Let the Games begin

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The first vacation week of August was marked by news of significant monetary policy measures by the Bank of England, a strong US labor market report and grumblings ahead of the Olympic Games in Brazil. Two of the three news points are likely to influence market sentiment as the summer wanes and business resumes at the other leading central banks – the US Federal Reserve, the Bank of Japan and the European Central Bank.

  • Shock, Surprise, Suspense – Headlines drive markets and this week was no exception.
  • “UK Rate Slashed to Lowest in 322-year History” (Wall Street Journal). The Bank of England’s Mark Carney shocked markets with a pre-emptive blunt force response to June’s Brexit referendum.
  • “US Payrolls Surge…” (Bloomberg News). This week’s labor report removed any concern that the economy was at risk of recession.”
  • “How Slow is US Economic Growth?” (CNBC). The initial estimate of second-quarter gross domestic product (GDP) indicated that the pace of growth remained slow for the third consecutive quarter.
  • “Consumer Spending Rises” (Reuters). Unsurprisingly, consumption remained the bright spot in the GDP report.

“UK Rate Slashed to Lowest in 322-year History” (Wall Street Journal)

The Bank of England blew those expecting only modest stimulus measures away with an unexpectedly large and diverse package, which combined interest-rate cuts, asset purchases and low-interest bank lending. With the UK economic outlook weakening, the central bank appears less concerned about the inflationary impact of a weaker sterling and more concerned that a pronounced decline in business and consumer confidence would lead to an economic slowdown. While Governor Mark Carney indicated that the BOE was capable of doing more and would consider follow-up measures, he is ‘not a fan’ of negative interest rates and is unlikely to follow other central banks down that path.

“US Payrolls Surge…” (Bloomberg News)

July’s labor market report appears to have removed any market concerns that the economy was at risk of recession. Employers added 255 000 jobs, exceeding economists’ expectations by a significant margin, while the unemployment rate held steady at 4.9%. Evidence of nascent wage pressures appeared with average hourly earnings exceeding economists’ forecasts. Job gains were broad-based. Market participants had eagerly awaited the report as they searched for clues after disappointing second-quarter GDP data.

Exhibit 1: Monthly changes in US non-farm payrolls and the unemployment rate from August 2014 through July 2016

US labor market statistics graph fftw

Source: BNPP IP, Bloomberg, as of 5 August 2016

“How Slow is US Economic Growth?” (CNBC)

In the second quarter, the US economy grew disappointingly slow, making the quarter the third in a row with sluggish growth. The data caught markets by surprise as many had expected a rebound from a weak first quarter. Delving into the details, it is clear to us that private investment continued to lag as we entered the eighth year of economic recovery. Paradoxically, investment has remained lackluster despite historically low capital costs. While this is not new, there appears to be some evidence now that the expansion is beginning to exhibit late-cycle characteristics. According to the latest senior loan officer survey, lending standards have tightened for the fourth consecutive quarter. This series has historically been closely correlated with shifting economic cycles and may portend a flatter trajectory of growth.

“Consumer Spending Rises” (Reuters)

Unsurprisingly, the consumer remained the bright light in the GDP report. Consumer spending, which has been the driving force of growth this year, advanced at a striking 4.2% annual pace in the second quarter, offsetting the weakness in business spending. June’s strong finish left markets more optimistic that the trend can continue into the third quarter. The robust pace, however, may be unsustainable as the rate of consumer spending has exceeded income growth for much of the year. Early evidence of a potential pullback may be seen in car sales which have slowed considerably since earlier in the year. A deceleration in consumption to a more sustainable pace should continue to support growth in the medium term.

Let the Games begin (…monetary policy will wait)

As the global forces that roiled markets in the last year fade from media attention, markets appear more attentive to the evolution of fundamental economic data and the implications for monetary policy and fiscal measures in advanced economies. Data from the remaining weeks of summer, however, is unlikely to elicit any material changes in policy in the near term. The US Federal Open Market Committee (FOMC) is on summer break until 21 September, with ample time to digest eight weeks of economic data. The Bank of Japan (BOJ) postponed any changes to monetary policy until a comprehensive review is completed, coincidentally also on 21 September. Meanwhile, the European Central Bank (ECB) is unlikely to make any adjustments until later this year.

Perhaps it’s time to shift our attention to Rio. This just in… “Everything is Going Wrong in Brazil Ahead of the Olympics” (Huffington Post)! [divider] [/divider]

This article was written by Kenneth O’Donnell, Head of Short Duration Fixed Income, on 8 August 2016 in New York

Ken O'Donnell

Head of Short Duration Fixed Income, CFA Charterholder

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