Tuesday, 23 August 2016

Global Economic Perspective: August


Date : August 17, 2016



In This Issue:

Investors Shrug off Disappointment in Headline US GDP Growth

Fixed income investors appeared to shrug off a disappointing US gross

domestic product (GDP) reading for 2016's second quarter, as evidenced

by a tightening of spreads in both the investment-grade and high-yield

market sectors. While we think decent consumer sector performance

appears capable of delivering more trend-like growth over the second

half of this year, we also believe the adoption of a coordinated

approach involving additional fiscal measures would offer welcome

support for economic growth.

Support Among Developed Markets for Coordinated Approach to Economic

Policy Likely to Grow

As governments around the world consider their response to the issue of

slow or declining growth, market pricing distortions as well as the

impact to the banking and financial sector are among the issues pointing

to the limits of a purely monetary approach to policy accommodation and

giving monetary authorities pause. Looking forward, we think a dialogue

among policymakers will likely broaden to include more countries in the

months to come.

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July Data Point to Continued Stability in Key Emerging Market Economies

Aided by government stimulus, the Chinese economy grew in the second

quarter of 2016 at the same rate as the prior quarter. Elsewhere, Indian

food inflation stands to benefit from a decent monsoon season, while

Brazil’s monetary authority remained on hold for the month.

Investors Shrug off Disappointment in Headline US GDP Growth

Preliminary readings for US economic growth in the second quarter of

2016 fell short of the market’s broad expectations. However, the

majority of the miss was the result of a shift in the volatile

inventories component. As inventories can fluctuate significantly from

period to period without much change in the net result over the longer

term, we would not be inclined to draw any broad conclusions with

respect to US growth prospects, particularly since the 1.2% annualized

growth estimate was accompanied by solid consumption readings.

US retail sales increased by a robust 0.6% from the prior month in June

amid a strong rebound in nonfarm payroll figures following a weak May

reading. In addition, the readings for May and June job gains were

revised upward, and wages continued to firm. While the headline

unemployment rate actually rose slightly to 4.9% in June and remained

there in July, the increase was largely driven by an improvement in the

labor force participation rate. The general direction of high frequency

data releases such as initial and continuing unemployment claims painted

a picture of a labor market approaching full employment as they

continued to trend downward while total job openings improved.

Additionally, Employment Cost Index figures released in July for the

12-month period ended in June 2016 showed an overall increase of 2.3%.

The wages and salaries component of the index increased at a rate of

2.5% for the 12-month period ended in June 2016, while the benefits

component increased at a rate of 2.0% for the same period. While slowing

somewhat, these figures are additional evidence that labor conditions

should be supportive of further gains in consumer spending.

Common gauges of manufacturing activity consolidated in July, evidencing

further stabilization in the manufacturing sector as the effects of the

US dollar’s sharp rise earlier in the year began to wear off. Among

other positive developments were increases in production, while new

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orders and new export orders remained solidly in expansionary mode.

Gains in the services sector also slowed slightly from the prior month's

level. Within the details of the report, increases in new orders, new

export orders and the backlog of orders were supportive of further

growth. Headline inflation figures remained muted during June as

increases in energy and other items outweighed a notable decline in food

costs. In comparison with year-ago figures, the price of services

accelerated while that of goods declined.

The above-mentioned references to improved economic activity were

reflected both in the minutes from the US Federal Reserve’s (Fed’s) June

meeting as well as in a statement released toward the end of July.

Notwithstanding the slightly hawkish tone of these communications, the

committee again declined to raise rates for the time being. Most

measures of US labor market conditions since the May employment report

have suggested that the month's weak reading was likely an aberration

rather than the start of a negative trend. The June meeting minutes also

alluded to concerns with respect to the impact of the upcoming (at the

time of the meeting) Brexit vote on financial markets, although the

vote's outcome appears to have been largely discounted by global markets

following a brief initial bout of volatility.

Indeed, fixed income investors appeared to shrug off the disappointing

second-quarter GDP reading as evidenced by a tightening of spreads in

both the investment-grade and high-yield market sectors. While we think

decent consumer sector performance, even impeded somewhat by corporate

investment and government spending, appears capable of delivering more

trend-like growth over the second half of the year (barring some kind of

unexpected shock), we also believe the adoption of a coordinated

approach involving additional fiscal measures would offer welcome

support for economic growth. While this approach has been championed by

Fed Chair Janet Yellen, whether it actually comes to pass may depend on

an improvement in the political climate.

Support Among Developed Markets for Coordinated Approach to Economic

Policy Likely to Grow

US monetary authorities are not alone in contemplating alternatives to

monetary policy. Both Japan and the eurozone appear to have reached a

point where quantitative easing may be doing more harm than good. In

both cases, central-bank bond purchases have resulted in flatter yield

curves as investors bid bond prices up. Over time, this has resulted in

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negative interest rates which, in turn, have adversely affected the

banking sector’s ability to generate income from its existing assets.

From this perspective, adopting a coordinated approach to expansionary

measures would be helpful in relieving these unintended effects on the

bond market.

The government of Japanese Prime Minister Shinzo Abe may have tacitly

acknowledged this limitation when the Bank of Japan announced only a

token increase along with a review of its quantitative easing measures

amid weakness in the domestic stock market and the ongoing appreciation

of the Japanese yen. The Ministry of Finance announced a new package of

fiscal measures shortly afterwards, and we think the Japanese government

may be signaling its intent to adopt a new approach in terms of both

fiscal and monetary measures to attack the problem of slow growth.

The Bank of England’s (BOE’s) Monetary Policy Committee cut its

benchmark interest rate in the wake of the Brexit referendum while also

announcing an additional package of measures, including corporate and

sovereign bond purchases as well as a lending program for banks. Despite

the uncertainty surrounding the mechanics and timing of the actual

Brexit process, it ultimately appears likely to have a negative effect

on UK economic growth. Recent readings from gauges of industrial

activity have already pointed to a sharp decline in activity. While the

BOE has publicly expressed its reluctance to pursue a purely monetary

approach to the issue, having voiced concern over the potential effects

of low interest rates on the banking and building sectors, concerns over

the extent of a slowdown may have prompted the additional measures.

Without the budgetary restrictions imposed by membership in the European

Union (EU) and given the concerns raised with respect to further

quantitative easing measures, the United Kingdom appears likely to

eventually adopt a coordinated approach through the announcement of a

package of fiscal measures later this year.

European economic data released in the immediate aftermath of the Brexit

referendum were generally positive. Amid positive economic growth, the

June unemployment rate of 10.1% indicated stability in eurozone labor

market conditions. In addition, inflation ticked up to a still very low

0.2% in July versus the year-ago period, although core inflation

remained at 0.9%. Lower energy prices stemming from the global glut of

crude oil have produced a drag on inflation over the past few quarters.

As a result, the headline annual inflation figure will likely tick up as

those effects wear off. In the second quarter, the French economy

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stagnated, largely due to weak household spending and lower business

investment, while the Spanish economy registered modest growth.

Elsewhere in the region, Germany’s preliminary estimate of inflation

data indicated year-on-year consumer price inflation rose slightly in

July while the country’s unemployment rate declined. European

policymakers continue to be confronted with a mixed economic picture

stemming from a range of factors, including the unexpected influx of

refugees, high levels of private debt and a perception of weakness in

the financial sector, although this last factor has been mitigated to

some extent by the results of the most recent European bank stress

tests. At the same time, European political conditions continue to hold

potential to destabilize the nascent recovery amid the unprecedented

wave of populist protectionist sentiment that shows little sign of

ebbing anytime soon.

Having already announced a major expansion of its asset purchase program

earlier this year, the European Central Bank (ECB) appeared to be in

watch-and-wait mode following the results of the Brexit referendum.

Given the large number of uncertainties surrounding the event, ECB

governors were likely anxious for more detail before rushing to commit

to any specific set of measures, although ECB Executive Board Member

Benoît Coeuré did suggest there was additional room to cut the deposit

rate if benefits continued to outweigh costs. While there has been

little talk of specific fiscal measures, EU officials have quietly

allowed both Spain and Portugal to exceed official budgetary strictures,

which could signal a growing willingness to move past traditional

approaches in confronting the issue of slow growth. While monetary

policy continues to play an important role, as evidenced by the recent

actions of the BOE as well as an August rate cut by the Reserve Bank of

Australia, the vast majority of stimulative measures undertaken since

the 2008–2009 global financial crisis have favored monetary over fiscal

policy for a number of reasons. As policymakers confront the limits of

the monetary approach, conversations have increasingly turned to a

discussion of potential alternatives to combat slow growth. Looking

forward, we think this dialogue will likely broaden to include more

countries in the months to come.

July Data Point to Continued Stability in Key Emerging Market Economies

Elsewhere, Chinese economic growth registered a positive 6.7% increase

in the second quarter of 2016, which left it unchanged from the prior

quarter. June data suggested further evidence of progress on the

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transition to a consumer-led economy as retail sales trended up. At the

same time, industrial production and fixed investment were likewise

supportive of the pace of growth. Private investment also reflected this

transition as investment in traditional extractive industries lagged

behind increases in service sectors such as information technology and

health care. Industrial profits were another bright spot after recording

a sustained decline during 2015. China’s annual Consumer Price Index

(CPI) increased on a year-on-year basis in June, mainly driven by price

increases across food, services, consumer goods and non-food items.

In India, the headline CPI reading for June remained at 5.8%, with food

accounting for a good portion of the result. The prospects for Indian

inflation received a favorable natural development in terms of a robust

monsoon season that could help alleviate the sharp increase in food

prices that has been a thorn in the side of the Reserve Bank of India’s

informal goal of capping inflation at 5% by 2017. India’s manufacturing

exports exhibited further stabilization during the month amid a monthly

trade deficit that rose to US$8.1 billion in June on the back of gains

in exports.

In Latin America, Brazil has been in wait-and-watch mode, with its

National Congress recently back from winter recess. Much of Brazil’s

immediate future depends on the actions that will be taken by the

legislature as it resumes activity. Among the items awaiting a decision

is a potential change in a repatriation bill that could help increase

the government’s tax collections. In the meantime, the central bank’s

monetary policy committee meeting minutes noted a number of balanced

risks to its inflation target while policymakers remained hesitant to

raise interest rates until a more favorable combination of economic

factors supporting non-inflationary growth becomes evident.

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What Are the Risks?

All investments involve risks, including possible loss of principal. The

value of investments can go down as well as up, and investors may not

get back the full amount invested. Bond prices generally move in the

opposite direction of interest rates. Thus, as prices of bonds in an

investment portfolio adjust to a rise in interest rates, the value of

the portfolio may decline. Investments in foreign securities involve

special risks including currency fluctuations, economic instability and

political developments. Investments in developing markets involve

heightened risks related to the same factors, in addition to those

associated with their relatively small size and lesser liquidity.

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