News You Can Use This Week
The data this week is
expected to confirm what many investors have come to assume. The
US economy accelerated in Q2. The eurozone economy is enjoying steady
growth, but the momentum appears to be slowing. The UK economy was unable
to recover much after a soft Q1. The Japanese economy is still not
generating price pressures, but growth, led by the export/industrial production
capex, is also fueling somewhat better consumption.
The Federal Reserve meeting
is not live in the sense that anyone expects a change in the policy of any
kind. For reasons beyond our ken, the
Federal Reserve insists on making changes only at the half of the FOMC meetings
which are followed by a press conference. Since there are several workarounds,
including, as we have suggested, holding press conferences after every
meeting, which the ECB and BOJ already do, for example.
In any event, the market
understands full well where the Fed is. It is getting close to
allowing its balance sheet to begin shrinking. After raising rates in
March and June, officials are not ready to go again: Not in July and not
September. December is a closer call. The softer price pressures
rather than, the weaker growth impulses become the focal point in Q2. It
will take a few months of data to assuage these concerns. The main
argument that what the headwind on prices is transitory seems to assume that
decline in prices is narrow. Breadth indicators of price changes,
therefore, be more important than usual in the current context. Sure
enough, the diffusion indicators for the CPI were narrow, until the recent June
reading.
When the balance sheet issue
was being discussed, NY Fed President Dudley suggested that the central bank
may have a brief pause in its efforts to normalize the Fed funds target rate
around the time that it decides to begin allowing the balance sheet to
shrink. This still seems the most likely
scenario. Given the apparent consensus to begin not reinvesting in full the
proceeds from maturing issues sooner rather than later, the September FOMC
meeting is a compelling venue to make such an announcement. Deferring a
rate decision until the December meeting, by which time the inflation picture
may clarify, seems prudent.
One of the consequences of
this scenario is that it would allow Fed officials to talk more about why the
core inflation measures have weakened. An FOMC statement that
does not show more puzzlement, if not a concern, risks a more dramatic reaction
a couple of days later when the first estimate of Q2 GDP is reported. The
GDP price deflator is expected to slow to 1.3% from 1.9%, and, potentially of
greater importance; the core PCE deflator may slow more dramatically–to below
1% from 2.0% in Q1. At the same time, these GDP figures are reported, the
US will release its Q2 estimate for Employment Cost Index, a broader measure of
labor costs (includes wages and benefits), which is also expected to show no
acceleration in what is understood to be a key driver of core inflation.
US earnings season kicks into
high gear with nearly 20% of the S&P 500 reporting in the week ahead. Among
the highlights include Amazon, Facebook, Alphabet, Caterpillar, GM, and
Chipotle. With about a third already reporting, it appears that earnings growth
is on track for around a 10% pace. Fund managers who push back against
claims that the market is overvalued point to the strong earnings growth
underpinning prices. Despite investors’ preference for European shares
over the US, we note that the S&P 500 has begun outperforming the Dow Jones
Stoxx 600–5.75% over the past three months.
Meanwhile, the summer drama
will continue in Washington, as President Trump’s son, son-in-law and former
campaign manager are set to testify before Senate committees next week.
News that Exxon was fined $2 mln last week for violating sanctions against
Russia, while Secretary of State Tillerson was the CEO is an additional
distraction from the economic agenda that is beginning to press. Leaving
aside health care reform, the infrastructure initiative, and tax reform, the
constraints of the debt ceiling are already evident in the T-bill market, and
the FY2018 fiscal year begins in a little more than two months.
ECB President Draghi signaled
that central bank would reconsider policy at the September meeting when
officials return from summer holidays, and new staff forecasts will be
available. Draghi’s suggestion that the market
over-interpreted his “reflation” comment at the Sintra conference implies that
the ECB may have been somewhat surprised by the market’s reaction.
Nevertheless, Draghi showed barely any concern about the rise in European
interest rates and the euro’s appreciation.
Money supply growth (M3) is
expected to have expanded at a steady pace of 5% over the past year. through
June. The Bank Lending Survey, released on July
18, confirmed that improvement in credit conditions. Lending is slowly
improving, and there has been a small pickup in demand from non-financial
businesses. The flash PMI for the eurozone will also be released.
It is expected to soften slightly.
Country-data may be more
interesting than the aggregate data. In particular,
Germany, France, and Spain offer preliminary looks at July inflation. On
a monthly basis, consumer prices may have eased, but the year-over-year rates
are expected to be little changed at 1.4%, 0.8%, and 1.6% respectively.
Only the German reading is changed from the June pace and by 0.1%
at that.
France and Spain also report
early estimates of Q2 GDP. A 0.5% quarterly
expansion in France would lift the year-over-year rate to 1.6% from 1.1%, which
would be the quickest pace since Q3 11. Spain’s economic growth remains among
the strongest in the OECD. A 0.9% Q2 expansion would translate to a
little more than a 3% year-over-year pace.
The German 10-year Bund yield
will begin the new week carrying over a six-day decline. The
yield has returned to the breakout level of 50 bp. The technical
indicators of the September 10-year Bund futures contract warn of additional gains
(lower yields) in the period ahead. We suspect there is potential toward
40 bp.
The UK reports Q2 GDP. It
is expected to remain lackluster. After a 0.2% pace in Q1, the British
economy may have expanded by 0.3% in Q2. Still, the year-over-year pace
would still slow from 2.0% in Q1 to 1.7%. A weak US dollar environment
may conceal sterling’s underlying weakness. Since the middle of the
month, it has depreciated two percent on a trade-weighted basis. The euro
has returned to the GBP0.9000 area, having had finished Q1 below GBP0.8500.
Sterling also appears to be rolling over against the yen. It was
turned back from JPY148 around the middle of the month, which is where turned
from in May as well. Sterling fell every day last week against the yen,
and technical potential extends toward JPY144.
The market will likely learn
very little from Japan next week. Headline
inflation and the core rate, which excludes fresh food, likely remained
unchanged in June at 0.4%. However, excluding fresh food and energy, the
rate may have dipped to -0.1% from zero. Contrary to the claims, the
truly stable price environment does not necessarily preclude consumption.
In fact, if the consensus is right, overall household spending will turn
positive for the first time since in 16 months. Meanwhile, the labor market
remains tight. The unemployment rate is expected to tick down to 3.0%
from 3.1%, and the jobs-to-applicant ratio may edge higher.
Lower yields would seem to
favor the yen playing some catch-up. The dollar fell
0.7% against the yen before the weekend, its largest single-day decline since
early June. There is scope for a third consecutive week of a little more
than 1% fall, which would take the dollar toward JPY110. The euro may
have reversed lower against the yen before the weekend after having found
offers in front of the high seen earlier this month.
OPEC’s monitoring committee
meets in Russia at the beginning of the week. Private
estimates point to increased OPEC output, not all of which is coming from
Libya and Nigeria, which were excluded from the quotas. Efforts to coax
them into capping output seem to have fallen on fallow fields. Ecuador’s
decision to drop out of the quota system, though not significant in terms, it
is a timely reminder that the agreement to cut output is finite, fragile, and
does not appear to be particularly effective.
