More of the same: low US inflation & stronger Chinese growth - Westpac

Westpac Analyst Richard Franulovich argues that continuing low inflation in the US and improving Chinese growth momentum are among two of the most noteworthy themes driving global markets at the moment. 

Key quotes:

"Our indicators suggest the low US inflation environment and stronger Chinese growth are both set to continue for sometime yet."

"Slide one below shows the outlook for Chinese industrial production based on a simple regression model that takes lagged values of China’s real effective exchange rate, real interest rates and total social financing as the key variables. Our model has been expecting stronger Chinese growth for close to 18 months as the exchange rate and interest rates have fallen and credit creation has accelerated, a point we have made earlier. Allowing for lags our model points to yet further acceleration in Chinese growth in coming months."

"Low US inflation is likely to continue for some months yet too. Simple correlations suggest that the employment to population ratio for 25-54 year olds is the most reliable indicator of US wage pressures. Between 2000 and 2016 (ie both pre and post crisis) the "line of best fit" has a strikingly high R2 of 0.93. That is head and shoulders above other widely watched labour slack indicators such as the unemployment rate, the broader U6 measure, the Fed’s labour market conditions index, the JOLTS vacancy rate, unemployment duration and small business hiring trends".

"The current benign 2.5% pace for US wages growth is perfectly consistent with an employment to population ratio for 25-54 year olds of 78.5%. What would it take for wages and salaries growth to hit 3%+? According to the scatterplot the employment to population ratio for 25-54 year olds would need to hit 80%. At its current trend growth pace it would take 2 years before the 25-54 year old employment to population ratio hits the 80% level that has historically been consistent with 3%+ wages growth."

"Our US data surprise index is admittedly very low at the moment and should soon push in a more USD supportive direction but the low inflation backdrop should continue. China’s stronger growth story has legs too."