June 1, 2015 Patrick Oliver-Kelley

US Zone

The U.S. GDP numbers for the first quarter exuded signs of weakness and since then the data has been mixed. Manufacturing remains in the doldrums, weighed down by a strong dollar and subdued expectations of external demand. On the flip side, consumer spending has recovered slightly but is subdued, the housing market continues to show signs of life, and the labor market is tightening and remains resilient. The trade deficit was worse than expected and inventory build-up is sluggish. Consumers continue to hesitate to spend. They will show up some time.  For the time being, ongoing data disappointments due mainly to weak oil prices, the strong dollar and modest income growth will continue. Headwinds remain strong but growth should accelerate into the 2% to 2.5% range in the second half of the year.

Euro Zone

The euro zone perked up a bit. Better than expected growth in France and Italy was enough to overcome a slowdown in Germany. In Europe generally, the most notable feature has been the lack of divergence between the core and periphery countries. The consumer of last resort is struggling. Output now appears on track for a 1.5% expansion for this year, driven by lower energy prices, a recovery of bank lending, reduced fiscal drag in the south, and the weaker euro. Of course, this is still well below the 2.2% average pace leading up to the Great Recession and real output has yet to regain its previous highs. Poor demographics, regulation and the lack of a coordinated fiscal policy all remain problems. Concerns about Europe triggering a global financial crisis, however, are receding and Greece, despite the histrionics of its Finance Minister and of its Prime Minister, appears to have little leverage as the government was elected on a mandate to stay within Europe.

Prime Minister David Cameron won a stunning election victory in Britain, confounding poll predictions to the contrary. Sterling currency, bonds and shares surged on a result that reversed near-universal expectations of an inconclusive “hung parliament”.

Asia Zone

The greatest American threat to China’s economic future is the possibility that America’s economic success could come to an end; the greatest economic danger China poses to the U.S. is the chance that China’s economy fails to grow. By contrast, if each country gets its own house in order and thus succeeds economically, that should diminish economic insecurity, which generates friction, and increase confidence about the future, which fosters a constructive relationship. The Chinese economy is slowing, the housing market has ground to a halt, its’ banking sector is under stress. Authorities are responding to the persistent deflationary pressures with a rising sense of urgency. In recent weeks, major state agencies have taken some coordinated endeavors. Longer term, these policies could potentially lead to a “big bang” in financial liberalization. In the near term, these policies are adding fuel to the raging bull market in Chinese stocks.

The outlier is China’s South China Sea land reclamation projects in the face of persistent criticism from the US. We say China is wrong to claim turning underwater land into airfields, would expand its sovereignty. China vigorously defends them. No question this is a sore spot that short of serious negotiation could become more than just absurd remarks.

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