Daily Economic Briefing: February 22, 2010

Daily Economic Briefing: February 22, 2010

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Page 1: Global data summary

• Today’s GDP reports from EM Asia remind that although regional growth moderated in 4Q09 it remained impressive. Taiwan and Thailand recorded 18.0%q/q, saar and 15.3% increases in real GDP; not surprisingly, gains of this magnitude were fueled by impressive growth in both domestic demand and exports. Elsewhere in the EM, Mexico continued to rebound from its severe recession, posting an 8.4% gain in GDP in 4Q09.

• Over the remainder of the week, the main focus will be on the US and Japan. Updates on US house prices and home sales will show whether the sequential recovery in prices is being maintained and whether sales are resuming their climb after a setback in 4Q. We also get January durable goods orders (we look for a decline in core orders, reflecting technical factors) and 4Q corporate profits (NIPA version). We look for a whopping 40% annualized increase in profits, as US companies reap the benefits of a more rapid demand recovery and vastly stronger labor productivity growth (see “Global labor markets stabilizing but not yet expanding” in this week’s GDW).

• Assuming that the impressive recovery in Japanese exports and IP maintained in January, the key question then becomes the trend in domestic demand. The forecast looks for consumption growth to slow sharply, but not stall, in response to diminished fiscal stimulus. Capex is thought to be accelerating, though not nearly enough to offset the downshift in consumption.

• Lastly, the Euro area and Japan will release January inflation. These reports follow Friday’s surprising 0.1%m/m drop in the US core CPI. The path of core inflation is extremely important for the economic outlook. A continued decline would confirm that the huge amount of measured resource slack in the advanced economies is being transmitted to pricing. This, in turn, would open the door to easier monetary policy for a more extended period and thus faster economic growth.

• Lower core inflation is especially critical for Fed policy. With zero short-term rates and a $2 trillion-plus balance sheet, the Fed has pulled out the stops to support growth. Fed officials have waved off concerns about asset bubbles and are conditioning policy on the path of core inflation and inflation expectations. A downside surprise in inflation in 2010 such as we forecast, with core inflation moving decisively below 1%oya, would support this approach. Friday’s remarks from NY Fed President Dudley were very clear on this point: “There is no inflation pressure in the US right now, so our focus has to be on growth and jobs,” i.e., on the recession’s costs in terms of chronic high unemployment and budget deficits.

Page 2: Looking for a decisive fall in DM core goods inflation

Our forecast calls for core inflation to fall to near 0.5%oya in the developed world by late this year as the high level of resource slack damps prices and wages. Broadly speaking, inflation outcomes over the past year have been consistent with this long-standing view, as developed market core inflation has declined from a peak of 1.9%oya in September 2008 to an estimated 1.1%oya in January.

The sectoral pattern of DM inflation has been mixed, however, with a slide in core services dominating an unexpected rise in core goods. The pickup in core goods inflation is not uniform. Goods inflation has risen in the US, the UK, Sweden and Norway; while it has fallen in the Euro area and Japan The roughly 3% rise in US core goods prices over the past year is the highest since the early 1990s.

A number of factors helps explain this divergence in the goods sector inflation readings. In the US, the rise in core goods prices is focused in autos and tobacco. The rise in US auto prices has not been fully explained but a portion of it reflects the forced retirement of existing stock in conjunction with cash for clunkers. It does appear that the rise in US car prices is beginning to taper off. The rise in tobacco prices reflects one-off tax hikes that are still affecting the year-ago inflation rate (prices rose 20%, not annualized, in March/April of 2008). In the UK and Scandinavia, passthrough from currency depreciation has been driving up prices. More recently, a hike in the UK VAT has further spurred price increases. In Canada, the repeal of sales tax cuts explain the 2008-2009 swings in core goods inflation, which has now settled back down.

Going forward, we expect the US will join the Euro area and Japan to deliver a decisive decline in core goods inflation in the DM, similar to what is happening in services. As shown in the accompanying exhibit, the historical evidence indicates that resource utilization and DM core goods inflation are positively correlated, though the transmission occurs with a lag.

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