The global manufacturing sector continued its improvement in July, with all the main global components of Markit Purchasing Managers' Index (PMI) with the exception of exports and employment back above 50 (50.6 in July from 48.8 in June). The gains in manufacturing were also broad based across components. The key sub-component, which is the new-orders index, jumped to 52.6 in July, from 48.8 in June. The sharp rise in new orders in the past two months, coupled with low levels of inventory, meant that the ratio of new orders to inventory also bounced to a 24-month high. High frequency alternative data point to an ongoing improvement in trade flows in July, following an uptick in June manufacturing activity across advanced economies.
US Federal Reserve (Fed) Chair Jerome Powell gave a much anticipated speech at the Kansas City Fed symposium, announcing a shift to a form of price-level 2% averaging across the cycle with an emphasis on maximum employment, particularly in minority communities. Powell noted that the Fed is not tying itself to a particular mathematical formula, and that the approach could be viewed “as a flexible form of average inflation targeting.” A major change is in an acknowledgement that the Phillips curve is much flatter now, the Fed will focus on “shortfalls” rather than “deviations” in employment from its maximum level. The upshot is that the Fed won’t pre-emptively raise interest rates as the unemployment rate falls unless it is accompanied by actual signs of inflation.
China’s exports continue to outperform global trade. Export growth rebounded more strongly in July from 0.5% year-on-year (YoY) in June to 7.2%YoY in July, benefiting from the re-opening of China’s key trading partners. However, import growth turned negative to -1.4%YoY, from 2.7%YoY previously, the trade balance bounced back significantly from US$46.4bn in June to US$62.33bn in July. Reflecting a flexibility to respond to global demand, specifically Covid-related products. The textiles subcategory “other made-up textile apparel,” which includes masks, rose from an average of US$2.3bn per month in 2019 to US$11.9bn per month in Q2, adding US$29bn to the quarter’s export growth. China’s manufacturing strength is not just its scale but its flexibility. BYD, a car manufacturer created the world’s largest face mask plant with daily production of 5 million masks. To put things in perspective, that would be quarter of China’s entire production capacity in February. Total daily production in China is now 110 million with 3000 new entrants since February.
Three consecutive positive reading of monthly profit growth, supported by the resilient exports, fiscal stimulus, and investment gains, further confirms that the economic recovery remains on track amid the severe flooding. Total industrial profit grew 19.6%YoY in July, up from 11.5%YoY in June and 6%YoY in May. Weekly auto sales data from the China Passenger Car Association show that the strong YoY growth momentum has lasted into August, rising 12% YoY in the first three weeks, compared to 6% YoY growth in July.
Asia ex-Japan remains on track for a gradual cyclical recovery in the next 12-18 months in spite of pockets of COVID-19 cases emergence supported by effective institutional response and largely communitarian societies. Despite the optimism expressed in equity market headlines, the recovery remains bifurcated with technology winners leading gains while manufacturing and small businesses continue to struggle.
While there is reason for optimism when it comes to a vaccine in reducing infection and mortality risks, the longer-term immunity, trust and efficacy of vaccinations remain uncertain. Consumers will remain cautious, as evident in rising savings while business sentiment towards investment continues to be muted. The risk of long-term impairment from consolidation in certain sectors continues, with long-term unemployment weighing on a return to pre-Covid economic activity levels without high levels of fiscal stimulus even if monetary accommodation persists.
The pandemic continues to post a risk in the event of a spike in infections heading into the end of the year. This coupled with political and policy uncertainty heading into the US elections would warrant a high degree of caution for investors. Even as headline inflation will be boosted by a rebound in inflation, spare capacity in the broader global economy will continue to weigh on inflation.
The heterogeneity of Asian economies will continue to reflect the divergence in growth between economies more closely linked to China’s consumption and the Asian tech supply chain as well as those that are more endogenously driven. What is consistent is that Asian economies that have the policy space, the political stability and the populace support to deal with the vicissitudes of an uncertain economic environment will do well. Our base case remains for continued monetary accommodation and proactive fiscal response where necessary in the year ahead.
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