Let the Games Begin

08 Aug 2016

Key takeaways

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

Full commentary

Shock, Surprise, Suspense – Headlines drive markets and this week was no exception. The first week of August vacation was interrupted by the announcement of significant U.K. monetary stimulus measures, a strong U.S. labor market report and grumblings ahead of the upcoming Olympics in Brazil. Two of the three headlines are likely to influence sentiment in these waning weeks of summer.

“U.K. Rate Slashed to Lowest in 322-year History” (Wall Street Journal). The Bank of England’s (BOE) Mark Carney shocked markets with a preemptive blunt force response to June’s Brexit referendum. Those expecting only modest stimulus measures were blown away by the unexpectedly large and diverse package, which combined interest rate cuts, balance sheet purchases and low-interest bank lending. With the outlook weakening, the U.K. central bank appears less concerned about the inflationary impact of a weaker currency and more concerned that a pronounced decline in business and consumer confidence would lead to an economic slowdown. While Mark Carney indicated that the BOE was capable of doing more and would consider follow-up measures, he is “not a fan” of a negative interest rate policy and is unlikely to follow other central banks down that path.

“U.S. Payrolls Surge…” (Bloomberg News). This week’s labor report removed any concern that the economy was at risk of recession. The payroll survey reported 255,000 job gains, 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’ expectations. Job gains were broad based impacting multiple sectors of the economy. The July labor report was closely followed by market participants searching for clues following the second quarter’s disappointing GDP report.

“How Slow is U.S. Economic Growth?” (CNBC). The initial estimate of second quarter U.S. GDP indicated that the pace of growth remained slow for the third consecutive quarter. The data caught markets by surprise, as many were expecting a rebound from a weak first quarter. Delving into the details, it is clear that private investment continued to lag as we entered the eighth year of the economic recovery. Paradoxically, investment has remained lackluster despite historically low capital costs. While this story is not new, there appears to be some evidence that the expansion is beginning to exhibit late-cycle characteristics. Last week’s senior loan officer survey showed that U.S. 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 going forward.

“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 weakness in business spending. The strong finish in June left markets more optimistic that the trend will 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 appearing in automobile sales which slowed considerably since earlier in the year. A modest deceleration in consumption, to a more sustainable pace, should continue to support growth in the medium term.

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 resultant implications for monetary/fiscal policy in advanced economies. Data from remaining weeks of summer, however, are unlikely to elicit any material changes in policy in the near term. The U.S. Federal Open Market Committee (FOMC) is on summer break until September 21, 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 the 21st of September. Meanwhile, the European Central Bank (ECB) is unlikely to make any adjustments until later in the calendar 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)!

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