Economy in Brief: June 2024

After release of Japan's headline report for the CPI for May, it appeared that the way had been made clear for the Bank of Japan to begin to raise rates and began to move interest rates into more sustainable, neutral, long-term territory. A rate hike could also go some way toward helping to support the yen that has been struggling. Headline inflation in Japan is at 2.9%; while it dipped to a 2.1% pace over six months, it's running at a 3.8% annual rate over three months.

However, new data on the core suggested Japanese inflation is running substantially weaker than headline inflation suggests. The generic all items excluding food and energy metric was flat in May, up by 1.6% over 12 months, up by 1.2% at an annual rate over six months, and up at only a 0.8% annual rate over three months. Core inflation shows that inflation pressures are not broadly shared. The statistic for all items except fresh food and energy rose by 0.1% in May, and has a stronger 2.1% gain over 12 months, quite close to the Bank of Japan target. However, over six months, this core metric is up but only a 1.3% annual rate; over three months, it's up at only a 0.4% annual rate. Neither of the measures of the core inflation rate shows that there's much inflation stirring in the Japanese economy. They are far from giving the BOJ an ‘all clear’ signal for any kind of rate hiking. Their sequential progression to lower inflation rates over the past year underscore ongoing price weakness.

These are data through May so two-thirds of the monthly data are now in hand. Quarter-to-date all item inflation is rising at a 2.9% annual rate; inflation for all items except food and energy is up at just a 0.9% annual rate; and for all items except fresh food and energy, the rate of increase in the quarter-to-date is only 0.5% at an annual rate.

The quarter-to-date data for all items except fresh food and energy comes in very close to the five-year average for that series which showed an average annual increase of 0.6% per year. For all items ex food and energy, the gain of 0.9% in the quarter-to-date is higher than the 0.6% it averaged over five years. However, headline inflation of 2.9% quarter-to-date is up considerably more strongly than the five-year average pace of 1.4%.

Germany's IFO survey had been engaged in an ongoing improvement, but this month there's a clear step back from that improving trend. The all-sector climate index from the IFO registers a reading of -15.3 in June, weaker than May’s -11.4 reading. The current conditions reading is a net positive, but it is unchanged month-to-month. However, expectations show an index value of -13.4 in June, below the -10.7 logged in May. That is very disappointing.

Business expectations have been improving since January. This is the first backtracking in that improving stretch. The reading of -13.4 for June brings it back to a level that is stronger than the reading for March but weaker than the reading for April.

Climate The overall climate reading weakened month-to-month. It shows slippage in manufacturing, wholesaling, and retailing. There's an improvement in services to plus 4.2 in June from plus 1.8 in May and there is a more modest improvement in construction to -25 in June from -25.6 in May. However, there is also sharp deterioration from month-to-month, with manufacturing falling to -9.2 in June from -6.5 in May, wholesaling falling to -26.7 in June from -19.8 in May, and retailing falling to -19.5 in June from -13.3 in May. Despite the significant improvement in services, there is deterioration elsewhere that dominates the climate reading this month. The rank standing for overall climate this month stands in its 20th percentile at the cusp of the lower 1/5 of the historic rank of all its observations. The weakest reading is wholesaling with a 12.6 percentile standing. The strongest sector is construction with 37.9 percentile standing. After its rebound this month, services moved up to a 22.6 percentile standing from 19.6% a month ago. Still, all of these are weak readings and not even marginally weak readings- all are well below their historic median that occur at a ranking at the 50th percentile.

Current The current reading is unchanged month-to-month at a positive reading of plus 1.2. It derives its positive reading and strength from the services sector where the current reading moved up to 14.0 in June from 11.8 in May. Manufacturing improved month-to-month, moving to -6.1 from -6.6 in May. The construction sector moved down to -17.1 in June from -16 in May, retailing fell to -7.1 in June from -2.2 in May, while wholesaling fell to -25.2 from -18.2 in May. Current conditions overall are unchanged on two improving sectors and three deteriorating sectors. The current index ranks weaker than the climate index with a 15-percentile standing overall; however, current conditions show two sector readings with percentile rank standings above their 50th percentiles, putting them above their historic medians. Those sectors are construction with a 54.9 percentile standing and retailing with a 59.5 percentile standing. Manufacturing has a 27.6 percentile standing while both wholesaling and services have a 19.1 percentile standing.

Expectations The expectations readings are what sinks the IFO survey this month. The all-sector reading falls to -13.4 in June from -10.7 in May. There are month-to-month improvements in services, but they log -5.2 in June compared to -7.6 in May and in construction that logs a -32.7 reading in June, up from -34.7 in May. However, manufacturing drops sharply to -12.3 in June from -6.4 in May, wholesaling drops significantly to -28.3 in June from -21.5 in May and retailing falls to -31.1 in June from -23.8 in May. Rankings show the all-sector expectations index with a 14.5 percentile standing, construction has only an 8.5 percentile standing, and retailing an 8-percentile standing. These are the two weakest sectors in expectations, and this contrasts sharply to their performance in the current index where they are the two strongest readings and the only ones with readings above their historic medians. On Expectations, wholesaling has a 10.3 percentile standing, manufacturing, an 18-percentile standing, and services, an 18.7 percentile standing.

In this week's newsletter, we delve into post-election dynamics in India. Initial market reactions to the election outcome were negative but swiftly reversed, underscoring India's promise as both a high-growth economy and attractive investment destination. In the short term, sentiment indicators signal ongoing growth in India’s pivotal sectors of services and manufacturing. Furthermore, India continues to be projected as the fastest-growing major economy this year by both the World Bank and the International Monetary Fund. Looking ahead, India is poised to leverage its demographic promise via its youthful workforce, a stark contrast to other major economies grappling with rapidly aging populations.

Turning to monetary policy, we note that while the central bank has kept policy rates unchanged in recent months, there is mounting pressure within its decision-making committee to consider rate cuts. On inflation, recent trends show a gradual disinflation driven by easing price pressures in non-core items, despite persistently high food price inflation. Shifting to currency markets, we note once more the Indian rupee’s resilience, which has been supported by central bank intervention and robust foreign reserves.

Market reactions to elections Indian equities plunged and bond yields surged on June 4th, following indications that Prime Minister Modi’s political party (BJP) would secure a smaller parliamentary majority than initially predicted. Among the initial market concerns was some apprehension that the BJP would need to depend on potentially fragile alliances with other parties to advance its reform agenda, a departure from its previous independent governance. However, initial apprehensions eased quickly as Indian equities rebounded and yields retraced, as evidenced in Chart 1. One of the key recent drivers behind rallies in Indian equity markets was the significantly higher involvement of retail investors, particularly in the options markets. This surge in participation has been partly spurred by regulatory measures aimed at enhancing market accessibility for individuals. Additionally, optimism about the longer-term outlook for the Indian economy has also contributed to the equity market rallies.

The flash readings for June in the S&P Global PMI indexes show widespread weakness, but the U.S. dominates whatever month-to-month improvement there is, showing gains in the composite, manufacturing, and services month-to month. Among other June entries in the table, only the U.K. has a month-to-month gain and that's for its manufacturing sector.

This is a clear switch from May when only eight sectors showed weakness out of the 21 sector entries for these seven reporting units each reporting 3 sectors. April also showed strength with only 5 of 21 sectors showing weakness and three of those being in the U.S.

Broader trends Average data, which are calculated only on the hard data which means they're updated through May, show the three-month averages weaker than the six-month averages. Only three sectors weaken over three months; those are the service sectors for the U.S. and for Japan plus a weaker manufacturing sector in Germany. Over six months compared to 12 months, there are six weaker sectors. All three sectors in Australia are weaker; and in Japan, the composite and the manufacturing sectors are weaker; in the U.S., the services sector is weaker. However, over a year compared to the year previous, there are only 5 sectors that are stronger. The chart at the top gives you a sense of the roller coaster ride that the PMIs have been through for services and manufacturing in the European Monetary Area.

Trend shift? The manufacturing data in the chart has been on a plateau for about 5 months while the services sector in the monetary union has only just begun to turn lower in the past two months. The question is whether there is some sort of new trend in place and whether the upswing is over. It's too soon to know this, but it's not too soon to wonder about it.