- The last week of July 2016 was a busy week in the financial markets, as we had policy meetings at both the Fed and at the Bank of Japan, in addition to the release of second quarter GDP figures in the US
- As noted by the Fed, one area of optimism for the US economy has been US households. Improvements in the labor market and a 4% year-over-year increase in personal income have helped produce a resilient US consumer.
- While consumer and housing activity remain robust, business activity and investment spending are stalled.
In the US, The Federal Open Market Committee (FOMC) left policy rates unchanged on Wednesday 27 July reiterating that the stance of monetary policy remains accommodative. The FOMC statement highlighted a strengthening labor market and the fact that economic activity has been expanding at a moderate pace.
The Fed also noted strong job gains in June and an increase in labor utilization. Household spending has been growing strongly and the Fed noted that near-term risks to the economic outlook had diminished. The impact of the UK’s historic Brexit vote has come off the boil for now. Market participants were less than impressed with the Fed’s more optimistic outlook for the US economy, which led to 2-year yields falling 2 bps after the FOMC’s statement.
The Bank of Japan also met on 28-29 July and disappointed markets, which had been expecting stronger stimulus measures. The BOJ left policy rates unchanged and while the size of the ETF purchase program was nearly doubled to 6 trillion yen, there was no change in the pace of their bond buying. Following the BOJ announcement, the US. dollar was sharply weaker versus the yen and was also weaker versus the euro.
U.S. second quarter GDP also disappointed on Friday 29 July coming in at 1.2%, well below the consensus estimate of 2.5%. Businesses remain cautious about the economic outlook resulting in a fall in inventories and also declines in corporate investment spending. U.S. interest rates fell further with the 10-year yield dipping below 1.5% and 2-year yields falling to 0.68%.
As noted by the Fed, one area of optimism for the U.S. economy has been U.S. households. Improvements in the labor market and a 4% year-over-year increase in personal income have helped produce a resilient U.S. consumer. June retail sales figures were up 0.6% month-over-month beating market expectations. We learned today that personal consumption rose 4.2% in the second quarter. Consumer sentiment dipped a bit in the Michigan survey but remains robust, and lower gasoline prices should help buoy disposable income this summer.
Against this backdrop, we take a closer look at the U.S. housing market. Housing and residential investments were a bright spot once again making positive contributions to second quarter GDP. New home sales were up 3.5% to an annualized pace of 592,000; the strongest level since 2008. The supply of new homes dropped to 4.9 months; the lowest level in more than a year. Existing home sales also rose 1.2% in June to a 5.57 million annualized rate; the most since 2007. Inventories of existing homes for sale were down 5.8% versus a year ago. Also encouraging was the share of first time home buyers, which rose to 33%; the highest level since 2012. Residential housing starts were up 4.8% in June, led by new single family homes, and new permits were up 1.5%. The chart below shows the Mortgage Bankers Association Purchase Index is near its post crisis highs (see exhibit 1).
Exhibit 1: This graph highlights the post crisis highs of the Mortgage Bankers Association Purchase Index since July 2010
Source: Mortgage Bankers Association, Bloomberg, as of August 1, 2016
Home prices have been on an upward trend with the S&P Case-Shiller U.S. National Home Price Index, showing a 5% increase year-over-year. Low inventory levels and fewer distressed sales have helped push prices higher. Stronger housing activity has been driven by better labor markets, improvements in household balance sheets and very low mortgage rates.
While the consumer and housing activity remain robust, business activity and investment spending are stalled. The key question for the Fed and for investors going forward is: “When will we see businesses take the baton from households and move the recovery forward?” Until then, we see the Fed as being on hold with no chance of a rate hike in September and no likely hikes for the balance of the year. [divider] [/divider]
This article was written by John Carey, head of structured securites, on August 1 2016 in New York