FINANCIAL NEWS HIGHLIGHTS OF THE WEEK
- The week offered plenty of data to gauge the strength of the global economic recovery, with the generally dovish rhetoric from major central banks, including the Fed, supporting global equities which also got a lift from the surge in oil prices.
- International data remained soft, solidifying expectations for further stimulative action from both the ECB and BoJ as soon as next month.
- U.S. data remained resilient, particularly so for domestically oriented sectors of the economy. Still, externally exposed manufacturing and mining activity appeared to rebound, suggesting that the worst may be behind these externally-exposed sectors.
FED AT THE CROSSROADS OF MONETARY POLICY
The recent week offered ample economic data, both domestic and international, to gauge the strength of the global economic recovery. Helping frame the discussion on both sides of the Atlantic was a bounty of central bank communications. The generally dovish rhetoric from major central banks, including the Fed, has supported global equities which also got a lift from the surge in oil prices related to anticipated action from OPEC next month.
International economic data has not inspired much confidence in global economic resilience, somewhat disconcerting given rising global risks. Japanese economic growth stalled last quarter as the yen strength exerted a drag on trade, spurring expectations for further stimulus from the Bank of Japan when it meets next month. Ditto for the ECB, which is anticipated to ease further when it meets in September, motivated by slowing growth, potential Brexit fallout, and the associated downside risk to inflation. Headline prices in the Eurozone fell 0.6% in July and are up only 0.2% from last year, while core inflation – which typically leads the headline – remained stuck below 1% for ten months despite the substantial stimulus already implemented.
The global themes have become a growing source of concern for the Federal Reserve. According to the minutes from the late-July meeting, released midweek, many FOMC members have become increasingly concerned about the potential for external shocks to affect the U.S. outlook. Despite diminished near-term risks, the medium- to longer-term risks have become all the more entrenched in Fed discussions. Moreover, the significant disinflationary impulses from abroad and still low inflation expectations at home appearto have shaken confidence amongst many FOMC members about getting back towards the 2% target. Inflation figures for July underwhelmed expectations, with the headline and core rate slipping slightly to 0.8% and 2.2% y/y, respectively.
But, while the Fed is cognizant of risks, it has also acknowledged that the U.S. recovery is on a relatively solid footing. In fact, the recent upbeat information had alleviated some of the concerns about continued labor market improvement. Domestic-oriented data remained positive this week with the pace of homebuilding up to above 1.2 million (annualized) in July, while the near record-low initial jobless claims suggesting strength in the labor market through August. These data confirm that consumption and housing will remain a key support for the ongoing U.S. recovery. Furthermore, both manufacturing and mining, which are more externally exposed have been hard-hit, but have recently made progress despite weakness abroad.
The diminished risks and positive data flow have emboldened hawkish members of the Committee, highlighting the growing divergence of views. Two participants were ready to raise rates in July, with recent commentary by influential FOMC members attempting to boost expectations for a hike. While we don’t rule out a scenario in which data continues to surprise to the upside and enable the Fed to raise this year – something the markets feel is an even bet – we feel that patience levels have increased amongst the FOMC alongside fears of global disinflationary pressures and low-growth outcomes. As such, we expect the Fed to sit tight through the end of this year, proceeding only cautiously thereafter.
Michael Dolega, Senior Economist
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