Stanley's Richard Berner sees slower growth and higher inflation as a global phenomenon with economic recoupling, and the impact on risky assets is not positive.

Global growth is slowing, reflecting spillovers from the US slowdown, tighter financial conditions, and the response to rising inflation in EM economies...

Ironically, the slowing in global growth could be the coup de grace for the US, just as it was the saving grace a year ago, and the evidence for such fading support is starting to appear in US exports...

Still-strong growth in much of the world and soaring commodity prices threaten higher global inflation...

Unfortunately, supply factors seem to be the dominant cause behind the rise in commodity prices lately...

Investors hoping for the ideal scenario of a mild global slowdown, a stronger dollar, cooling inflation, and lower interest rates abroad seem likely to be disappointed. The baseline I see will involve an unappetizing combination of slower growth, high inflation, and little decline in interest rates, which spells malaise for risky assets. In contrast, if overseas growth were to slow enough to bring down inflation and interest rates and boost the dollar, overseas earnings and credit quality would suffer significantly. Neither outcome seems positive for equities or other risky assets.

China raises reserve requirement

China's fight against inflation continues. China View reports:

China's central bank announced on Monday that it would raise the reserve requirement ratio for commercial banks by half a percentage point to curb excess liquidity and ease inflation.

This is the fourth such move this year, and it will lift the country's reserve requirement ratio to a new high of 16.5 percent as of May 20.

This comes on the same day that China reported a rebound in inflation.

China's consumer price index (CPI),the main gauge of inflation, rose 8.5 percent year-on-year in April, the National Bureau of Statistics (NBS) said on Monday.

The figure, compared with 8.3 percent in March and a nearly 12-year-high of 8.7 percent in February...

Food prices soared 22.1 percent in April, 0.7 percentage points higher than in March...

Non-food prices in April were up 1.8 percent year-on-year, compared with 1.4 percent in November.

The producer price index (PPI), which measures the value of finished products when they leave the factory, rose 8.1 percent in April year-on- year, setting three-year highs for a fourth consecutive month.

Meanwhile, foreign direct investment is surging.

China saw 35.02 billion U.S. dollars worth of foreign direct investment (FDI) utilized in the first four months, up 59.32 percent from the same period last year, the Ministry of Commerce (MOC) said on Monday.

The number of newly approved foreign-funded enterprises, however, shrank 23.15 percent to 9,490 in the January-April period.

But there are signs that China's trade surplus has peaked.

China's trade surplus reached 16.68billion U.S. dollars in April, the General Administration of Customs said on Monday.

The figure was down 1.14 percent year-on-year but up 24.5 percent from 13.4 billion U.S. dollars in March, and it almost doubled the 8.6 billion U.S. dollars posted in February.

Exports in April rose 21.8 percent over April last year to 118.71 billion U.S. dollars, while imports rose 26.3 percent to 102.03 billion U.S. dollars...

Total trade in the first four months hit 791.1 billion U.S. dollars, up 24.4 percent year-on-year. The four-month trade surplus was 58 billion U.S. dollars, down 5.32 billion U.S. dollars year-on-year.

Exports in the four-month period were 424.6 billion U.S. dollars, up 21.5 percent, or 6 percentage points less than a year earlier. Imports were 366.6 billion U.S. dollars, up 27.9 percent, or 8.8 percentage points more than a year earlier.

However, none of these reports would have rocked China as much as the earthquake in Sichuan.

Japanese and US leading indices indicate weakness, US trade deficit improves

The rise in Japan's leading index above 50 in February could not be sustained in March. From Bloomberg:

Japan's economy may slow as cooling export growth prompts companies to cut output, the government's broadest outlook indicator showed.

The leading index, derived from 12 statistics including production and stock prices, fell to 20 percent in March from 54.5 the previous month, signaling growth will slow over the next two quarters, the Cabinet Office said today in Tokyo. The index has been below 50 in nine of the past 12 months...

The coincident index fell to 33.3 percent in March from 70 in February, today's report showed.

In the US, the ECRI's leading index improved last week but remained in recession territory. Reuters reports:

The Economic Cycle Research Institute, a New York-based independent forecasting group, said its Weekly Leading Index edged up to 133.5 in the week to May 2 from 131.8 in the prior week, revised from 131.9...

The index's annualized growth rate remained negative, but improved to minus 8.0 percent from minus 8.7 percent.

There was also an improvement in the US trade deficit in March. Reuters reports:

The trade gap shrank 5.7 percent in March to $58.2 billion, the Commerce Department reported on Friday, much smaller than expected...

The narrowing trade gap means the U.S. economic growth was somewhat stronger than first estimated. Based on the trade data, Gault said he expected the government to raise its estimate of first quarter U.S. economic growth to 0.9 percent, from an initial reading of 0.6 percent last month.

Ian Shepherdson, chief U.S. economist with High Frequency Economics, pegged first quarter growth at 1.1 percent because of a stronger-than-expected contribution from trade.

But there were negatives in the trade report as well.

... The decline reflected...a record $6.1 billion drop in imports to $206.7 billion, which showed the U.S. slowdown has taken a toll on consumer and business demand for foreign goods...

U.S. exports retreated slightly in March, but were still the second highest on record at $148.5 billion...

In fact, Brad Setser says that:

... there actually wasn’t a lot to like in this month’s trade release.

... [M]uch of the fall in the deficit came from a big fall in the volume of imported petroleum...

The real problem though was on the export side. Export growth looks to be slowing...

The improvement in the nominal trade balance...also has stalled.

It isn’t hard to see why: oil

And with oil prices hitting records on a daily basis recently, it's going to be tough to see further improvement in the trade deficit without significant falls in import volumes.

Interest rates left unchanged in Europe amid negative data

The two most important central banks in Europe left interest rates unchanged yesterday. Bloomberg reports:

The European Central Bank and the Bank of England kept interest rates unchanged today, trying to balance the risk of faster inflation against the danger that higher credit costs will drag down economic growth.

The Frankfurt-based ECB left its benchmark refinancing rate at 4 percent, as predicted by all 53 economists surveyed by Bloomberg News, and President Jean-Claude Trichet signaled it won't cut rates anytime soon. The Bank of England, which has lowered rates three times since early December, left its benchmark at 5 percent, still the highest among the Group of Seven nations.

Economic growth, though, may be faltering in Europe.

Retail sales in the euro area declined 1.6 percent in March from a year earlier, the most since at least 1995. Sales declined 0.4 percent from February.

In Germany, Europe's largest economy, industrial production fell 0.5 percent in March, manufacturing orders fell 0.6 percent and exports fell 0.5 percent.

In the UK, the National Institute of Economic and Social Research estimates that the economy grew by 0.4 percent in the three months to April. This is after data out on Wednesday showed that British manufacturing output fell 0.5 percent in March, its sharpest decline in six months. Also on Wednesday, a survey by the Nationwide building society showed that British consumer morale had fallen to its lowest level since records began four years ago while a report by REC/KPMG showed that permanent job placements fell in April for the second time in three months.