Carol Stone, CBE

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<img align="left" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/061227a.jpg" width="353">
New home sales rebounded 3.4% in November to 1.047 million, almost reversing October&#39;s decline. October sales were revised higher by 9,000. The Action Economics consensus forecast called for a more modest increase to 1.020 million (see Haver&#39;s AS1REPNA database). November sales were up in the Northeast, the Midwest and the West, but still down in the South.<img align="right" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/061227b.jpg" width="353">
Home prices also rose, with the median gaining 3.2% to $251,700, the highest level since April&#39;s $257,000, which is the record high. October prices were revised lower, but those in September were increased.
The November sales pushed down builders&#39; inventories from 553,000 at the end of October to 545,000, making a fourth consecutive monthly decline. At the current sales pace, this level represents 6.3 months&#39; sales. While this is well above the year-ago amount of 4.9 months, it is also well down from July&#39;s peak of 7.2 months.<img align="left" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/061227b.jpg" width="353">
Thus, the housing sector seems to be holding in pretty well. After the substantial &quot;bubble&quot; that began in the middle of 2003, a consolidation was to be expected. But current conditions indicate some stabilization, suggesting that &quot;consolidation&quot; may be an appropriate description, not &quot;implosion&quot;. Flexible pricing and sensitive interest rates have helped. In fact, last week&#39;s cost for 30-year fixed-rate mortgage commitments is down more than 10 basis points from November&#39;s 6.27% shown in the table, giving a total reduction of about 60 basis points from July&#39;s high. Here&#39;s hoping the New Year extends this performance. 

<table border="0" cellspacing="0" width="100%">
<colgroup><col><col><col><col><col><col><col></colgroup>
<thead>
<tr>
<th scope="col" class="firstcol">US New Homes, Seas Adj</th>
<th scope="col">Nov 2006</th>
<th scope="col">Oct 2006</th>
<th scope="col">Sept 2006</th>
<th scope="col">Nov 2005</th>
<th scope="col">2005</th>
<th scope="col">2004</th>
<th scope="col">2003</th>
</tr>
</thead>
<tbody>
<tr class="odd">
<td class="firstcol">Total Sales (SAAR, 000s)</td>
<td>1,047</td>
<td>1,013</td>
<td>1,053</td>
<td>1,236</td>
<td>1,280</td>
<td>1,201</td>
<td>1,091</td>
</tr>
<tr>
<td class="firstcol">Median Price (NSA, $)</td>
<td>251,700</td>
<td>243,800</td>
<td>225,500</td>
<td>237,900</td>
<td>234,208</td>
<td>217,817</td>
<td>191,383</td>
</tr>
<tr class="odd">
<td class="firstcol">Inventory: Months&#39; Supply</td>
<td>6.3</td>
<td>6.7</td>
<td>6.6</td>
<td>4.9</td>
<td>4.4</td>
<td>4.0</td>
<td>3.8</td>
</tr>
<tr>
<td class="firstcol">FHLMC Mortgage Rate (%)</td>
<td>6.27</td>
<td>6.36</td>
<td>6.41</td>
<td>6.33</td>
<td>5.86</td>
<td>5.84</td>
<td>5.82</td>
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New home sales rebounded 3.4% in November to 1.047 million, almost reversing October's decline. October sales were revised higher by 9,000. The Action Economics consensus forecast called for a more modest increase to 1.020 million [...]

New Home Sales Gain 3.4% in November; Prices Also Up, Inventories Down

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<img align="left" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/061226a.jpg" width="353">
It seem appropriate on the Day after Christmas to look at consumer spending; last Friday here, Tom Moeller called our attention to the total PCE increase in November of 0.5% in current dollars and also 0.5% in real terms.One of the aspects of the BEA&#39;s monthly data release that has always been fascinating for us is the detail available in the &quot;Underlying Tables&quot;, a supplement to the full national accounts; historically these tables were known as &quot;unpublished data&quot;, which were available only by phone from BEA or to specific subscribers to these extra tables. Now these are more widely disseminated on the BEA&#39;s website and, of course, in Haver&#39;s USNA database.All of our following discussion is in nominal terms so we can talk about the percentage distribution, a calculation that is not valid in chain dollar terms.<img align="right" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/061226b.jpg" width="353">
First in the major tables, we can see that energy expenditures are declining: 2.8% in November, the fourth consecutive nominal decrease; they are even below the year-ago period by 1.5%. This carries them down from a peak of 6.5% of total PCE in July to &quot;just&quot; 5.5% last month.
If we also exclude food, so we can look at the so-called &quot;core&quot; items, we see that they have diminished enough to allow non-core spending to increase more. In September, for instance, as total PCE was flat, non-core spending rose 0.6%. In October and November, it also expanded more than the total, so its share has increased to 80.63%, the highest since July 2005. The low this year was 79.82% in July.
What are people doing with their extra &quot;spending money&quot;? More home theater. As seen in the second graph, audio and video equipment outlays have surged over the last three months following a pause from February through August. A further breakdown shows the renewed expansion in TV receivers, audio and video, and a 5% spike in computers in November. Among nondurable goods, spending on toys and flowers began to grow in September as well.<img align="left" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/061226c.jpg" width="353">
Services saw less pronounced responses; transportation has slowed generally, with modest outright declines in both local and intercity travel. Consumers&#39; medical care expenses show less growth. Recreational services are erratic; movie theater outlays show a seesaw pattern, perhaps corresponding to the release of big-name films (although we couldn&#39;t correlate quickly a list of movie releases to the pattern in the BEA figures), but the trend is generally weak. Expenditures on spectator sports are also up-and-down monthly, but show modest growth overall.
Presently, then, it looks that consumers are trying to make their homes more a location of activity and entertainment, with less reliance on energy-involving travel. And perhaps, we can speculate, the availability of home electronics means they are going out less to movies, cultural events and sports. At the same time, the breakdown of the core &quot;food&quot; category does show that people are spending more on &quot;purchased&quot; meals, that is, on eating out, with particularly strong growth in the alcohol component.

<table border="0" cellspacing="0" width="100%">
<colgroup><col><col><col><col><col><col><col></colgroup>
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<tr>
<th scope="col" class="firstcol">PCE: Select Items, &nbsp;SAAR, Bil.$</th>
<th scope="col">Nov 2006 </th>
<th scope="col">Oct 2006 </th>
<th scope="col">Sept 2006 </th>
<th scope="col">Nov 2005 </th>
<th scope="col">2005 </th>
<th scope="col">2004 </th>
<th scope="col">2003 </th>
</tr>
</thead>
<tbody>
<tr class="odd">
<td class="firstcol">Total</td>
<td>9,425.2</td>
<td>9,374.7</td>
<td>9,348.5</td>
<td>8,916.4</td>
<td>8,742.4</td>
<td>8,211.5</td>
<td>7,703.6</td>
</tr>
<tr>
<td class="firstcol">&nbsp; % Change</td>
<td>0.5</td>
<td>0.3</td>
<td>-0.0</td>
<td>5.7</td>
<td>6.5</td>
<td>6.6</td>
<td>4.8</td>
</tr>
<tr class="odd">
<td class="firstcol">Energy G &amp; S</td>
<td>515.3</td>
<td>530.2</td>
<td>551.5</td>
<td>523.2</td>
<td>501.9</td>
<td>425.3</td>
<td>376.9</td>
</tr>
<tr>
<td class="firstcol">&nbsp; % of Total</td>
<td>5.5</td>
<td>5.7</td>
<td>5.9</td>
<td>5.9</td>
<td>5.7</td>
<td>5.2</td>
<td>4.9</td>
</tr>
<tr class="odd">
<td class="firstcol">PCE ex Food &amp; Energy</td>
<td>7,599.8</td>
<td>7,553.8</td>
<td>7,515.4</td>
<td>7,162.1</td>
<td>7,039.1</td>
<td>6,671.4</td>
<td>6,280.8</td>
</tr>
<tr>
<td class="firstcol">&nbsp; % of Total</td>
<td>80.63</td>
<td>80.58</td>
<td>80.39</td>
<td>80.32</td>
<td>80.52</td>
<td>81.42</td>
<td>81.42</td>
</tr>
<tr class="odd">
<td class="firstcol">&nbsp; % Change</td>
<td>0.6</td>
<td>0.5</td>
<td>0.6</td>
<td>6.1</td>
<td>5.5</td>
<td>6.2</td>
<td>4.4</td>
</tr>
</tbody>
</table>
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It seem appropriate on the Day after Christmas to look at consumer spending; last Friday here, Tom Moeller called our attention to the total PCE increase in November of 0.5% in current dollars and also 0.5% in real terms.One of the [...]

Discretionary Consumer Spending Picks Up in US as Energy Outlays Fall

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<img align="left" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/061222h.jpg" width="353">
Businesses in France and Italy, mostly manufacturers, reported some tapering down of confidence in December surveys. Conditions in general are much better than in the previous couple of years, but readings in these surveys have eased since the summer.
In France, the INSEE monthly survey was off 2 points in December to 106 from 108 in November. This put the average for all of 2006 at 107. The December value is up from 102 last December and the average of 101 for all of 2005. These indexes are a synthetic measure, scaled to average 100 over time. So businesses assess their conditions as 7% &quot;better than average&quot; this month.<img align="right" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/061222i.jpg" width="353">
The mixed and skittish nature of business conditions is suggested, though, by the fact that the current assessment of industrial production dropped suddenly to -2 in December from +14 and +21 in November and October, respectively. These data are net balances, the percentage experiencing or expecting positive outcomes less the percentage on the negative side. Wide swings tend to appear in these French data, so it&#39;s hard to judge the significance of any single month. Order books also give an ambiguous picture. The net balance in December was -7, worse than recent readings, particularly the -3 that prevailed in July, August and September. However, such erosion is modest compared with the much bigger declines that characterized the last five years.
In Italy, the privately conducted ISAE survey showed flat business confidence in December at 96.7 on a base of 2000=100. The peak in this survey was 98.2 in June. All of 2006 averaged 95.8, a noticeable improvement from readings in the mid-to-high 80s that carried through from 2001 until this year. Near-term production forecasts eased to +17 from a peak of +23 in June, but again, lower expectations were the norm for much of the time since 2001. Order books at Italian companies are even clearer in this distinction: the December balance is +5, the highest number since November 2000, and in fact the non-negative readings since June are the first since December 2000.<img align="left" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/061222j.jpg" width="353">
So industry in Italy and France is experiencing improved conditions, suggesting they have weathered the near-recession in 2000-2001 and the growing competition from Asian manufacturers. But we&#39;d guess that recent high energy and commodity prices, along with a strong euro, have slowed them down lately. Hopefully the let-up in oil and copper prices will help stabilize their activity, although other metals, especially tin, lead and nickel, are still strong.

<table border="0" cellspacing="0" width="100%">
<colgroup><col><col><col><col><col><col><col></colgroup>
<thead>
<tr>
<th scope="col" class="firstcol">Business Surveys, SA</th>
<th scope="col">Dec 2006</th>
<th scope="col">Nov 2006</th>
<th scope="col">Oct 2006</th>
<th scope="col">Year Ago</th>
<th scope="col">2006</th>
<th scope="col">2005</th>
<th scope="col">2004</th>
</tr>
</thead>
<tbody>
<tr class="odd">
<td class="firstcol">FRANCE: Business Climate Indicator</td>
<td>106</td>
<td>108</td>
<td>107</td>
<td>102</td>
<td>107</td>
<td>101</td>
<td>104</td>
</tr>
<tr>
<td class="firstcol">Industrial Production Trend, % Bal</td>
<td>-2</td>
<td>14</td>
<td>21</td>
<td>-4</td>
<td>5</td>
<td>-12</td>
<td>5</td>
</tr>
<tr class="odd">
<td class="firstcol">Order Books</td>
<td>-7</td>
<td>-4</td>
<td>-5</td>
<td>-15</td>
<td>-6</td>
<td>-17</td>
<td>-15</td>
</tr>
<tr>
<td class="firstcol">ITALY: ISAE Business Confidence Indicator, 2000=100</td>
<td>96.7</td>
<td>96.7</td>
<td>97.0</td>
<td>91.4</td>
<td>95.8</td>
<td>87.5</td>
<td>89.5</td>
</tr>
<tr class="odd">
<td class="firstcol">Production Forecast, % Bal</td>
<td>17</td>
<td>19</td>
<td>20</td>
<td>15</td>
<td>19</td>
<td>12</td>
<td>15</td>
</tr>
<tr>
<td class="firstcol">Order Books</td>
<td>5</td>
<td>3</td>
<td>2</td>
<td>-10</td>
<td>-1</td>
<td>-18</td>
<td>-15</td>
</tr>
</tbody>
</table>
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Businesses in France and Italy, mostly manufacturers, reported some tapering down of confidence in December surveys. Conditions in general are much better than in the previous couple of years, but readings in these surveys have eased [...]

Business Enthusiasm Cools a Bit in France & Italy Amid Generally Constructive Climate

Tom Moeller

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<img align="left" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/061222d.jpg" width="353">
The University of Michigan&#39;s full month reading of consumer sentiment in December slipped 0.4% to 91.7, but that was less than the 2.1% drop in the preliminary report. Consensus expectations for a reading of 90.2.
During the last ten years there has been a 76% correlation between the level of consumer sentiment and the y/y change in real consumer spending and during those ten years sentiment has a 68% correlation with the change in nonfarm payrolls.
Consumer expectations for the economy improved from the preliminary read but they still fell 2.4% for the second consecutive monthly decline. Business conditions during the next twelve months fell 6.3% (+1.0% y/y) and long term expected business cosnditions were unchanged for the second month (+10.2% y/y). Expected personal finances slipped for the second consecutive month (-3.9% y/y).<img align="right" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/061222e.jpg" width="353">
The reading of current economic conditions actually improved 2.0%, about the same as in the preliminary report. Perceived buying conditions for large household goods rose 3.2% (-1.8% y/y) but perceptions of current personal finances were unchanged (0.0s% y/y).
The reading of whether it&#39;s a good time to buy house fell m/m but remained up from the lows this past Summer.
Expected inflation during the next year increased to 3.5% but for the next five years expected inflation fell to 3.4%. Since 1980 there has been an inverse 63% correlation between the level of sentiment and expected inflation during the next year.
Consumers&#39; opinion about gov&#39;t economic policy slipped m/m to just 89 versus a midmonth read of 86.
The University of Michigan survey is not seasonally adjusted.The mid-month survey is based on telephone interviews with 250 households nationwide on personal finances and business and buying conditions. The survey is expanded to a total of 500 interviews at month end.

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<th scope="col" class="firstcol"><a href="http://www.haverselect.com/dlx/USECON/@EF/@EF14/@EF1402/@EF1402.HTM">University of Michigan</a></th>
<th scope="col">December (Final)</th>
<th scope="col">December (Prelim.</th>
<th scope="col">November</th>
<th scope="col">Y/Y</th>
<th scope="col">2006</th>
<th scope="col">2005</th>
<th scope="col">2004</th>
</tr>
</thead>
<tbody>
<tr class="odd">
<td class="firstcol">Consumer Sentiment</td>
<td>91.7</td>
<td>90.2</td>
<td>92.1</td>
<td>0.2%</td>
<td>87.2</td>
<td>88.6</td>
<td>95.2</td>
</tr>
<tr>
<td class="firstcol">&nbsp;&nbsp; Current Conditions</td>
<td>108.1</td>
<td>108.2</td>
<td>106.0</td>
<td>-0.9%</td>
<td>105.1</td>
<td>105.9</td>
<td>105.6</td>
</tr>
<tr class="odd">
<td class="firstcol">&nbsp;&nbsp; Expectations</td>
<td>81.2</td>
<td>78.6</td>
<td>83.2</td>
<td>1.2%</td>
<td>75.7</td>
<td>77.4</td>
<td>88.5</td>
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The University of Michigan's full month reading of consumer sentiment in December slipped 0.4% to 91.7, but that was less than the 2.1% drop in the preliminary report. Consensus expectations for a reading of 90.2. During the last ten [...]

U.S. Consumer Sentiment Recovered Some

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<img align="left" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/061222b.jpg" width="353">
New orders for durable goods rose 1.9% last month, a gain after the offsetting volatility of the prior two months when orders fell 8.2% in October after an 8.7% September spike. Consensus expectations had been for a 1.5% rise n total orders during November.
During the last ten years there has been a 69% correlation between the y/y change in durable goods orders and the change in output of durable goods..
A 14.4% rise in total aircraft &amp; parts orders last month, however, still added volatility. In addition, orders for motor vehicles &amp; parts rose 0.2% (-3.9% y/y). Less transportation altogether, slipped 1.1%.<img align="right" border="0" height="265" src="https://haver-commentaries.s3.eu-west-1.amazonaws.com/comments/061222c.jpg" width="353">
And broad based order declines in other industries continued to raise questions about the health of the factory sector. Orders for nondefense capital goods less aircraft fell 1.4% reflecting a 1.5% (+5.2% y/y) slide in electrical equipment orders and an 8.9% (+3.8% y/y) drop in machinery. During the last ten years there has been an 86% correlation between the y/y change in capital goods orders less aircraft and the y/y change in business fixed investment in equipment &amp; software from the GDP accounts.
Primary metals orders fell 1.9% (+4.1% y/y), down for the third month in the last four. To the upside were orders for computer s &amp; electronic products which rose 7.5% (10.4% y/y).
Shipments of durable goods increased another slight 0.1% (2.7% y/y) after the downwardly revised 0.3% October uptick. Less the transportation sector shipments fell 0.1% (+4.6% y/y) for the second decline in the last three months. During the last ten years there has been an 82% correlation between the y/y change in durable goods shipments and the change in industrial production of durable goods.
Durable inventories rose just 0.3% (7.8% y/y), the weakest monthly increase since a decline in February. Less the transportation sector inventories also increased a modest 0.2% (8.4% y/y) and the inventory to shipments ratio outside of transportation rose to the highest level since July of last year.

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<th scope="col" class="firstcol"><a href="http://www.haverselect.com/dlx/USECON/@ED/@ED01/@ED0101/@ED0101.HTM">NAICS Classification</a></th>
<th scope="col">November</th>
<th scope="col">October</th>
<th scope="col">Y/Y</th>
<th scope="col">2005</th>
<th scope="col">2004</th>
<th scope="col">2003</th>
</tr>
</thead>
<tbody>
<tr class="odd">
<td class="firstcol">Durable Goods Orders</td>
<td>1.9%</td>
<td>-8.2%</td>
<td>-0.0%</td>
<td>9.0%</td>
<td>6.4%</td>
<td>-0.6%</td>
</tr>
<tr>
<td class="firstcol">&nbsp;&nbsp;&nbsp; Excluding Transportation</td>
<td>-1.1%</td>
<td>-1.6%</td>
<td>3.4%</td>
<td>9.4%</td>
<td>7.6%</td>
<td>-1.7%</td>
</tr>
<tr class="odd">
<td class="firstcol">Nondefense Capital Goods</td>
<td>-0.2%</td>
<td>-14.8%</td>
<td>-8.4%</td>
<td>21.4%</td>
<td>5.6%</td>
<td>-3.4%</td>
</tr>
<tr>
<td class="firstcol">&nbsp;Excluding Aircraft</td>
<td>-1.4%</td>
<td>-3.9%</td>
<td>6.2%</td>
<td>12.3%</td>
<td>2.8%</td>
<td>-2.0%</td>
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New orders for durable goods rose 1.9% last month, a gain after the offsetting volatility of the prior two months when orders fell 8.2% in October after an 8.7% September spike. Consensus expectations had been for a 1.5% rise n total [...]

U.S. Durable Goods Orders Rebounded, But ...

Inflationary impact of surge in oil prices larger in Europe than in the US

Futures market thinks the price of oil will recede significantly over the next six months

Recent pickup in US defense orders could help support overall growth ahead

Cost of transporting crude oil has soared to series high

Market-based inflation expectations have not yet reflected recent surge in oil prices

Global equity markets are fearing a major economic disruption from soaring oil prices

Is recent drop in sentiment signaling softer growth ahead?

With the Iran conflict, geopolitical risk has soared to alarming levels

Soaring AI-related investment in US underpinning strong contribution of business spending to overall growth

AI-related outperformance of IP in Advanced Asia ex Japan

Resilient US economy pushing up Blue Chip 2026 outlook

US and China big leaders in adoption of AI models

Robust US demand for advanced technology products

China's export growth rotating away from the US

More pronounced upward revisions in countries more exposed to AI investment

Stable job openings and hiring rates point to cautious hiring

Global freight costs are on the rise while supply chain pressures are contained

Accelerating positive economic surprises in the G10 are boosting the global economy

Considerably more monetary ease expected from US and UK as Japan tightens

Tighter US immigration enforcement adversely impacting labor force

Economic policy uncertainty, while still elevated, is declining

Gradual disinflation and easier monetary policies across advanced economies

Largest October layoffs since 2003, led by technology

Subdued global shipping costs not yet pointing to supply chain problems

PMIs show still-elevated but slowing US inflation

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Tian Yong Woon

In this week’s Letter, we cover the latest developments and implications of the Middle East conflict for Asia, while also making space for other important themes, including artificial intelligence (AI). The Middle East conflict remains in a no deal state coming out of the weekend, though some early Monday optimism emerged in Asian markets following Iran’s reported offer to reopen the Strait of Hormuz (chart 1). Nonetheless, as the Strait closure drags on, so too do the fiscal costs of domestic fossil fuel subsidies across Asia, which have been shown to move closely with crude oil prices (chart 2). While such measures offer direct relief by cushioning household energy costs, they remain difficult to sustain over the long haul.

Over the week, we also saw a further fraying in regional monetary policy trends, with the Philippines hiking its policy rate for the first time in about two years amid inflation concerns, while Indonesia stood pat on rates (chart 3). Investor attention is likely to remain fixed on monetary policy this week, with the Bank of Japan due to decide on policy. Expectations for an April hike have faded amid the persistent Middle East conflict, though yen weakness continues to present a source of concern (chart 4). The week also brings China’s latest PMI readings (chart 5), adding to the recent run of hard data accompanying the Q1 GDP release.

Beyond the Middle East conflict, the evolution of AI continues to demand close attention. Before geopolitical tensions took centre stage, AI was the dominant market narrative — and that enthusiasm has hardly faded. If anything, recent developments suggest the story is broadening: use cases are expanding, scalability is improving, and access is widening beyond large corporates to the mass market — increasingly spilling into the realm of physical AI. It may well be this persistent wave of optimism that is helping to underpin equity valuations, even as the geopolitical backdrop darkens (chart 6).

**The Middle East conflict**
About two months in, we remain stuck in the limbo of the US-Iran conflict, which has left the Strait of Hormuz largely closed and much of the world starved of the critical oil flows needed to power the global economy. The back and forth between the US and Iran has persisted in recent weeks, with both sides again failing to reach a peace deal over the weekend, though Monday’s news of Iran offering to reopen the Strait has revived some hope in markets. In truth, commodity and market valuations do not hinge so much on a peace deal itself, but rather on the resumption of oil flows through the Strait, something that could materialise even in the absence of a formal deal, though any agreement that includes and credibly delivers such a reopening would likely be warmly received by markets. Until then, market gyrations are likely to persist, with prices fluctuating in response to each new snippet of news. And until then, the world will continue both to be starved of, while gradually adapting to, the drip feed of oil flows emerging from the Strait.

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**The fiscal costs of the Middle East conflict**
As the Middle East conflict drags on, so too does the strain on fiscal resources across parts of Asia, as the costs of energy-related subsidy programmes continue to mount. While such programmes have an immediate, direct, and tangible impact in shielding households from surging energy costs, they are far from sustainable, particularly if oil prices remain well above targeted levels or stay elevated for an extended period. As chart 2 illustrates, the costs of these explicit subsidy programmes tend to rise closely with crude oil prices, as seen in India and Indonesia. Other measures adopted elsewhere, such as drawing down oil reserves, may be less fiscally costly, but are similarly difficult to sustain indefinitely. In both respects, the clock is ticking, and the world continues to hold its breath as the conflict drags on.

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**The latest central bank responses to the conflict**
Over the past week, Asia saw two central bank decisions. The Philippines’ (BSP) opted to deliver its first rate hike in about two years, while Indonesia’s (BI) chose to stand pat on policy rates and instead committed to stepped up FX intervention (chart 3). This latest round of decisions points to a further fraying of what had been a broad regional monetary policy consensus, namely that central banks would delay additional easing while maintaining a high bar for outright tightening. Domestic considerations, however, remain paramount. In the Philippines’ case, the central bank has moved to rein in inflation, which is already showing notable signs of price pass through stemming from disruptions linked to the Strait of Hormuz. That said, BSP is not the first in the region to buck the reluctance to tighten. Singapore’s central bank had already tightened policy in mid-April, albeit through its own distinct framework, given its use of the exchange rate rather than policy rates as the primary channel for monetary policy.

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**The week ahead**
Looking to the week ahead, a major central bank decision looms in Japan. Market expectations for the Bank of Japan to deliver a rate hike at its April meeting have ebbed amid the persistence of the Middle East conflict, to which Japan remains particularly vulnerable given its reliance on oil imports flowing through the Strait of Hormuz. At the same time, inflation in Japan has yet to become a major concern, with recent readings having picked up but not yet entering troubling territory. One potential source of concern, however, lies with the Japanese yen, which has remained on a weakening trend since early last year (chart 4). That depreciation has been one of the key arguments underpinning calls for further rate hikes.

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The week also brings China’s latest PMIs into focus. March saw a divergence between China’s official PMI readings, which improved, and the unofficial readings from RatingDog, which instead pulled back. Nonetheless, both official and unofficial gauges remained in expansionary territory (chart 5), with investors now watching closely to see whether that resilience can be sustained amid ongoing stresses from the Middle East, or whether offsetting drivers can continue to keep Chinese business sentiment and prospects buoyant.

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**Beyond the strait**
Moving beyond the Middle East conflict, a whole host of developments continue to unfold globally, many of which have in fact helped offset some of the pessimism wrought by the Strait’s chokehold. One such development is artificial intelligence (AI), which had dominated headlines before the outbreak of the conflict and continues to advance at breakneck pace. AI capabilities are still rapidly evolving, while practical applications, such as physical AI embodied in humanoid robots, are beginning to show broader and stronger use cases. Production of such robots is also becoming increasingly scalable and within reach not just for industrial complexes and healthcare, but for the mass market as well. It is perhaps growing optimism around these prospects that has helped keep equity valuations buoyant, even in the face of the festering conflict in the Middle East. Moreover, while concerns over AI-driven job displacement persist, new opportunities are emerging as well, particularly for AI adopters, with a growing share of job postings in Western economies increasingly referencing AI-related skills, as shown in chart 6.

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Asia

Economic Letter from Asia: Not Just About the Strait

Robert Brusca

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**The Distributive Trades Survey**

The U.K. Distributive Trades Survey for April 2026 and the look-ahead expectation readings for May paint an extremely soured outlook for the U.K. economy.

**Retail ranking**: Surveys for retail sales compared to a year ago, orders compared to a year ago, and sales evaluated for the time of year all have rankings near zero, which is the worst result on this timeline. This zero distinction applies to retail sales compared to a year ago. The best ranking is 11.6%; that is for sales evaluated for the time of year. Orders compared to a year ago have a 4.2 percentile standing. The stock-to-sales ratio—which is a completely different concept—shows that the inventory-to-sales ratio has a 29.9 percentile standing.

**Retail diffusion**: The raw April diffusion readings (up minus down diffusion) show that sales compared to a year ago slipped to a reading of -68 in April from -52 in March. Orders fell to -46 in April from -26 in March. Sales evaluated for the time of year fell to -32 April from -23 in March. All three measures weakened, and all three weakened decisively, resulting in extremely weak rankings. All of the rankings are executed on data back to 2002.

**Expectations for retailing**: The expectations readings for May show slippage again across all three metrics: expected sales compared to a year ago, expected orders compared to a year ago, and expected sales for the time of year. Expected sales compared to a year ago fell to -60 in May from -49 in April. Orders compared to a year ago declined to -45 in May from -30 in April, and sales for the time of year slipped to -43 from -19. In May, these readings have rankings in a 0.4 percentile standing for sales compared to a year ago, a 1.8 percentile standing for sales evaluated relative to the time of year, and a 4.6 percentile standing for orders compared to a year ago. These two panels on current and expected retail sales volumes are just simply terrible: weak monthly, weak in ranking terms, and showing slipping momentum.

The distributor trade series also provides data on the wholesale sector. While the wholesale sector is not quite as beat up as the retail sector, it's still extremely weak. There is no cause for any kind of hope that things are getting better based on wholesaling trends.

**Wholesaling**: The wholesale survey for sales compared to a year ago edged lower to -32 in April from -31 in March. Orders compared to a year ago remained at a reading of -41 in April. Sales evaluated for the time of year improved to a reading of -20 in April from -39 in March—a significant step up, but still very weak. The percentile standings for these three categories show sales compared to a year ago at the 8.8 percentile, orders compared to a year ago at the 5.6 percentile, and sales evaluated for the time of year at the 14.8 percentile.

**Wholesale Expectations**: The look-ahead observations, which provide expectations for wholesaling in May, show a similar constellation of readings, with sales compared to a year ago falling to -37 in May from -27 in April and orders compared to a year ago falling to -42 from -38, while sales evaluated for the time of year improved to  16 from  37. That category for wholesale sales improved both in April in real time and in May for expectations; however, it continues to have a very weak percentile standing, at the 17.9 percentile in May, while sales for a year ago have a 6.7 percentile standing and orders for a year ago have a 6.0 percentile standing.

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While some of the global PMI data have improved, these survey data for the U.K. are particularly dour. The war in Ukraine drags on, and there's a new conflict in Iran that has shut the Strait of Hormuz, creating energy problems for much of Europe. More broadly, supply chains have been harmed. In addition, the U.K. is undergoing a bout of political instability, as its Prime Minister is under pressure and a good deal of political uncertainty is being worsened by deteriorating economic performance.

Both the U.K. and the European Monetary Union had been showing some progress on inflation until the Iran war hit. Now, as the oil prices are up so sharply, headline inflation is going to be worse everywhere and there will probably be a bit more attention directed to the core inflation rate. However, the U.K. has had inflation too hot for a while, and it has failed to settle down. At its last meeting, the Bank of England’s Monetary Policy Committee warned that if the war was still ongoing at the next meeting, there would be a risk of a rate hike. So, it would seem that a rate hike is going to be in play unless the economy falls off a cliff first, which, based on the distributive trades data, is also something that could happen. The U.K. economy appears to be on very unsound footing, and what happens next is just about anybody's guess.

United Kingdom

U.K. Retail Sales: Worse Than During Covid

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The onset of the war in Iran appears to have hit the German economy extremely hard as the Ifo survey shows very substantial and broad-based decline across its survey in April. The Ifo survey features readings for five sectors as well as an aggregate reading, and it surveys them for climate, current conditions, and expectations. The decline in the Ifo survey is present for all three concepts and across all five sectors, marking the weakening in April as a highly significant and extremely disturbing development. Only manufacturing in the current conditions survey escapes a month-to-month decline.

**The Ifo sequences**: The **climate** reading fell both overall and across each of the five sectors. **Current conditions** declined for the overall and for four of the five sectors, with manufacturing the sole exception. **Expectations** declined for the overall and for all sectors. Several of the sector declines were for a very substantial magnitude, especially when compared to historic changes in these indexes.

**Monthly changes in readings—severe broad deterioration**
The month-to-month change in the climate reading has weakened more month-to-month 19% of the time. That overall result, however, is boosted by manufacturing where the monthly change has been weaker 35% of the time (on data back to 2011). However, all other sectors have seen climate weaker m/m only 2.3% to 6.3% of the time! The current situation readings weakened, with the headline weakening more m/m 11% of the time. This was boosted by manufacturing, the only sector that improved on the month; its ranking on change was in its 85th percentile—quite good and truly stand-alone good news. The other current changes by sector ranged from construction being weaker 1.7% of the time, to retailing that has been weaker about 30% of the time in terms of m/m changes. Expectation changes were uniformly terrible, with the headline drop weaker only 6.3% of the time and sector change month-to-month weaker between 9% and 1.7% of the time. The monthly weakening was uniform and substantial. I document it with these calculations, but you can also see it on the chart above.

**Climate**: The bottom line is that the all-sector index for climate fell to -20.3 in April from -18 in March, placing it at a 10.5 percentile standing on data since 1993. The sector ranking is the highest for construction with a 42.2 percentile standing and the weakness for services at a 1.1 percentile standing—weaker than the table reading nearly 99% of the time. In terms of percentile standing levels or monthly changes, conditions are closing in on grim.

**Current conditions**: Current conditions saw the all-sector index slip to -5.3 in April from -2.4 in March. The headline ranking stands at a 9.8 percentile mark, making it—like the climate reading—weaker than its current reading only about 10% of the time. The strongest reading under current conditions is for construction which has a 60.6 percentile standing; it is the only ranking in the table above its historic median. Manufacturing, the only sector in the survey that improved month-to-month, has a 22.5 percentile standing, while services record the weakest percentile standing under current conditions, at an 8.4 percentile standing.

**Expectations:** The all-sector index for expectations fell to -25.3 in April from -19.9 in March, placing it at a 6.3 percentile standing. The percentile standings across sectors range from a high of 9.5% for manufacturing to a low of 1.5% for retailing. Up until earlier this year, the Ifo was showing signs of improvement; however, all of that has simply collapsed in the last month. Weakness is across economic concepts and sectors, as documented above. For reference, the table also gives a separate set of rankings on where the various indexes stand since the invasion of Ukraine, since that was another marked event that drove the index, that had been improving after Covid, down to lower levels.  Ranked even on this reduced scale looking at conditions only since the invasion of Ukraine, when conditions have generally been weaker, the current rankings across the Ifo survey remained extremely weak. This is a very disturbing survey for the German economy.

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Germany

German Ifo Plunges Everywhere

Andrew Cates

**Energy shock lifts inflation, trims growth**
The IMF’s latest WEO revisions for 2026 broadly reflect the classic stagflationary impact of the recent Middle East energy shock, with growth downgraded and inflation revised higher across most major economies. Higher energy prices act as a tax on real incomes while simultaneously pushing up costs. That said, the picture is not uniform: a number of economies—notably the US, China and India—have seen growth upgrades, reflecting stronger-than-expected momentum so far in 2026. By contrast, the UK stands out at the stagflationary extreme, combining one of the largest growth downgrades with a relatively strong inflation uplift—consistent with its weaker underlying momentum, greater energy sensitivity and more persistent domestic inflation dynamics. More broadly, while the global revisions remain modest—pointing to resilience in activity—the message is that disinflation is no longer a smooth glide back to target but increasingly contingent on energy prices and geopolitical developments.

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**Markets largely shrug off rising economic pessimism**
Notwithstanding a more downbeat assessment from economists—including the IMF’s stagflationary tilt to the outlook—there has been remarkably little follow-through into financial markets. Measures of systemic stress in both the US and UK remain low by historical standards, suggesting that investors are, for now, largely looking through the Middle East conflict. There are several possible explanations: corporate profits remain resilient, the AI-driven investment narrative continues to dominate market thinking, and markets may be assuming that any energy shock will be temporary and contained. In effect, investors appear to be pricing a benign baseline in which geopolitical risks do not materially disrupt growth, inflation expectations or policy. The UK is a partial exception, with a somewhat more visible uptick in stress, which aligns more closely with the IMF’s more challenging growth-inflation trade-off and the economy’s greater sensitivity to energy prices.

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**Volatility falls despite deteriorating growth surprises**
Market optimism is also increasingly at odds with the incoming data flow. Typically, equity volatility declines when growth surprises are positive and inflation surprises are benign. However, the recent pattern has broken that relationship. Growth surprises across the G10 have turned increasingly negative (our series is inverted in the chart below), yet volatility has continued to fall. In other words, markets are becoming less sensitive to weakening macro data, continuing to price a benign outlook even as the data deteriorate. This divergence reinforces the broader theme: investors are, for now, looking through both geopolitical risks and softer economic momentum, placing greater weight on resilience in earnings, the AI-driven narrative and the assumption that policy will remain supportive.

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**Inflation Nowcasts Have Jumped**
Incoming data suggest that headline inflation has moved higher in recent weeks, broadly in line with expectations given the rise in energy prices following the Middle East shock. Nowcasts for CPI across the major economies show a clear rebound in March and April from the lows seen at the start of 2026, with the move occurring in a relatively synchronised fashion. This reinforces the view that the recent pickup in inflation is being driven primarily by a common external factor—energy.

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**Energy shock not yet feeding into underlying inflation**
However, the detailed breakdown of March inflation outcomes suggests that this remains, for now, a largely headline-driven phenomenon. While headline CPI prints were firm across most economies, core inflation—stripping out energy and food—was more subdued and in some cases weaker. This indicates that there has been very limited pass-through from higher energy prices into broader goods and services inflation at this early stage. In other words, the shock is still being absorbed rather than propagated. That distinction is critical for policy and markets alike: as long as second-round effects remain contained, central banks may be able to look through the near-term rise in inflation, even as headline rates move higher.

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**Inflation Expectations Rising as Growth Sentiment Falters**
It remains early days, and much will hinge on how inflation expectations evolve from here. The latest ZEW survey for Germany already conveys the hallmarks of a classic stagflationary shock, with macroeconomic expectations weakening even as inflation expectations have ratcheted sharply higher. This shift is important: while the recent rise in headline inflation has so far shown limited pass-through into core, a sustained increase in expectations would raise the risk of second-round effects and make the inflation process more persistent. In that sense, the ZEW data highlight the key fault line in the current environment—whether the energy-driven shock remains contained, or begins to embed itself more broadly through expectations and pricing behaviour.

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Financial markets have remained notably calm in recent weeks despite rising geopolitical tensions in the Middle East, a more downbeat macroeconomic narrative and elevated uncertainty. Measures of financial stress and volatility remain low, and equity markets continue to look through both the conflict and softer data. That resilience sits alongside a more nuanced macro backdrop. The IMF’s latest WEO revisions point to a classic stagflationary energy shock—growth downgraded and inflation revised higher—although the global impact remains modest and uneven, with some economies still benefiting from stronger momentum (chart 1). At the same time, market pricing appears increasingly detached from the data flow, with volatility declining even as growth surprises have turned more negative relative to inflation (charts 2 and 3). Incoming inflation data reinforce the idea of a largely headline-driven shock, with nowcasts rising in line with higher energy prices but only limited pass-through into core inflation so far (charts 4 and 5). However, it remains early days. Survey evidence, such as the latest ZEW release, suggests that inflation expectations may already be responding in a more concerning way, with a marked rise alongside weakening growth sentiment (chart 6). Taken together, the key question for markets is whether this remains a contained, energy-driven shock that can be looked through—or whether it begins to embed more persistently via expectations, forcing a reassessment of the currently benign outlook.

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Charts of the Week: Risks Build, Markets Shrug

Sandy Batten

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The National Activity Index published by the Federal Reserve Bank of Chicago (CFNAI) slipped to -0.20 in March from an upwardly revised +0.03 in February (previously (-0.11). This is the lowest monthly reading since last November. Smoothing out the monthly volatility, the index's three-month moving average (CFNAI-MA3) declined to -0.03 in March from an upwardly revised +0.03 in February (previously -0.01).

This index is expressed in standard deviation units from zero (with a value of zero defined as trend real GDP growth). Research at the FRB Chicago indicates that readings on the 3-month average of -0.70 or below are consistent with the economy being in a recession. Therefore, even though the March reading on the 3-month average was negative, it indicates that the US economy is still growing, just slightly slower than trend, and is well away from recessionary conditions. The 3-month average would be much deeper in negative territory if the economy was at risk of contracting.

The National Activity Index is a composite of 85 economic indicators, grouped into four major categories: production and income; employment, unemployment, and hours worked; personal consumption and housing; sales, orders, and inventories. Three of the four broad categories of indicators used to construct the index decreased from February, and three categories made negative contributions in March. Production-related indicators contributed –0.20 to the CFNAI in March, down from +0.13 in February. The sales, orders, and inventories category's contribution to the CFNAI was –0.01 in March, down from +0.05 in February. Employment-related indicators contributed +0.02 to the CFNAI in March, up from –0.15 in February. The personal consumption and housing category's contribution to the CFNAI was –0.01 in March, down from a neutral value in February.

The CFNAI Diffusion Index, which measures the breadth of the change in the component series and is also a three-month moving average, increased to –0.04 in March from –0.08 in February. This is the highest reading since February 2025. A reading of zero indicates that all of the indicators are growing at their long-term average. If all of the underlying indicators in a given month are below their long-run averages, the diffusion index will equal -1. If all of the indicators are above their long-run averages, it will equal +1. Thirty-four of the 85 individual indicators made positive contributions to the CFNAI in March, while 51 made negative contributions. Forty-three indicators improved from February to March, while 40 indicators deteriorated and two were unchanged. Of the indicators that improved, 16 made negative contributions.

These figures are available in Haver's **SURVEYS** database.

- The monthly reading fell to -0.20 in March from an upwardly revised +0.03 in February.
- The three-month average slipped from +0.03 to -0.03.
- Despite the slip in March, the index points to near-trend economic growth and is well above recession territory.

Economy in Brief

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New Home Sales Gain 3.4% in November; Prices Also Up, Inventories Down

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New Home Sales Gain 3.4% in November; Prices Also Up, Inventories Down

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