U.K.: The Resurgent Economy

The Bank of England kept interest rates unchanged at 4.5% today, as expected. But the raft of stronger economic data suggests that a bias to tighten could soon emerge.

The U.K. Purchasing Manager's Services Index (PMI) rose sharply to 59.7 in April from 57.4, its highest level in more than two years. Strength in the new business component was largely responsible for the bulk of the gains. On balance, the risks to the U.K. economy are on the upside given the stronger than expected expansion in the manufacturing sector, a reinvigorated housing market supported by rising mortgage approvals, and solid export growth. Moreover, stronger €uro area growth and competitiveness gains from a weak real effective exchange rate will help drive U.K. growth this year. Bottom line: Economic growth in the U.K. will continue to surprise on the upside.

U.S. Investment: Slower Growth Ahead

The growth of U.S. core durable goods orders (excluding aircraft and parts) has peaked, although there is no risk of a major retrenchment.

Continue to expect a US consumer slowdown in the coming months and a modest softening in business expansion plans. Companies want to protect margins and will be less aggressive when faced with uncertainty about final demand. However, the foundations under the economy remain intact: low inflation, strong profits, and high rates of return on capital. In addition, the gap between the return on capital and the cost of capital is still wide and should continue to spur investment. Bottom line: US corporate balance sheets are still strong, which means that slower growth in consumer spending should not lead to major cutbacks in hiring and capital spending.

U.S. Fed Funds Rate: Hikes Are Almost Over

There are many economic relationships with the fed funds rate that have historically been helpful in timing when the Fed will stop tightening. Most are close to signaling a peak.

The Fed is nearly finished hiking rates whenever 12-month rate expectations move below the 6-month measure, although the size of the gap that coincides with an end to rate increases has varied over time. Currently, there is a modest negative gap, suggesting the end is near. In addition, BCA's Fed Monitor has fallen to a neutral level and the housing market is in a persistent downturn. Bottom line: Further weakness in consumer spending would imply that the Fed will pause after the May FOMC meeting.

And finally

A young boy named Gordon bought a donkey from an old farmer for £100.

The farmer agreed to deliver the donkey the next day. But when the farmer drove up the following day, he said, "Sorry son, but I have some bad news...the donkey is on my truck, but he's dead."

Gordon replied, "Well then, just give me my money back."

The farmer said, "I can't do that. I already went and spent it."

The boy Gordon said, "OK then, just unload the donkey anyway".

The farmer asked, "What are ya gonna do with him?" 

Gordon said, "I'm going to raffle him off."

To which the farmer exclaimed, "You can't raffle a dead donkey!"

But Gordon, with a big smile on his face, said "Certainly I can. Watch me. I just won't tell anybody that he's dead."

A month later the farmer met up with Gordon and asked, "What happened with that dead donkey?"

Gordon said, "I raffled him off. I sold 500 tickets at £2 a piece and made a huge profit"

Totally amazed, the farmer asked, "Didn't anyone complain that you had stolen their money because you lied about the donkey being dead?"

And Gordon replied, "The only person who found out about the donkey being dead was the raffle winner, when he came to claim his prize. So I gave him his £2 back plus £200 extra, which is double the going value of a donkey, so he thought I was a great bloke."

Gordon grew up and eventually became the Chancellor of the Exchequer, and no matter how many times he lied or how much money he stole from British voters, as long as he gave them back some of the stolen money, most of them still thought he was a great guy.

Prometheus from sources: ADM, Barclays Capital, Cazenove, Charles Stanley, HSBC, ING, SocGen, UBS.