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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value of investments can go down as well as up, and investors may not
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opposite direction of interest rates. Thus, as prices of bonds in an
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