Global bond yields continued to drop, with the US 10-year dipping as low as 1.54% before edging up slightly at the end of the week, pulled down by “Brexit” fears.
The Federal Open Market Committee left rates unchanged at their meeting on Wednesday, noting the slowdown in job growth and heightened global economic uncertainty.
The real fireworks in the Fed’s release were in the survey of economic projections (SEP). Fed members’ expectations for future policy rates migrated lower across the forecast horizon.
The median projection for 2016 continued to be for two rate hikes, but there are now six dots below the median (projecting only one rate hike), up from only one previously. The downward movement was even more pronounced in 2017 and 2018 with the median estimates implying just three rate hikes (from four) in each of the next two years.
The Fed’s nervousness is mainly owed to the fact that it does not trust the US economy. Although many Americans complain about the health of their economy, it is, in fact, doing rather well:
- Firstly, household debt has long fallen to a sustainable level, which has resolved the cause of the debt crisis.
- Secondly, the US economy has been in an upswing since the middle of 2009 without having seen any exaggerations that would need to be corrected through a recession.
- Thirdly, an unemployment rate of only 4.7% means that the US economy will soon operate at full employment. Even broader measures of unemployment have fallen massively.
In the UK, the EU referendum vote is still very open but EU supporters are already sounding shrill warnings, signalling that the EU may deny the UK access to the single market after a Brexit decision.
Nevertheless, shall Brexit supporters win, a tidy divorce appears more likely than a messy one, the rationale being the EU also has an interest in avoiding an escalation. A long-term sustained sterling depreciation, beyond the inevitable weakness on the day after a Brexit decision, is only likely in the event of a messy divorce.
The Bank of England decided to keep the policy rate at 0.5% and to keep the asset purchase target at GBP 375 billion.
The minutes spent quite a lot of space focusing on what will happen if there will be a vote to Leave. The combination of movements in demand, supply and the exchange rate could lead to a materially lower path for growth and a notably higher path for inflation than in the projections set out in the May Inflation Report.
In the euro area the main focus will be on the PMI figures for June. The manufacturing PMI is expected to decline again in June as the order inventory balance, which is usually a good leading indicator, showed weakness in May due to a decline in new orders.
An expected spill-over from the worsening financial sentiment in recent weeks also suggests that manufacturing PMI will decline. The service PMI is expected to follow a similar tendency. The service PMI increased in May, but service business expectations showed weakness and the rising oil price since the start of 2016 is expected to impose a dampening effect on the domestic-driven service PMI for June.
In China, growth in retail sales and industrial production was almost stable in May and only slightly weaker than expected. However, fixed investment was a large negative surprise.
Growth fell more than both consensus had expected, from 10.1% year-on-year in April to 7.4% in May. The statistics office publishes only the year-to-date growth rate, which fell from 10.6% year-on-year to 9.5%, the lowest since 2000.
Furthermore, the low investments are primarily due to private companies holding back their investments, as state-owned enterprises’ investment growth was strong at above 20% year-on-year. Thus, growth is once again kept high by public support as local governments and their enterprises are encouraged to invest.
The distribution among sectors shows a similar picture. Infrastructure and property investment growth is still increasing, albeit at a slower pace. But that is overshadowed by a decline in investments by the industrial sector, due to overcapacity in the heavy industries such as steel and coal.
Sources: Danske Bank, Commerzbank, Haendelsbank, TD Economics.