GCC non-oil growth continues to gather strength

KUWAIT: Global equities surged in June following a rough May, helped by expectations that key central banks will loosen policy to ward off an economic slowdown. The US S&P rose 6.9 percent m/m for its biggest June gain since 1955. The prospect of slower growth and monetary stimulus also saw bond yields sink further, with the US 10-year treasury yield below 2.0 percent in late June and German bunds at a record low of -0.3 percent. Markets were also boosted by a truce on tariff hikes agreed between the US and China, though a full-scale trade deal still looks some way off. Meanwhile oil prices rose through the month anticipating a decision – subsequently realized – by the OPEC+ group to extend current supply cuts into next year.

Fed paves the way for future rate cuts
The Federal Reserve as expected left interest rates on hold at 2.25-2.50 percent in June, but paved the way for looser policy by dropping calls for ‘patience’ in future rate changes and committing to “act as appropriate to sustain the expansion”. Although recent economic activity data is by no means all bad, the Fed is mulling a rate cut as ‘insurance’ against a future slowdown (including as a result of slower global trade), as well as low inflation, which was unchanged at 1.6 percent y/y in May on the Fed’s preferred core PCE measure and well below the 2 percent target.

Financial markets – as well as President Trump – are increasingly expectant of looser policy, with futures markets certain of at least a 25 bps cut in July and pricing in a 92 percent chance of at least 50 bps in cuts by year-end. However, some analysts believe that markets are getting ahead of themselves and the Fed’s own ‘dot plot’ projections still (just about) point to no change in rates this year.

Surveys of manufacturing activity – which is often considered a good lead indicator of the broader economy – have weakened and are among the Fed’s key concerns. The Empire State survey for example plunged into contraction territory in June while the closely-watched ISM manufacturing index slipped to just 51.7 having already slowed markedly since last year.

The hope is that weakness is exaggerated by tariff and trade fears that need not materialize if US-China tensions can be diffused, while the more domestically-oriented service sector remains solid. Consumer spending for example rebounded to 4.4 percent y/y in April-May and consumer confidence (despite dropping in June) remains at historically high levels backed up by 50-year-low unemployment of 3.6 percent and 3 percent+ earnings growth. Even so, with the economic expansion now the longest in US history at 121 months, a sizeable slowdown in GDP growth looks almost certain. ‘Nowcast’ estimates point to annualized GDP growth of only 1-1.5 percent in both 2Q19 and 3Q19, less than half of the 3.1 percent recorded in Q1, which was lifted by a strong rise in inventories.

Manufacturing weakness is also weighing on Europe’s economy, with the Eurozone manufacturing PMI remaining in contraction territory in June at 47.6 and Germany the worst performer at 45.0 – reflecting the global slowdown, regional political uncertainties and problems in the crucial auto sector.

The figures suggest that manufacturing output may have fallen 0.7 percent q/q in 2Q19, perhaps limiting growth in overall GDP to 0.2-0.3 percent down from 0.4 percent in Q1. The consensus view is that growth will pick up in H2 if global trade recovers, helped by an improving labor market where wage growth rose to a 10-year high of 2.5 percent in 1Q19 and unemployment fell to 7.5 percent in May. However business confidence remains low and there are risks to the outlook from fresh US tariffs (including due to an aircraft subsidy dispute), Brexit (the terms of which are still unresolved) and rising public debt in Italy, despite some recently announced cuts to spending.

Against this backdrop and core inflation that rose but remained well below the ‘close to but below 2 percent’ target at 1.1 percent y/y in June, the European Central Bank (ECB) declared its readiness to implement fresh stimulus. This could be in the form of interest rate cuts, or more likely a resumption of the bond purchase program that it halted last December, combined with stronger forward guidance on policy. Unless the outlook deteriorates further, the ECB may wait until its September policy meeting for any major policy shift. ECB president Mario Draghi leaves his post in October and some analysts hope for a program of long-term quantitative easing to be announced not just as the most effective policy option, but as a way of committing his successor, currently slated to be former IMF chief Christine Lagarde, to future stimulus (though she is already considered a dovish appointment).

The UK economy is also showing signs of a steeper downturn, with quarterly growth estimated to be close to zero in 2Q19 (0.5 percent in Q1) and the construction PMI plunging to a decade low of 43.1 in June amid delays to investment caused by Brexit-related uncertainty. Former London Mayor Boris Johnson is currently favorite to replace outgoing prime minister Theresa May when the governing Conservative party elects a new leader on 22nd July and has pledged to seek changes to the negotiated withdrawal agreement with the EU or sanction a ‘no deal’ exit at the end of October. Neither option will be easy to deliver and given the government’s wafer-thin majority in parliament, the chances of a general election are considerable, the outcome of which would be highly unpredictable for Brexit. Bank of England governor Mark Carney hinted recently that interest rates could be cut from their current 0.75 percent given Brexit and global risks, contrasting earlier official guidance of ‘gradual’ and ‘limited’ rate hikes.

BoJ signals potential easing
The Bank of Japan left monetary policy on hold last month but, like the Fed and ECB, signaled the potential to adopt further stimulus measures if the global economic outlook continues to worsen. Growth in Japanese exports fell for the sixth consecutive month in May (-7.8 percent y/y) mainly on the back of weaker Chinese demand for semiconductor manufacturing equipment and car parts, a sign that the ongoing trade war with the US has sapped Chinese manufacturers’ appetite for intermediate products. Imports also fell in May (-1.5 percent y/y) after growing by a decent 6.4 percent y/y in the previous month, reflecting the underlying softness in domestic consumption.

China looks to boost investment
The Chinese government announced that it plans to further liberalize key sectors including finance and manufacturing as soon as next year, in a bid to prop up foreign investment inflows. The announcement comes amid signs of continued economic weakness, not least because of trade tensions with the US. Indeed, the latest PMI data came in softer than expected. The private Caixin manufacturing PMI slipped into contraction territory in June for the first time in months. The official manufacturing PMI also pointed to a contraction coming in at 49.4, unchanged from May’s reading. On the upside, the official non-manufacturing PMI was broadly unchanged at a decent 54.2. Meanwhile the renminbi, having fallen sharply in May on trade and growth concerns, was more stable through June, amid trade talk progress and US dollar softness.

Concerns over the weakening global economy have pressured oil prices, even as OPEC+ extended its production cut agreement for nine months to March 2020 (which had been largely priced in before the announcement in early July). In June, oil prices had been whipsawed by opposing, bullish and bearish forces. Brent fell to its lowest level since January in mid-month as US-China trade tensions escalated before geopolitics – the attacks of ships off the Strait of Hormuz and Saudi infrastructure – and the long-awaited drawdown in US crude stocks pushed Brent back up to close the month up 3 percent at $66.6/bbl. The downing of a US drone by Iran and the subsequent abortive US airstrike and sanctions applied to Iran’s Supreme Leader Ali Khamenei only served to further raise oil’s geopolitical risk premium. However Brent subsequently eased back to $62.4/bbl in early July as global growth concerns reasserted themselves.
Non-oil activity in the GCC continued to gather momentum, with both the Saudi and UAE PMIs comfortably in expansion territory (57.4 and 57.7, respectively) in June, driven by increases in new orders and output. Employment gains, however, were negligible. Official data show Saudi GDP expanded 1.7 percent y/y in 1Q19, up on the 1.5 percent recorded a year earlier, led by 2.1 percent growth in the non-oil sector. Meanwhile growth in Qatar picked up to 0.9 percent y/y in 1Q19 from 0.3 percent in 4Q18, with non-hydrocarbon growth at 1.6 percent.

Finally, according to UNCTAD, foreign direct investment flows to the GCC edged up 0.1 percent in 2018 to $17.4 billion, with the UAE attracting the lion’s share ($10.4 billion). Moves to attract FDI and foreign expertise have accelerated across the GCC. Saudi like the UAE and Qatar is offering skilled expats permanent residency and is relaxing limits on foreign ownership of listed firms in strategic investors.

NBK ECONOMIC REPORT