Strength and challenges in the first quarter of 2018

5 min read

Monthly economic commentary - March 2018

Led by US and Asian markets, global markets roared into the New Year – it was the best start to a year for the S&P 500 index since 1987, as markets reacted to an across the board improving economic outlook.

But this optimism soured, as a stronger-than-expected wage growth figure in the US in February alarmed markets by its implications for inflation (and thus, upward pressure on interest rates) leading to a poor quarter for equities. These woes were further compounded by President Trump’s surprise moves in March to introduce tariffs on a range of US imports, in a strategy clearly aimed at China. These moves affected US and global stock markets – particularly, as Beijing came straight back with plans for reciprocal tariffs, fostering concerns of a highly unwelcome trade war.

US interest rates were raised in the quarter, with the March meeting of the Federal Reserve Open Market Committee lifting official interest rates from 1.5% to 1.75% in Jay Powell’s debut as chair. The Fed released relatively upbeat expectations for the US economy and inflation, supporting the case that the central bank could raise interest rates three more times this year.

Job creation in the US was strong in the quarter, with 200,000 jobs added in the non-farm sector in January, ahead of the market’s median expectation of about 180,000 jobs, and a much stronger-than-expected performance in February, with 313,000 jobs created, well ahead of economists’ expectation of a gain of 200,000 jobs. February’s jobs gain was the most in a month since July 2016. The US unemployment rate was steady at 4.1%, a 17-year low.

Average wages rose 2.6% in the year to February, a slowdown from the 2.9% annual growth reported for January which had sparked the market sell-off, being seen as stoking the fears of rising inflation.

The US economy was initially reported as expanding at a 2.6% annual rate in the fourth quarter of 2017, to grow 2.3% for the year, up from the 1.5% growth in 2016. The Commerce Department then revised, downward, its estimate of fourth-quarter growth to 2.5%, before the third estimate, in late March, was lifted to 2.9%, representing only a slight moderation from the September 2017 quarter’s 3.2% pace.

Growth in consumer spending, which accounts for more than two-thirds of US economic activity, was revised up to a 4% rate in the December 2017 quarter, from the 3.8% growth rate pace reported in February. That was the fastest pace since the December 2014 quarter, and was a brisk lift from the 2.2% rate of growth in the September 2017 quarter.

US stock markets struggle

US stock markets struggled over the quarter, with the hardest hit being technology stocks affected by the initial revelations of the Facebook scandal – in which whistle-blowers revealed that the data of up to 87 million people was improperly shared with the political consultancy Cambridge Analytica. This helped to depress the major indices in March. For the quarter, the Dow Jones Industrial Average slid 2% and the S&P 500 index eased 0.8%, while the Nasdaq Composite index managed a 2.6% rise – thanks mainly to its 7.4% surge in January. Volatility returned to the US market over the quarter, after spending much of last year at multi decade lows – and touching a record low in October 2017, at 9.19. The Volatility Index (VIX) surged from 11.04 at the beginning of the quarter to 19.97 at its end, albeit a number equal to the last 10 year average of 20.

Political worries was the focus in Europe

In Europe, political worries continued to overshadow markets, with the drawn-out negotiations in Germany to settle on a government finally seeing Chancellor Angela Merkel taking office in March heading a coalition of her Conservatives with the Social Democrats, six months after the country’s inconclusive election. Meanwhile, a similarly indecisive election result in Italy has left that country prone to a drawn-out process of negotiations before its next government can be formed.

The forward-looking Eurozone composite purchasing managers’ index (PMI) hit a reading of 58.6 points in January, the highest since June 2006, well before the global financial crisis, according to data firm IHS Markit. The December quarter saw the strongest factory output increase in Europe since 2000. February saw data showing that the Eurozone economy grew by 2.5% in 2017, mainly driven by strong performances from Germany, Spain and France.

However, the Eurozone composite PMI weakened over the rest of the quarter, to 57.1 in February and 55.3 in March, missing economists’ forecasts, although still comfortably above the 50 level, which indicates expansion. The Eurozone’s private-sector economy grew at the slowest pace in 14 months in March. Germany’s unemployment rate held steady at 5.4%, the lowest since German reunification in 1990, while in France, unemployment is at 8.9%, its lowest level since 2009.

For the European stock markets, they were not immune from the sharp declines in the US markets with the Euro STOXX 600 index retreating 4% over the quarter, led by Germany’s DAX, which lost 6.4%, and the CAC 40 in Paris, which dropped by 2.7%. In the United Kingdom, the FTSE-100 index sank 8.2%.

Asia reports positive signs

In Asia, Japan's manufacturing sector's strong momentum carried through into 2018, growing at its fastest pace in almost four years in January, before slowing in February, and rebounding in March. Official data showed Japan’s economy growing at 0.4% in the December quarter, making an annual growth rate of 1.6%, well ahead of both the economists’ median estimate of 0.9%, and the preliminary reading of 0.5%.

Japan’s economy has expanded for eight consecutive quarters, the longest uninterrupted streak since a 12-quarter run of growth during the mid-to-late 1980s boom. The country’s unemployment rate fell to 2.4% in the quarter, the lowest rate in 24 years.

China’s official PMI weakened in January to an eight-month low of 51.3, as factory activity cooled, and then slipped further in February, to a 19-month low of 50.3. But the country’s industrial output rose 7.2% in January-February, while fixed asset investment, an indicator of infrastructure investment, was also strong, up 7.9% versus an estimate of 7%. The figures were taken as a pointer to solid first-quarter economic growth. Beijing is forecasting growth of 6.5% in 2018, down from 6.9% in 2017.

The private Caixin/Markit manufacturing PMI, which focuses on China’s small and mid-sized businesses – was much stronger than the official figure in February, hitting a six-month high at a stronger-then-expected reading of 51.7, but weakened to 51.2 in March as new export orders increased at the slowest rate for the March quarter.

On the Asian stock markets, the Nikkei index gave up 5% over the quarter, the Shanghai Composite index was down 4.2% and South Korea’s KOSPI index eased 0.9%, while the Hang Seng index in Hong Kong bucked the trend, advancing by 0.6%,–helped mainly by its 9.9% surge in January, which was its biggest monthly rise since April 2015.

In Australia, the S&P/ASX 200 Accumulation index dropped 3.9% for the quarter, led lower by the A-REIT (real estate investment trust) index (down 6.4%), the S&P/ASX 200 Resources Accumulation index (down 4.2%) and the S&P/ASX 200 Industrials Accumulation index (down 3.8%). On the commodities front, oil had a strong first quarter, with Brent crude up 6.8% and West Texas Intermediate (WTI) gaining 7.5%, while gold gained a more sedate 1.7%, copper was down about 8% and iron ore retreated 13.1%.

In the foreign exchange world, the Australian dollar slipped about 1.7% against the US dollar, ending the quarter at 76.79 US cents, while the Euro gained 2.7% against the greenback and the British pound strengthened by 3.7%. The US currency had a tough quarter against the yen, losing 5.7%.

Information current as at 31 March 2018. This article provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such. This information does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness, having regard to your personal objectives, financial situation and needs having regard to these factors before acting on it. Past performance is not a reliable indicator of future performance. This article may contain material provided by third parties derived from sources believed to be accurate at its issue date. While such material is published with necessary permission, no company in the Westpac Group accepts any responsibility for the accuracy or completeness of, or endorses any such material. Except where contrary to law, we intend by this notice to exclude liability for this material.

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