06 Feb 2018

Economic Insights - January 29 - February 2, 2018

Article Image: 
Insights for Jan 29 - Feb 2
by Robin J. Anderson, Ph.D., Senior Global Economist
Table of Contents: 

Topic Summaries:

  • Inflation’s (sort of) return: Last year, economic growth was great, but rates stayed low. However, with tentative signs of inflation’s return, and positive economic momentum here to stay, the days of dull bond markets are likely over. 
  • The sweet spot: The global economy is in the middle of a self-sustaining expansion. Labor markets are bustling in the United States, Europe, and Japan. Manufacturing surveys are excellent. What’s not to like?

Looking back

In 2016 and 2017, global growth rebounded. Economic growth started to look normal for the first time since the financial crisis. Brazil and Russia exited recession; even Greece was no longer contracting. The Eurozone, Japan, and the United States were expanding robustly.  

But, there were still relics from the crisis: weak inflation and ultra-low interest rates. U.S. inflation hit a soft patch in 2017. Interest rates stayed very low. The U.S. 10-year rate started 2017 at 2.44%, and ended the year at 2.41%. The German 10-year government bond (bund) ended the year at 0.43%. Low interest rates helped spur equity markets. Returns were excellent and volatility stayed low.

However, 2018 is starting out differently. Interest rates are moving up, and with that, market volatility has returned. Last week, the U.S. 10-year Treasury rate broke through 2.8%, and is now at the highest level since early 2014. The U.S. 30-year Treasury reached 3% for the first time since early 2017. The German bund moved above 0.75%. Stock markets corrected, reacting to the sharp updraft in interest rates.

Inflation’s (sort of) return

Why did rates move up? At some point, the bond market had to start pricing in better growth. But, there are more signs that pricing pressures are coming to life. As of December, U.S. core PCE inflation was up 1.9%, on a three-month annualized basis. Pay growth remains below prior highs, but is finally trending up. Average hourly earnings (more on that below) grew 2.9% year-over-year in January, the fastest pace since June 2009. The employment cost index also hit a cycle high at the end of 2017. The Institute of Supply Management’s (ISM) Prices Paid Index reached the highest level since May 2011. Even in Europe inflation pressures are sprouting. According to Bloomberg, respondents to manufacturing surveys stated that prices were rising at the fastest rate in six-and-a-half years. However, don’t forget that overall hard inflation numbers remain very low in Europe.

In their latest policy statement, the Federal Reserve (Fed) finally acknowledged inflation’s return. The Federal Open Market Committee (FOMC) changed its language around price pressures. Gone are the days of inflation being below 2% in the “near term.” Now, the Fed expects inflation to “move up this year and stabilize around the FOMC’s 2% percent objective.” The FOMC also stated that market-based inflation measures had increased.

The bond market has finally realized that inflation isn’t dead. The disconnect between very strong economic numbers and languishing bond yields that existed last year is over. In general, better global growth prospects likely mean that higher rates are here to stay. But how much further can rates rise? U.S. pricing pressures may build up faster than expected and could put more upward pressure on yields.

Higher-than-expected inflation is certainly plausible. Tax cuts are coming at a time when the U.S. economy is already buzzing; stimulus now could tip the economy into the hot zone. Wireless-plan pricing dragged down year-over-year inflation much of last year, but is set to roll off the numbers in March.

Another catalyst for higher rates may come from abroad. Inflation data remains quite muted in Europe and Japan. Most recently, the Eurozone core CPI increased 1%, Spanish prices were up 0.7%, and Italian inflation rose only 0.8%. The Japanese core inflation rate is barely above 0. But, economies are doing well. As shown in the next section, some labor markets are downright roaring. Inflation could come back more quickly than expected going forward. The European Central Bank and Bank of Japan may then accelerate plans to normalize policy. Higher ex-U.S. rates would surely force U.S. Treasurys up even more.

The sweet spot

The global economy appears to be in a sweet spot, a self-sustaining economic expansion. Each week, evidence of a coordinated pick up in global growth mounts. Labor markets are growing briskly and manufacturers are humming. Strong labor markets are bolstering domestic demand spurring more production and trade. Companies are investing and hiring more to keep up with demand. Central banks are staying accommodative. The cycle continues.

The U.S. jobs report surprised to the upside. Headline payrolls increased by 200,000. Separately, the ADP report showed private payrolls up by 234,000 and has printed 200,000 jobs or more in five of the last six months. According to the Bureau of Labor Statistics, construction hiring popped up by 36,000. More broadly, goods-producing sectors added 57,000 jobs, after adding 55,000 and 78,000 in December and November, respectively. The services sector added 139,000 jobs led by education and health with 38,000 created. Flows into the labor force remain strong, that’s keeping payroll growth robust even as the unemployment rate stays low.

The unemployment rate picked up only slightly, from 4.095% to 4.149% as the labor force grew more quickly than the number of employed. U6, the broadest measure of unemployment, increased marginally, up to 8.2% from 8.1% last month. Temporary help, which leads broader job growth, gained only 2,000 jobs after losing the same amount in December.

As mentioned above, average hourly earnings grew at the fastest pace since 2009. There were, though, a couple caveats to that number. Pay for production and nonsupervisory workers grew only 2.4% (versus 2.9% overall wage growth), suggesting that managers’ pay may have driven the headline gains. Hours worked ticked down to 34.3 from 34.5, so weekly wages grew by only 2.6%. While wage growth should continue trending up, some of last month’s pop-up in average hourly earnings may have been noise. In general, January’s jobs report was more than strong enough to keep the Fed on track to raise rates in March.

Labor markets are solidly picking up in Europe and Japan too. Japan’s labor market is super. The job to applicant ratio is at a record high of 1.59, so for every 100 workers there are 159 jobs available! The euro area unemployment rate held constant at 8.7%, but is down one percentage point since December 2016. UK job vacancies are the highest on record at 810,000. The German unemployment rate is the lowest since reunification, and the UK unemployment rate is the lowest since 1975. Italian unemployment reached the best rate since late 2012. According to GaveKal, an independent investment-research provider, as the rest of Europe has improved, European Union (EU) migration growth into Germany has likely slowed. Gavekal shows that employment growth for non-Germans living in Germany was up 0.7% year-over-year in the third quarter of 2017, versus 10% previously.

Purchasing manager indexes (PMIs) are fantastic. The ISM manufacturing PMI was very strong, at 59.1, and the ISM services PMI rose sharply, up from 56.0 to 59.9. The Eurozone manufacturing PMI was 59.6. Germany’s PMI hovered above 60; Italy’s PMI hit 59. Japan’s PMI is at a record high. China’s Caixin PMI was unchanged at 51.5, and the NBS PMI declined slightly to 51.3. One negative: new export orders fell below 50.0 for the first time since October 2016.  

This self-sustaining global economic expansion should last for a little while. It’s hard to find a negative data point out there. As mentioned above, this burst in global growth may finally be leading to a bit of inflation. Right now, that inflation is benign. But, if the United States and other countries run into capacity constraints, this boom could overheat. Until then, the sweet-spot continues.


Unless otherwise noted, all data is sourced from Bloomberg.

Unless otherwise noted, the information in this document has been derived from sources believed to be accurate as of February 2018. Information derived from sources other than Principal Global Investors or its affiliates is believed to be reliable; however, we do not independently verify or guarantee its accuracy or validity. Past performance is not necessarily indicative or a guarantee of future performance and should not be relied upon to make an investment decision.

The information in this document contains general information only on investment matters. It does not take account of any investor’s investment objectives, particular needs or financial situation and should not be construed as specific investment advice, an opinion or recommendation or be relied on in any way as a guarantee, promise, forecast or prediction of future events regarding a particular investment or the markets in general. All expressions of opinion and predictions in this document are subject to change without notice.  Any reference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such investment or security, nor an indication that Principal Global Investors or its affiliates has recommended a specific security for any client account.

Principal Financial Group, Inc.,  Its affiliates, and its officers, directors, employees, agents,  disclaim any express or implied warranty of reliability or accuracy (including by reason of negligence) arising out of any for error or omission in this document or in the information or data provided in this document.   

Any representations, example, or data not specifically attributed to a third party herein, has been calculated by, and can be attributed to Principal Global Investors.  Principal Global Investors disclaims any and all express or implied warranties of reliability or accuracy arising out of any for error or omission attributable to any third party representation, example, or data provided herein.

All figures shown in this document are in U.S. dollars unless otherwise noted.
This document is issued in:
• The United States by Principal Global Investors, LLC, which is regulated by the U.S. Securities and Exchange Commission.
• Europe by Principal Global Investors (Europe) Limited, Level 1, 1 Wood Street, London EC2V 7JB, registered in England, No. 03819986, which has approved its contents, and which is authorised and regulated by the Financial Conduct Authority.
• Singapore by Principal Global Investors (Singapore) Limited (ACRA Reg. No. 199603735H), which is regulated by the Monetary Authority of Singapore and is directed exclusively at institutional investors as defined by the Securities and Futures Act (Chapter 289).
• Australia by Principal Global Investors (Australia) Limited (ABN 45 102 488 068, AFS License No. 225385), which is regulated by the Australian Securities and Investment Commission and is only directed at wholesale investors (as defined in sections 761G and 761GA of the Corporations Act).
• This document is issued by Principal Global Investors LLC, a branch registered in the Dubai International Financial Centre and authorized by the Dubai Financial Services Authority as a representative office and is delivered on an individual basis to the recipient and should not be passed on or otherwise distributed by the recipient to any other person or organisation. This document is intended for sophisticated institutional and professional investors only.
• Switzerland by Principal Global Investors (Switzerland) GmbH which is authorised by the Swiss Financial Market Supervisory Authority (“FINMA”). 
• In Europe, this document is directly exclusively at Professional Clients and Eligible Counterparties and should not be relied upon by Retail Clients (all as defined by MiFID). In connection with its management of client portfolios, Principal Global Investors (Europe) Limited may delegate management authority to affiliates that are not authorised and regulated within Europe.  In any such case, the client may not benefit from all protections offered by rules and regulations enacted under MiFID. 
• India by Principal Pnb Asset Management Company Private Limited (PPAMC). PPAMC offers only the units of the schemes of Principal Mutual Fund, a mutual fund registered with SEBI.
• Hong Kong by Principal Global Investors (Hong Kong) Limited, which is regulated by the Securities and Futures Commission and is directed exclusively at professional investors as defined by the Securities and Futures Ordinance
This material is not intended for distribution to, or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

Expressions of opinions and predictions are accurate as of the date of this communication and are subject to change without notice. There is no assurance that such events or prospections will occur and actual condition may be significantly different than that shown here. 
Insurance products and plan administrative services provided through Principal Life Insurance Co. Principal Funds, Inc. is distributed by Principal Funds Distributor, Inc. Securities offered through Principal Securities, Inc., 800-547-7754, Member SIPC and/or independent broker/dealers. Principal Life, Principal Funds Distributor, Inc. and Principal Securities are members of the Principal Financial Group®, Des Moines, IA 50392.

©2018 Principal Financial Services, Inc. Principal, Principal and the symbol design and Principal Financial Group are trademarks and service marks of Principal Financial Services, Inc., a member of the Principal Financial Group.  Principal Global Investors is the asset management arm of the Principal Financial Group.

MM8299-98 | 02/2018 |  42069-022019