HIGHLIGHTS OF THE WEEK
- Chinese economic growth slowed 6.2% y/y in the second quarter of this year, as rising trade tensions weighed on activity. Signs of wear are also showing in the U.S., where industrial output continued to grow at a slow pace in June.
- U.S. housing data remains soft. Starts eased in June, while permits dropped precipitously (-6.1% m/m), pointing to more weakness in the pipeline. That said, the services side of the economy continues to hold up well, with consumption providing a major helping hand. Retail sales rose by 0.4% in June, extending the winning streak to four straight months.
- The resilience of the American consumer suggests less urgency for the Fed to cut rates later this month. But, Fed speakers pushed back against that notion this week, emphasizing the need to get ahead of any potential weakness.
Resilient Consumer Unlikely To Change Fed’s Mind
The first half of July, which was marked by a G20 meeting and major Fed communications, was a hard act to follow. But this week still offered plenty of kick, with political developments and a few primary data releases dominating headlines. Of note, tensions in the Persian Gulf remained high with the U.S. claiming that it shot down an Iranian drone in the Strait of Hormuz. The U.S.-China trade spat also continued to reverberate, with President Trump stating that trade talks still have “a long way to go” and calling for an inquiry into Google’s work with China.
The trade blows are inflicting wounds on both sides. Figures out this week showed that Chinese economic growth slowed to 6.2% year-on-year – the slowest pace in 27 years, with output in secondary industries (construction and manufacturing) decelerating to 5.6% from 6.1% in the first quarter. In the U.S., industrial output continued to grow at a slow pace in June, in line with signals from the ISM manufacturing survey (Chart 1). The impact of the trade conflict is not confined to manufacturing. An annual NAR survey showed that Chinese home purchases in the U.S. fell by 56% in the 12-months ending in March.
The good news is that despite all the challenges (trade-related or not), the larger services side of the U.S. economy continues to hold up well. The Fed’s Beige Book corroborated this narrative in what appeared to be another steady-as-she-goes report for the mid-May to early-July period. Consumer spending is providing a major helping hand. Retail sales extended their winning streak to four straight months, with the tally up 0.4% in June. Sales in the ‘control group’, which excludes volatile categories and is used in calculating GDP, rose by an even more impressive 0.7%. With the month prior also receiving a slight upgrade, control group sales in the second quarter advanced 7.5% annualized – the strongest showing since mid-2014 (Chart 2). This bodes well for real consumer spending in the second quarter, which we expect to come in at around 4% annualized – a strong rebound from the sluggish start to the year.
Housing data, on the other hand, remains soft. Starts edged lower in June (-0.9%) and have generally moved sideways in recent months. Building permits, however, fell precipitously on the month (-6.1% m/m), suggesting some weakness is still in the pipeline. Despite a favorable demand backdrop and relatively low and falling interest rates, new construction is struggling to kick into higher gear. A lack of buildable lots, labor shortages and increased production costs remain key hurdles.
Looking past housing challenges, the resilience of the American consumer suggests less urgency for the Fed to cut rates later this month. However, several Fed speakers pushed back against that notion this week, emphasizing the need to get ahead of any potential weakness. Still, should the data continue to hold up, the case for limited stimulus (i.e. only 1-2 cuts) is likely to prevail.
Admir Kolaj, Economist | 416-944-6318
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