Economic Outlook – 25 August 2019

US

• The yield on the benchmark 10-year Treasury note jumped at the start of trading last Monday but later decreased sharply to end the week modestly lower. On Thursday, the yield curve again inverted, with two-year Treasury yields moving above 10-year yields, a closely watched (but not foolproof) indicator of a coming recession. The inversion appeared to follow comments from Philadelphia Fed President Patrick Harker, who told CNBC that he thought the Fed’s quarter-point rate cut in July would prove sufficient. Nevertheless, futures markets ended the week pricing in a roughly 88.0% chance of at least two cuts by the end of the year, according to CME Group data.

• Mortgage rates, which tend to follow 10-year Treasury yields closely, dipped below 4.0% during June for the first time since 2016 and are giving the housing market a modest boost. The slide in rates has led to a surge in refinancing activity and induced a solid pickup in purchase applications. In the week ending 16 August, the MBA Mortgage Refinance Index was up 180.3% over the year, while the Purchase Index rose a solid 5.3%.

• Given the recent improvement in mortgage applications, it was not surprising to see a bump in existing home sales during July. Overall resales rose 2.5% during the month to a 5.42 million-unit annual pace, while sales for June were revised slightly higher. Total home sales are now up 0.6% over the year. That marks the first positive year-on-year reading since early 2018. This is a more favorable comparison given overall weakness last year but nonetheless reflects a steadily rising trend.

• New home sales plunged 12.8% in July to 635,000 units, annualised, a 2-month low. But before anyone jumps to any conclusions, note that June was revised up big time, and are now up 20.9% to 728,000 a.r. (was 646,000), the highest since July 2007. There were small downward revisions to April and May but that is neither here nor there.

• Fed Chair Powell capped the week with a speech at the Kansas City Fed’s Jackson Hole Symposium in which he reiterated that the FOMC will “act as appropriate” in the face of deteriorating global growth, and emphasised the need for a risk management approach to monetary policy. Earlier in the week, FOMC minutes for the late-July meeting revealed that most Fed officials viewed the recent 25 bps rate cut as a “mid-cycle adjustment”, a phrase which Powell noticeably did not use in his speech on Friday, perhaps hinting that another rate cut is coming in September.

• The Fed’s minutes revealed that while the majority of the FOMC members supported the July rate cut as a “prudent step from a risk-management perspective,” there was a diversity of views among members. It is known that two voting members dissented, but the minutes showed that those in favor of cuts citing different reasons for monetary easing ranging from low inflation to headwinds from trade tensions and insurance against slowing global growth.

• The Business Roundtable, a group made up of CEOs of major US corporations, last week changed their view of what the purpose of a corporation should be from maximizing shareholder value to delivering value to all stakeholders, including employees, customers, suppliers and communities. The group calls the new view a modern standard for corporate responsibility.

• The pace of corporate stock buybacks slowed in the second quarter, according to the Wall Street Journal. Members of the S&P 500 Index repurchased $166 billion worth of shares last quarter, down from $206 billion in the first quarter and less than the $190 billion repurchased during the same quarter a year ago. Companies have spent $4.2 trillion on buybacks since 2013, the Journal reported.

• The US are showing a consistently low level of weekly jobless claims, which is an indication of an overall healthy labor market. In fact, initial claims for the week ending 17 August fell 12,000 to 209,000.

• Stocks suffered their fourth consecutive weekly loss as a late-week escalation in the US – China trade dispute undermined optimism over retail sales and Federal Reserve policy. Trading volumes were exceptionally thin through most of the week, reflecting the final weeks of the summer vacation season. Earnings and revenue beats from Target, Lowe’s, and Home Depot helped consumer discretionary shares outperform the broader market, and low long-term bond yields supported the utilities and real estate sectors.

• On Monday, preliminary capex orders in July are due, which will be interesting in the light of the ongoing manufacturing slowdown (recession?) and trade war uncertainty. It seems that many companies are reluctant to invest in the current environment.

• On Friday, PCE data for July are due to be published. PCE core is expected to rise +0.2% month-on-month in July, implying an unchanged PCE core inflation rate at 1.6%. Retail sales suggest private consumption grew strongly in July.

EU

• Eurozone Composite PMI came in better than expected at 51.8 in August, compared to 51.5 in July. The manufacturing sector remains under pressure at 47, albeit better than last month (46.5). The service sector continues to show strength with a better-than-expected 53.4 compared to 53.2 in July. Despite beating expectations across the board for the eurozone, this round of releases is likely to boost the case for renewed ECB stimulus in next month’s meeting.

• In Germany, composite PMI beat expectations and came in at 51.4 compared to 50.9 in July. Manufacturing PMI was 43.6 compared to 43.2 the previous month, which represents a two-month high but is nonetheless testament to a struggling sector. The service sector continues to buck the trend of the manufacturing sector, as service PMI came in at 54.4, compared to 54.5 the previous month.

• European Central Bank governing council member Olli Rehn last week indicated that an aggressive easing in monetary policy is likely at the bank’s September meeting, and the minutes of the governing council’s July meeting, released Thursday, said the same. More deeply negative policy rates, additional bond buying and stronger forward guidance are expected to be parts of the package.

• Germany issued 30-year debt at a yield of -0.11% last week, but it was able to sell only about 40.0% of the €2 billion issue to investors. US President Donald Trump praised Germany’s ability to issue negative yielding debt as he put more pressure on the Fed to aggressively ease monetary policy.

• Signs that Germany is entering recession piled up during the week. The IHS Purchasing Managers’ Index showed orders at factories and services companies dropping at the fastest pace in six years, and companies expect output to fall in the next 12 months. Meanwhile, the Bundesbank said the country could fall into recession. The economy contracted 0.1% for the three months ended June 30. The bank also said the downturn in industry is at the center of its worries about the economy. In June, numbers showed industrial output was 5.2% lower than a year ago, the largest annual decline in almost a decade. Bloomberg reported early in the week that German officials were preparing stimulus measures designed to spur car buying and investments in energy efficiency.

• British Prime Minister Boris Johnson traveled to Berlin and Paris last week in an effort to restart Brexit negotiations. German Chancellor Angela Merkel expressed a willingness to break the Brexit impasse, challenging Johnson to formulate an alternative to the Irish backstop in the next 30 days while offering that she sees such an alternative as possible. The backstop, which would keep the United Kingdom within the European Union’s customs union, has been the main sticking point preventing the UK from reaching a divorce agreement with the EU. French President Emmanuel Macron said any compromise would need to closely adhere to what was previously agreed to with former British PM Theresa May. The UK press reports that EU officials are beginning to back away from their hard line on the necessity of the backstop and are beginning to seriously consider alternative arrangements.

• Italian Interior Minister Matteo Salvini of the nationalist League party succeeded in ending the League’s coalition with the populist Five Star Movement, but he has yet to realise his ambition of vying for power in a general election, with Italian President Sergio Mattarella, who has in the past described himself as a political referee, exploring potential political combinations to avoid sending Italy back to the polls. Consultations will continue until Tuesday. Meanwhile, discussions aimed at forging an alliance between the Five Star Movement and the traditional center-left Democratic Party are underway. Salvini says he is open to forming a government with Five Star if it adopts a more constructive attitude toward the League’s preferred policies. If a majority in Parliament cannot be achieved, the president will set an election to take place in 45 to 90 days. The League is favored to win any election with the help of smaller center-right parties. Italy faces difficult budget negotiations with the European Union this fall owing to the country’s public debt being deemed excessive under EU rules.

• Most major European markets rose throughout the week but remained under pressure after the fresh round of US and China tariffs threats. The pan-European STOXX Europe 600 Index, the exporter-heavy German DAX, and Italy’s FTSE MIB Index all rose. In its minutes released Thursday, the European Central Bank signaled that a stimulus package to address the region’s slowdown may be in the works. 

• On Friday, the August inflation print is due. This will be the last inflation input before the ECB meeting in September, hence setting the scene for the monetary stimulus package. In July, headline inflation fell to a three-year low of 1.0% year-on-year, while core inflation stood at 0.9% year-on-year, just below the 1.0% level it has hovered around for the last five years.

• The German Ifo is out on Monday. The current situation of the index is expected to fall in line with the weak ZEW and the expectations component to fall on the back of ongoing geopolitical uncertainties.

UK

• The British pound gained some ground against the US dollar but remained under pressure after hitting two-year lows earlier in the month. UK Prime Minister Boris Johnson held meetings with French President Emmanuel Macron and German Chancellor Angela Merkel, which increased hopes that a Brexit deal could still be within reach. Macron said that there is little chance that the European Union will substantially renegotiate the withdrawal agreement, notably the largest point of contention; the so-called Irish backstop, designed to preserve an open border between Northern Ireland and the Republic of Ireland. 

• The pound’s weakness has recently prompted a number of purchases of UK companies, and the week brought news that Hasbro had agreed to buy “Peppa Pig” maker Entertainment One, while Hong Kong property company CKA was buying Greene King, the UK’s biggest-listed pub and brewery group. According to Dealogic, $66 billion worth of deals have been announced this year, with about $16 billion of those struck since Boris Johnson became prime minister in July. 

• British retail sales plunged in August at the fastest pace since December 2008, according to a survey published on Thursday that added to signs of a slowing economy ahead of Brexit in just over two months’ time. The Confederation of British Industry’s gauge of retailers (the difference between those reporting rising and falling sales volumes) slumped to -49 in August from -16 in July, the second weakest reading since records began in 1983.

• Major British employers gave average pay rises of 2.6% to staff in the three months to July, the highest pace of increase in more than 10 years, data from industry consultants XpertHR showed. Annual pay settlements in Britain began to rise roughly a year ago as the lowest unemployment rate since the mid-1970s put pressure on employers to retain staff, but deals had been stuck at around 2.5% in recent months.

• There are no market movers in the UK this week.

China

• US President Donald Trump took to Twitter Friday morning after China’s State Council announced that tariffs of 5.0% to 10.0% will be imposed on additional imports from the US beginning on 1 September. Trump said US companies should immediately seek alternatives to China, including by bringing operations back to the United States. Also, Trump obliquely threatened to intervene in currency markets to weaken the surging US dollar.

• Interest rate reform from China’s central bank lifted investor sentiment. The People’s Bank of China (PBOC) announced several market-based changes to the formation of the loan prime rate (LPR), which the central bank said would henceforth be a key reference rate for new loans. Following the changes, the LPR was listed at a lower rate later in the week; effectively amounting to an easing in monetary policy and raising hopes of fresh stimulus measures. While the PBOC’s changes to the LPR are modest in the short term, its longer-term goal is more significant since it moves China to a more market-driven interest rate system and improves the transmission of wider monetary conditions to lending rates.

• There are no market movers in China this week.

Sources: T. Rowe Price, Reuters, MFS Investment Management, Handelsbanken Capital Market, TD Economics, Danske Bank, BMO Economics, Wells Fargo.