By Nicole Busuttil
The growth divergence between the major economies has played out differently over the past six months than was expected at the end of the first quarter of the year. At the time, the US was knee-deep in a banking crisis, while the Fed was hiking rates at the fastest pace seen in decades. Markets were waiting for the next shoe to drop, expecting commercial real estate to slow down and push the US into a recession. The rest of the world, on the other hand, was doing better, with China’s reopening boosting growth in the economy and with the collapse in natural gas prices being a big boost to European consumers and businesses. Therefore, the US expansion seemed frail, but other economies looked set to pick up the slack.
Over Q2, however, this picture was very different. China’s recovery disappointed and Euro Area data pointed to the economy as having entered a technical recession from 4Q2022. In contrast, the US seemed to go from strength to strength, with high levels of job additions being reported, strong wage gains, and growing services and retail activity.
The US dynamic is not only playing out during Q3 but is sharpening and extending for longer than many expected in Q2. Recent data from the US docket is proving that the US consumer is not letting up. July retail sales revealed that consumers remained a key contributor to growth, with both headline and core sales exceeding expectations on a month-on-month basis. It is true that sales in July likely got a boost from Amazon’s Prime Day sales, and this will likely weigh on non-store sales in August and September, however, strength was broad-based across other control group components as well as food services and bars. Therefore, we expect consumer spending to be on a strong footing in Q3. Other July data was upbeat too, with industrial production increasing more than expected month-on-month and housing starts rebounding after a sharp decline in June.
In contrast, in China, July activity data pointed to a weaker-than-expected economy, and probably will be aggravated further by the recent developments in the property sector. On the latter, the real estate sector has turned out to be a significant drag on the economy, with key leading indicators such as new starts and property sales suggesting a slowing growth month-on-month. Recent default fears surrounding the largest real estate companies, such as Country Garden, will also likely add to growth headwinds. When looking at activity data, the recovery of consumption stalled. Retail sales contracted month-on-month, the first time since December. This may be a direct spillover from the weaker property sector, from lower sales of furniture, electronics and other household items. However, poor labour market prospects, as evidenced by the rising unemployment rate, together with the deteriorating financial position are likely to also be contributing to the slowdown in consumer spending and economic growth.
Meanwhile, Europe’s growth momentum is somewhere in between. In the second estimate release, Q2 GDP growth was confirmed at 0.3% quarter-on-quarter, likely due to the boost from travel and related services. However, when looking at activity data, manufacturing weakness lingers on across industries and countries, with services pulling the bloc’s activity up. Expectations are for the region to stagnate due to the increasing drag from monetary policy offsetting increased real incomes from falling inflation. Furthermore, recent data suggests that energy-intensive sectors’ production did not recover as much as expected despite the fall in energy prices, and
with energy prices resuming their upward trend, we will likely see a hit to the bloc’s industrial production once again.
In summary, the continued divergence between the world’s largest economies is driven by very different, but well known, fundamental forces. In the US, we are still seeing a strong labour market supporting income and spending, which in turn feeds back into employment creation. This, together with strong real incomes, supports the outlook for the housing market. In contrast, China is seeing a slowdown in both consumer spending and the real estate market, resulting in an overall slowdown in GDP growth, and fiscal stimulus is doing little to aid the world’s second largest economy.
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business.