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Market Recap Friday, September 22, 2017

In Brief

  • U.S.: FOMC meeting September 20: Fed is leaving short-term interest rates unchanged, but December Fed hike possible; QE unwind, fiscal progress?
  • Eurozone: Eurozone upturn regains momentum in September; ZEW current sentiment situation; German general elections on September 24
  • U.K.: U.K. households experience the strongest squeeze on finances for three years in the third quarter of 2017
  • Japan: August exports rose 18.1% YoY vs. est. 14.3%; weakness in the Yen has helped exports
  • China: Yuan fixed back; downgrade ahead of politburo
  • LEIs: Signaling softer global activity over next six months

On the U.S.

The Federal Reserve is leaving short-term interest rates unchanged, while announcing a plan to start shrinking its massive bond holdings in a move to normalize its balance sheet. The Federal Open Market Committee (FOMC) said September 20 that it would keep the federal funds rate in a range of 1% to 1.25%, but Fed officials hinted that they might raise rates one more time by year-end if inflation rises. Their latest economic forecasts show policymakers expect three rates hikes in 2018, which would bring the benchmark rate to between 2% and 2.25% by the end of next year. The Fed announced it will begin unwinding its balance sheet. Fiscal stimulus could boost the outlook.

On Europe

The headline HIS Markit Eurozone PMI increased to 56.7 in September from 55.7 in August, a four-month high; inflows of new orders showed the largest monthly increase since April 2011, representing a renewed surge in demand. Flash Eurozone Services PMI Activity Index grew to 55.6 from 54.7 in August, which is a four-month high; service sector activity showed the largest rise since May. Flash Eurozone Manufacturing PMI Output Index increased to 59.5 from 58.3 in August, a 77-month high, and flash Eurozone Manufacturing PMI increased to 58.2 from 57.4 in August, a 79-month high; the outperformance of manufacturing relative to services also increased to the widest since January 2014.

The faster pace of business activity growth and the upturn in demand in September was accompanied by rising price pressures. Input cost and selling price inflation gathered pace for a second successive month, with both reaching the highest rates since April. Prices charged for services rose to the greatest extent since May, while the increase in factory gate prices was the joint-highest since June 2011.

ZEW current situation sentiment, as well as expectations towards rates, inflation, and markets, were little changed in September in the euro area countries. Economic expectations ticked up slightly across the board. Euro area consumer confidence moved largely sideways again. While the soft data is topping, the hard data is still catching up. Solid growth is still on track for the third quarter.

German general elections are this Sunday, September 24th. According to the polls, Chancellor Merkel’s party, the Christian Democratic Union, and its sister party, the Christian Social Union, are expected to claim most seats in the Bundestag again. As a result, Chancellor Merkel would serve for her fourth term. The AfD and FDP parties are unlikely to gain overwhelming popularity, ousting Merkel. Yet the two parties are likely to garner over 5% of the vote each and thus enter the 19th Bundestag. If so, it would be the first time the AfD, the Populist Party in Germany founded a few short years ago, gains national parliamentary representation.

On the U.K.

September data confirmed that U.K. household finances deteriorated at the sharpest pace for three years in the third quarter. The seasonally adjusted IHS Markit Household Finance Index (HFI) was down to 42.8 in September from 43.4 in August and well below the neutral 50.0 threshold. The average index reading dropped to 42.6 in the third quarter, which was the lowest since the third quarter of 2014.

Intense pressures on household finances were recorded across all regions in September, driven principally by the on-going squeeze on real incomes from higher prices and low wage growth. The amount of cash available to spend continued to fall at one of the steepest rates seen over the past three years. However, spending rose again, and at an increased rate, fueled by a combination of modest growth in income from employment and reduced savings.

Households meanwhile indicated a continued recovery in their house price expectations from the 10-month low seen in June. Expectations for finances in the next 12 months September data also indicated that UK households expect a sustained deterioration in their financial well-being over the next 12 months. However, the seasonally adjusted index edged up to 47.8 from 47.3 in August, to signal the lowest degree of pessimism for seven months. There was a wide divergence across UK regions during September.

On Japan

Japanese exports and imports surged in August, with both treating expectations as a recovery in trade appeared to gain momentum. Exports rose 18.1% from a year earlier, the biggest increase since November 2013. Imports climbed 15.2%. The trade surplus was 113.6 billion yen. Shipments of autos to the U.S. increased 28.3%, though part of the increase in overall shipments to the U.S. can be attributed to lower exports the previous year, according to the Ministry of Finance. Shipments of electronic parts to Asia rose 21.6%. The weakness in the Yen has helped exports, which is key for Japan.

On China

China’s yuan firmed against the U.S. dollar on September 22 as the greenback pared gains made following the Federal Reserve’s hawkish policy statement and as investors took the latest Chinese sovereign rating downgrade in their stride. However, the Chinese currency remains on course for its second weekly loss. It has lost more than 1,500 pips from a 21-month peak hit on August 8 as a rallying yuan forced authorities to put a brake on its rise and relax some restrictions on capital outflows.

S&P cut China’s credit rating, as China’s attempts to reduce risks from its rapid buildup in debt are not working as quickly as expected and credit growth is still too fast. This follows a similar downgrade by Moody’s in late May, but the timing raised eyebrows as it came just weeks ahead of one of the country’s most politically sensitive events, the twice-a-decade Communist Party Congress (CPC). It is tough to see much rocking the boat before the key Politburo reshuffle in mid-October.

On LEIs

The OECD’s Leading Economic Indicators (LEIs) continue to indicate economic activities in the third quarter and fourth quarter will be milder in most G7 countries, as (a) the nominal reacceleration concludes, (b) the “spinach” period commences in U.S. politics, and (c) real growth drivers are pushed out further and further. On the flip side, LEIs for India, China, and Mexico are all reaccelerating, signaling better 2H17 growth in each of those countries. However, the OECD’s Total LEI is still showing the global economy will undergo a softer patch over the next six months.

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Market Recap Friday, September 15, 2017

In Brief

  • U.S.: August NFIB small business confidence index up 0.1 month on month to 105.3; CPI surprises to the upside in August; inflation expectations continue to rise
  • Eurozone: Earlier in the cycle, job gains are still nascent; Bank of France estimated French GDP growth of 0.5% in 3Q17; eurozone industrial production up 0.1% in July; EU posts record card registration figures
  • U.K.: Inflation rate up to 2.9%
  • Japan: More inflation in the pipeline
  • China: Yuan has weakened as the government has relaxed currency controls; PPI ticks higher as retail, IP moderate
  • Thought: Potential impact from hurricanes

On the U.S.

The latest issue of The National Federation of Independent Business (NFIB) Small Business Economic Trends came out on September 12. The headline number came in at 105.3, up 0.1 from the previous month. Five of the components increased while five declined. The lofty reading kept intact a string of historically high performance extending back to last November. Small business owners reported a seasonally-adjusted average employment change per firm of 0.18 workers per firm over the past three months, virtually unchanged from July. The net percent of owners raising average selling prices increased 1 point to a net 9%, which was the highest reading since 2014. 3% of owners reported that all their borrowing needs were not satisfied, unchanged, and historically very low. 34% reported all credit needs met and 49% explicitly said they were not interested in a loan. Including those who did not answer the question, 63% of owners have no interest in borrowing.

There is no big inflation worry for now but the U.S. CPI surprised on the upside in August, which rose 0.4% after edging up 0.1% in July. Core is still tame. U.S. consumer prices accelerated in August amid a jump in the cost of gasoline and rents. The data showed signs of firming inflation that could allow further monetary policy tightening from the Federal Reserve this year.

On Europe

Europe had the double dip. While the U.S. is later-cycle, it is tougher to make that case in the euro zone. Other statistical releases this week showed solid growth in the euro area is still on track for the third quarter. French business sentiment surveys, EA industrial production, and new car registrations made good signs.

The Bank of France maintained its forecast for French quarterly GDP growth of 0.5% in the third quarter, unchanged from the second quarter. The prediction was part of the central bank’s August business climate survey. The survey showed that the business sentiment indicator for the manufacturing industry dipped to 104 points in August from 105 points in July, although sentiment in the services industry rose to 100 points last month from 99 points in July. The business sentiment indicator for the construction industry also rose to 103 points in August from 102 in July.

Eurozone industrial production rose a little in July following a drop the month before as a jump in the production of capital and consumer goods offset a decline in energy, according to data released by Eurostat on September 13. Industrial production was up 0.1%, in line with estimates and compared to a 0.6% decline in June. The production of capital goods rose by 0.8%, durable consumer goods by 0.7% and intermediate goods by 0.5%. Meanwhile, production of non-durable consumer goods fell by 0.4% and energy by 1.2%. Compared with July 2016, industrial production in the eurozone was up 3.2%, missing expectations for a 3.4% gain. The production of durable consumer goods rose by 5.7%, intermediate goods by 4.8%, capital goods by 4.3% and energy by 1.2%, while production of non-durable consumer goods fell by 0.5%. In the EU-28 group of nations, industrial production was down by 0.3% on the month and up 3.1% on the year.

Passenger car registrations in Europe in August increased by 5.6% totaling 865,047 units. In volume terms, the figures topped those of August 2008, marking the European market’s best performance in a decade. Among the five big markets, Italy and Spain posted strongest increases with 15.8% and 13.0% rises respectively. France and Germany with 9.4% and 3.5% rises respectively also registered positive growth while demand in the UK declined 6.4%.

On the U.K.

The U.K.’s inflation rate climbed to its joint highest in more than five years in August as general commodity price appreciation, month-on-month rises in travel, apparel, and petrol. The UK CPI rose to 2.9% in August, up from 2.6% in July. The Bank of England has repeatedly said it would look through the transitory effects on inflation, and tightening monetary policy to offset hot inflation of this sort would be too costly for the economy.

On Japan

The upward trend in inflation continues in Japan. Import prices ascended 12.5% year on year and headline producer prices rose 2.9% in August. The biggest price increases were from petroleum and coal products, 12.5% y/y, iron and steel, 11.2%, and nonferrous metals, 16.8%, which is consistent with the global commodity reflation.

Meanwhile, domestic politics are looking better. Prime Minister Abe is pushing structural reforms to increase the labor force. Meanwhile, his approval rates are recovering. “Abe directed a government council on regulatory reform to devise frameworks as early as this year toward clearing Japan’s day-care waiting lists, reworking the system for wireless spectrum allocation and promoting the growth of the forestry industry. The council also will resume discussion of topics such as encouraging the hiring of overseas workers and promoting foreign tourism, issuing conclusions next summer,” Nikkei noted on September 13.

On China

The PBOC has scrapped a reserve requirement rule on trades called currency forwards, making it cheaper for investors to buy dollars while selling the yuan. The PBOC is also removing a reserve requirement on yuan deposits for foreign banks. The China yuan could weaken as local investors diversify abroad, but this is not a bad thing; the removal of emergency controls should be interpreted as a positive now.

Producers’ input and output prices rose again to 7.7% y/y and 6.5% in August. Like Japan’s PPI, energy and metals experienced the largest price increases. The strength in copper, iron ore, and China stocks indicates that there is currently no problem in China. The PBOC’s action to relax currency controls is another sign of confidence.

Potential Impact from Hurricanes

Two major hurricanes disrupted activity in the third quarter, making jobless claims rise and likely depressing payrolls in September, but rebuilding should help the data as we measure it going forward. Used car prices should rise.

The ISM Report on Business Survey found that two-thirds of responding supply managers believe input materials pricing would be at least somewhat negatively impacted over the next three months with greater than 27% expecting prices to be negatively or very negatively impacted. Relatedly, 56% of respondents believe supplier deliveries will be at least somewhat negatively impacted over the next three months with nearly 19% expecting deliveries to be negatively or very negatively impacted. Overall, 67% of respondents expect at least some negative impact to prices over the next three months with 27% of respondents expecting negative to very negative impacts. Even six months out, 56% expect at least some negative impact on prices. The manufacturing sub-sectors are more concerned than their non-manufacturing counterparts about negative price impacts three and six months out. The findings about supplier deliveries are similar, but less dramatic. Overall, 54% of respondents expect at least some negative impact to deliveries over the next three months with 19% expecting negative to very negative impacts. Six months out, a more than 36% expect at least some negative impact on prices. The manufacturing sub-sectors are notably more concerned than their non-manufacturing counterparts about slowed deliveries three and six months out.

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Market Recap Friday, September 8, 2017

In Brief

  • U.S.: ISM PMI up 2.5% to 58.8; ISM NMI up 1.4% to 55.3; job growth has started to slow, typical in 2H of a business cycle
  • Euro zone: Manufacturing sector underpinned solid growth of euro zone economy
  • U.K.: Service sector growth slipped to 11-month low
  • China: The PBOC halted initial coin offerings
  • Second round of NAFTA talks concluded

On the U.S.

The U.S. manufacturing sector, as measured by the ISM PMI, expanded by 2.5% to 58.8 during August 2017, which was its highest reading since April 2011. The PMI has averaged 56.7 for the first eight months of 2017. Four of the five component indices accelerated during August. The increase was attributed to Production and New Orders, with support from Employment and Supplier Deliveries. The Inventories Index, which grew 5.5% to 55.5, indicated that a significant replenishment cycle was starting. This level is difficult to sustain. A key measure of the manufacturing sector is New Orders Minus Inventories. In August, New Orders grew 4.8 pp, which was faster than Inventories did, marking a continued strain on supply chains, as they work to maintain supply-demand balance. In the near term, this is positive as the higher velocity can put pressure on available capacity and may encourage capital investment. The Manufacturing Customers’ Inventories Index decreased 8.0% to 41.0, showing a significant drawdown at the finished goods level. On the other hand, the Prices Index stayed elevated. 16 of the 18 industries reported paying higher prices for raw materials and intermediate goods.

The ISM Non-Manufacturing Index (NMI) grew 1.4% to 55.3, indicating stronger growth in the sector and its key components. While the sector is supporting job growth, it is still underperforming as compared with manufacturing. The accelerating pace in the NMI was led by improvements in Business Activity, New Orders, and Employment. Supplier Deliveries had a minor negative impact on the composite index. In August, pricing pressure strengthened further as the Non-Manufacturing Prices Index indicated higher prices on average with a minor degree of inflation. Concerns over inflation concerns historically begin when the Index exceeds 60 for an extended period.

The U.S. job market slowed down in August, with employers adding a solid but less-than-robust 156,000 jobs and holding back on meaningful pay raises for most workers. The U.S. economy is still steadily generating jobs, although more slowly than it did earlier in its recovery. With the economy now in its ninth year of expansion and unemployment near a 16-year low, fewer people are looking for job opportunities and fewer jobs are being filled. The hiring data for August have yet to account for the damage from Hurricane Harvey, whose economic impact will be felt in coming months as more people will seek unemployment benefits and industrial production will likely reflect the loss of Texas refineries and factories. The unemployment rate was up slightly to a still-low 4.4% from 4.3%. One reason that not many analysts expressed concern about slower job gain in August is that monthly employment reports can be volatile, especially figures for August. Employers are preparing for the start of fall, schools are reopening, and the government cannot always precisely factor those changes into its August employment data.

On Euro Zone

Economic growth in the euro zone remained solid in August, evidenced by the final IHS Markit Euro zone PMI Composite Output Index of 55.7, down only marginally from the flash estimate of 55.8. Output growth so far in the third quarter is slightly below its second quarter high, but it remains among the best seen over the past seven years. August saw a solid expansion of manufacturing production, with the pace of increase regaining most of the momentum. Growth in the service sector activity eased to a seven-month low, but it still remained above its long-term trend.  This, in turn, led to rising backlogs of work, which firms across the euro zone responded to by increasing employment. Employment growth was registered for the 34th month running and, although slower than in July, remained among the best seen over the past ten years. Job creation was strongest in Ireland, Spain, and Germany, while comparatively modest increases were seen in France and Italy. Only Spain recorded a sharper pace of expansion. Price pressures accelerated in August, with rates of increase in output charges and input costs both hitting three-month highs. However, the pace of inflation remained below peaks. Business optimism continued to ease from May’s record high in August. The degree of positivity was the lowest during the year-to-date period, but solid overall.

On the U.K.

The U.K. service providers recorded solid rises in business activity during August, but rates of growth eased from July and remained notably weaker than seen on average in the first half of 2017. At 53.2 in August, the headline seasonally adjusted IHS Markit/CIPS Services PMI Business Activity Index registered above 50.0. However, the index dropped from 53.8 in July and signaled the slowest pace of business activity expansion since September 2016. The rate of job creation accelerated for the third month running to its strongest since the start of 2016.

August data pointed to a sharp increase in average cost burdens at service sector companies. The rate of input price inflation picked up further from May and was the fastest for six months. Higher operating expenses placed pressure on firms to increase their average prices charged in August. The latest rise in service sector charges was the fastest since April. Meanwhile, latest data revealed that service providers’ business confidence edged up to a three-month high, but remained subdued in comparison to those seen prior to the EU referendum last summer.

On China

Bitcoin tumbled as much as 11.4%, the most since July after The People’s Bank of China (PBOC) said initial coin offerings (ICOs) are illegal and asked all related fundraising activity to be halted immediately, issuing the strongest regulatory challenge so far to the burgeoning market for digital token sales. The PBOC said on its website September 4 that it had completed investigations into ICOs, and would strictly punish offerings in the future while penalizing legal violations in those already completed. Additionally, those who have already raised money must provide refunds, though the PBOC did not specify how the money would be paid back to investors. Digital token financing and trading platforms are prohibited from doing conversions of coins with fiat currencies. Digital tokens cannot be used as currency on the market and banks are forbidden from offering services to ICOs.

Second Round of NAFTA Talks Conclude

Canada, Mexico, and the U.S. have concluded the second round of talks on the renegotiation of NAFTA, during which they made progress on consolidating certain proposals into a single text. The talks were held in Mexico City on September 1-5. According to a trilateral statement issued by Canada, Mexico, and the U.S., more than two dozen working groups worked diligently to advance the discussions and exchanged information and proposals. The statement added that, in several groups, these efforts resulted in the consolidation of proposals into a single text. This text will be used in subsequent negotiating rounds. The statement also stressed that all sides share a goal of concluding the renegotiation process toward the end of 2017. The third round of negotiations will take place in Ottawa, Canada, September 23-27.

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Market Recap Friday, September 1, 2017

In Brief

  • U.S.: Hurricane Harvey hit insurance stocks and auto giants; U.S. nonfarm payrolls preview
  • Euro: The euro hit a multi-year high after Draghi did not comment on the currency strength
  • U.K.: Home prices reverse monthly rise
  • Thoughts: M&A could be the biggest beneficiary from a tax cut on repatriated profits

On the U.S.

As Houston grapples with Hurricane Harvey, Wall Street is reeling in its aftermath. Energy stocks fell as much refining activity around the Texas coast came to a standstill. In addition to energy names, property and casualty insurance company stocks were also among Wall Street’s casualties August 28 in an otherwise mixed day for the market.

On August 23, the ADP survey sent a strongly positive surprise by informing that the private sector added 237,000 employees in August, exceeding the expectations of around 185,000. This was the largest monthly increase in five months. The June figure was revised upward to 201,000 from 178,000. The July NFP and August ADP suggest that the employment sector has accelerated its recovery from previous strong levels. That said, the employment sector has been on the healthy path for long.

On Euro

The euro soared to its highest level in over two years against U.S. dollar after European Central Bank (ECB) President Mario Draghi did not comment on a strong euro, which most analysts had expected. The dollar index dropped to a more than one-year low following Draghi’s speech and after Federal Reserve Chair Janet Yellen made no reference to U.S. monetary policy in her speech. Euro has climbed 13% year to date against the U.S. dollar, as it benefited from political dysfunction in Washington and the Federal Reserve’s gradual monetary tightening pace. A solid euro zone currency is a headwind for the export-driven euro zone economy.

On the U.K.

U.K. house prices fell by 0.1% in August compared to a modest increase of 0.3% in July, according to the figures from lender Nationwide on August 29. As compared with the same month last year, prices rose by 2.1%. Nationwide Chief Economist Robert Gardner said the slowdown in the housing sector was surprising, given the strength of the labor market and falling unemployment rate. House prices posted three consecutive monthly drops in the three months through May before rising in June, the longest run of declines since 2009, signaling that demand might be cooling as accelerating inflation squeezes consumers. Consumer price inflation stood at 2.6% in July, down from May’s peak of 2.9%, but still well above the Bank of England (BOE) ‘s 2% target and the pace of growth in wages.

Thought: M&A Could Be Biggest Beneficiary from a Tax Cut on Repatriated Profits

A subtle but an important change has occurred since the U.S. election is that companies electing to engage in M&A have outperformed companies choosing other outlets for the uses of their cash. Perhaps most significantly, the amount and efficacy of share repurchases have waned significantly over the period. The economy could benefit from changes in the tax code that would rest somewhere between a simple corporate tax cut and tax reform.

Any legislation will include both a cut in the statutory corporate rate and on taxes paid on repatriated corporate profits. M&A activities could be the biggest beneficiary from an influx of foreign profits abroad, especially at a time when the political winds are far from predictable. In this sense, U.S. companies may choose to do their capital expenditures via acquisitions as opposed to greenfield additions to plant. This may be another tailwind for small-cap stocks that are burdened with higher taxes and regulatory costs than their large cap cousins.

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Market Recap Friday, August 25, 2017

In Brief

  • U.S.: PMI pop in August 2017 amid milder trend; dollar index clocks 15-month low
  • EU: ZEW sentiment fading; sentiment also easing elsewhere in Europe; euro appreciation is a headwind to European growth; Eurozone manufacturing sector supports strong expansion of economy
  • U.K.: GDP grew by 0.3% in 2Q17; pound edged up; composition of growth drivers is changing
  • Asia: Asia markets resilient; Japan’s July core CPI up 0.5% YoY, more growth in the works for the third quarter
  • At Jackson Hole, the death of an economic model may concern central bankers

On the U.S.

U.S. private sector companies showed a sharp and accelerated increase in business activity during August, indicated by the IHS Markit Flash U.S. Composite PMI Output Index escalating to a 27-month high of 56.0 in August, largely driven by the robust orders, output, and hiring in the services sector, the index of which was at 56.9 in August.

Business conditions continued to improve across the U.S. manufacturing sector in August. The HIS Markit Flash U.S. Manufacturing Purchasing Managers’ Index eased to 52.5. Investors could expect a resurgence in the PMIs at the start of 2018 if tax reform comes to fruition.

The Dollar Index fell to a fresh 15-month low of 92.42 after ECB President Draghi, while speaking at the Jackson Hole Symposium, refrained from commenting on the EUR exchange rate. The resulting spike in the EUR/USD yielded another leg lower in the USD across the board. Draghi’s silence on the exchange rate means the central bank is not as alarmed by the recent appreciation in the EUR as previously thought. His U.S. counterpart, Yellen, also disappointed the hawks earlier today by avoiding the policy talk. Yellen’s speech was a recitation of the financial crisis, regulatory failures, and how things have improved since then.

On the EU

Positive sentiment in the euro-area has had a nice run. However, the German Zentrum für Europäische Wirtschaftsforschung (ZEW) Economic Sentiment fell for a third month to 10.0 in August, compared with the forecast of 15.0. The current situation sentiment measurement remained euphoric at 86.7. The fall in economic expectations is due to the auto industry, rather than the upcoming election. Profit expectations for automobile companies plummeted -31.8 points in August as the sector battled fines and changing preferences. This is worrisome as the auto industry is one of the bigger employers in Germany.

Sentiment is also easing elsewhere in Europe. In France, President Macron is facing resistance implementing “spinach” reforms. Like the U.S. post-election, optimism is tempering in Europe as structural changes are not coming as easily as hoped. EU consumer confidence is beginning to trend sideways.

Euro appreciation is a headwind to European growth. While the ECB president startled investors in 2014 by laying the groundwork for quantitative easing, his published remarks at the Federal Reserve symposium in Wyoming on Friday included nothing on policy makers’ deliberations scheduled for September 7 or on their concerns over the euro appreciation. In response to his silence, the single currency jumped to the highest level in more than two and a half years against the dollar.

Based on the headline IHS Markit Eurozone PMI’s 55.8 in August, the euro zone economy maintained growth momentum; the index again signaled strong growth of the euro area private sector. The expansion was supported by a strong rise in manufacturing production, while services business activity increased at a weaker pace.

On the U.K.

The U.K. economy grew by 0.3% in the second quarter, in line with the initial estimates. While the pound regained some ground following the GDP numbers, after languishing at an eight-year low against the euro.

Consumer spending slowed for the third time to 0.1% due to the VED tax and steep inflation. Despite the robust labor market, consumers are no longer the workhorse of the U.K. economy. More people are becoming employed, but real wage growth is still in negative territory. Residents are spending in less in volume terms and using debt to pay for necessities. Government spending, up 0.6%, and capex, up 0.7%, helped picked up the slack again, contributing 0.1% pts each. Net trade added 0.0% pts.

On Asia

Asian stocks advanced on Friday, once again shrugging off a sluggish day on Wall Street, and the dollar strengthened as attention shifted to the central bankers’ symposium that began on Thursday in Jackson Hole, Wyoming. MSCI’s broadest index of Asia-Pacific shares outside Japan, was up 0.25%, set to end the week 1.6% higher. The MSCI World index was steady, heading for a 0.7% weekly gain. Japan’s Nikkei advanced 0.6%, heading for a flat end to the week. China’s Shanghai Composite index jumped 1.5% to its highest level since January 2016. Hong Kong’s Hang Seng gained almost 1%. South Korea’s KOSPI climbed almost 0.1% and Australia’s S&P/ASX 200 index was little changed.

Like the European and U.S. PMIs, Japanese activity surprised to the upside in August. The Manufacturing PMI made a broad-based move up to 52.8. Unlike the European and U.S. PMIs, the Markit Manufacturing PMI for Japan is trending sideways, ranging 52-53 since December 2016. According to the summer PMI readings, Japan’s quiet recovery is still on track in the third quarter. Yet, structural problems still exist and are restraining growth.

Central Bankers’ Annual Gathering at Jackson Hole

As central bankers gather at the annual Jackson Hole symposium on Friday, analysts think the death of a major economic concept could dominate discussions. Known as Phillips curve, an economic concept developed by New Zealand economist William Phillips, it shows that inflation and unemployment have a stable and inverse relationship. However, in the recent months with central banks using artificial ways to pump money into the economy, this inverse relationship is seen to be dying. A number of analysts have warned that this could be risky for the global economy and discussions around the death of the Phillips curve could dominate the Jackson Hole symposium.

Thoughts

It is odd for an economy like the U.S. to accelerate in the second half of a business cycle. Similarly, it would be odd for the yield curve to stay constant or steepen. But this is not a normal cycle, and one of the key unique items, QE, is set to be undone. True, this will occur slowly at first, but the market has not taken the Fed all that seriously for years, as the FOMC has said they wanted to normalize.

The ECB minutes, meanwhile, worried about a currency overshoot. “While it was remarked that the appreciation of the euro to date could be seen in part as reflecting changes in relative fundamentals in the euro area vis-a-vis the rest of the world, concerns were expressed about the risk of the exchange-rate overshooting in the future,” an account of the July 19-20 policy meeting published by the ECB showed. Bottom line is that the Fed is looking for ways to tighten while the ECB is watching any additional euro strength closely. The U.S. data remains broadly positive, though housing starts still restrained.

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Market Recap Friday, August 18, 2017

In Brief

  • U.S.: Home builder sentiment climbed in August 2017 and consumers still likely pent up demand for housing; 10-year breakeven inflation rate rose in July for the first time in five months; NAFTA changed U.S. trade with Canada and Mexico; dollar fell in July against most other currencies
  • EU: The hard data released this week reconfirmed the recovery remains on track and broad based
  • U.K.: Pound fell after U.K. inflation disappointed
  • Japan: Better second-quarter growth than expected; second-quarter earnings climbed for 68% of the listed companies; Abe reaffirmed the plan to complete doubling of consumption tax in 2019
  • China: M2 money supply 9.2% vs. 9.5% forecast; IMF raised China 2018-2020 growth outlook; economy moderating but no imminent risk; China reclaims spot as the biggest holder of U.S. Treasuries
  • Thought: Consider a more diversified approach to global credit markets

On the U.S.

U.S. home builder sentiment, as measured by the National Association of Home Builders (NAHB) Wells Fargo Housing Market Index, increased to 68 in August, up four points from 64 in July and the highest level since May; a reading above 50 generally indicates more builders view sales conditions as good. On the other hand, the level of reading is still far from the pre-recession peak. One explanation for the mismatch is home builders are confident about the outlook for the U.S. economy but in short supply of materials and qualified workers.

The U.S. 10-year inflation breakeven inflation rate, the difference between nominal and real yields and a measure of inflation expectations, rose in July for the first time in five months. It began with a rate at 1.74% in July, about the same level it had been just prior to the U.S. election. President Trump’s surprise victory had propelled the rate to as high as 2.08% on the back of expectations for fiscal stimulus and its likely inflationary effect. The subsequent slide in the breakeven rate had been a mixed result of falling oil prices, underwhelming inflation data, and diminishing expectations for the extent of fiscal stimulus. The increase in July’s rate to 1.82% was contributed by oil prices rising again, but stimulus expectations, inflation data, and Fed policy will all continue to be factors in the direction of the rate moves.

The Trump administration set an intense tone on August 16 at the beginning of the renegotiation of the North American Free Trade Agreement (NAFTA), driving a wedge into its relationship with Canada and Mexico. The U.S. is also pledging to make reducing its trade deficit a priority, a point that Canada and Mexico partners sought to rebut. While the growth of the U.S. economy has followed trade, the changing dynamics have also prompted concerns about decreasing employment, especially in the well-paying manufacturing sector and the rising trade deficit.

The U.S. dollar fell again in July against other developed market currencies, as captured by the U.S. Dollar Index (DXY), touching 13-month low in its fifth consecutive monthly decline. Fed Chair Yellen’s more cautious testimony and soft inflation data contributed to the decline in the U.S. dollar, but developments in other developed markets also added to the appreciation of other currencies. In particular, euro gained 3.6% in July, yen nearly 2%, and pound 1.5%. Emerging markets (EM) currencies also saw gains against the U.S. dollar, as captured by the JP Morgan Emerging Market Currency Index. Index gains were generally broad-based and helped by Asian and Latin American currencies.

On the EU

The seasonally-adjusted GDP rose by 0.6% in both the euro area (EA)and the European Union (EU) during the second quarter from the previous quarter, and rose by 2.2% in the EA and by 2.3% in the EU, respectively, from the same quarter of the previous year, according to a flash estimate published by Eurostat, the statistical office of the EU. The hard data reconfirmed that the recovery remains on track and broad based; even in Italy, the GDP grew by 0.4% from the previous quarter and by 1.5% from the same quarter of the previous year.

On the U.K.

The British Pound fell to almost eight-year low against the euro after another disappointing inflation report. The U.K. prices rose at an annual rate of 2.6% in July on the consumer price index measure, matching the June print and below economists’ expectation of 2.7%, lowering the likelihood of an imminent interest rate hike from the Bank of England. The near-instantaneous response from markets after that inflation print came in was a drop in GBP.

On Japan

The growth of Japan continues to be an under-the-radar story. The second-quarter GDP expanded an annualized 4.0% versus a forecast of 2.5% growth; compared to the previous quarter, the GDP grew 1.0%, much stronger than expected. Real GDP was more diverse than in the past, with investment contributing 0.7%, consumer spending 0.5%, and government spending 0.1%. Net trade was a drag. The Japan GDP deflator rose to 102.6 after falling the last four quarters.

The Nikkei 225 remains almost 17-year high in both JYP and USD terms. Japan’s corporate earnings have broadly recovered, with a record 68% of nearly 1,600 listed companies booking higher net profit for the second quarter, as growth among makers of autos and electronics spread to their materials and equipment suppliers.

To restore Japan’s fiscal health, Prime Minister Shinzo Abe remains committed to a plan to complete the doubling of the consumption tax to 10% in October 2019. Under the initial plan, the consumption tax was to be raised to 10% from the current 8% in October 2015, but Abe has already postponed it twice to try to ensure a solid economic recovery.

On China

Growth in China’s broad money supply, as measured by M2, the money supply that includes cash, checking deposits, savings deposits, money market securities, mutual funds, and other time deposits, slipped to a new record low, indicating the People’s Bank of China (PBOC) is not letting up in their drive to control excess borrowing and safeguard the financial system. Aggregate financing stood at 1.22 trillion yuan ($182.7 billion) in July, the PBOC said on August 15, compared with an estimated 1 trillion yuan in a Bloomberg survey. New yuan loans stood at 825.5 billion yuan, as compared to a projected 800 billion yuan. M2 increased 9.2%, versus economists’ forecast of a 9.5% growth rate. The slower increase in M2 will become a “new normal,” and “The relevance of M2 growth to China’s economy and its predictability has reduced, and its changes should not be overinterpreted” the PBOC said in its quarterly monetary policy report. The divergence between M2 growth and aggregate financing mirrors that the PBOC is attempting to adjust cutting leverage while ensuring enough funds to support the real economy.

The International Monetary Fund (IMF) raised the growth outlook for China for the period between 2017 and 2021 but cautioned the projected sharp increase in nonfinancial sector debt could hurt growth. Although China’s retail sales, investment, industrial production, and lending all slowed further in July, they remain rapid. Imbalances exist in the economy, but probably few immediate risks.

China’s holdings of U.S. bonds, notes, and bills rose to $1.15 trillion in June, up $44.3 billion from a month earlier, according to Treasury Department data released August 15 in Washington. Japan owned $1.09 trillion; Japan had overtaken China in October 2016 as the largest holder of U.S. Treasuries. China and Japan account for more than a third of all foreign ownership of Treasuries.

Thoughts

Low market volatility continued to fuel risk appetite, driving equities higher and interest rate curves steeper. The MSCI World Index rose 2.4% amid a strong start to the second-quarter earnings season, taking year-to-date gains to 13.3%. With a robust 6% return in July, EM equities, as measured by the MSCI Emerging Markets Index Daily Net TR, extended their positive run in 2017 to over 25%; Brazilian stocks reacted positively to the conviction of former President Lula on corruption charges, Russia benefitted from higher oil prices, and Chinese equities were supported by better-than-expected second-quarter GDP growth.

After a turbulent 2015 and inconsistent start to 2016, global credit markets have since bounced back and continued to rally. This has led investors to ask whether there is still value in corporate bond markets and how they can balance their return objectives against the downside risks. Many credit investors focus on specific areas of the global credit markets, such as U.S. investment grade corporate bonds, high yield bonds, EM debt, and securitized loans. In addition, many investors attempt to time their allocations to various credit sectors. An active, tactical, and multi-sector approach to credit investing can produce better long-term results through structural diversification, bottom-up credit selection, and the ability to scale into and out of risk as relative valuations become compelling.

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Market Recap Friday, August 11, 2017

In Brief

  • U.S.: Producer prices recorded the biggest drop in 11 months; productivity rose 0.9% in 2Q17, consistent with the climb in the JOLTS Quits
  • Eurozone: Soft and hard data in Germany eased slightly but remain robust; Bank of France sees economic growth of 0.5% in 2Q17
  • U.K.: The Brexit dulled another quarter of the economic activity but has not yet impacted employment and is disappearing from inflation; the U.K. economy was better in 2Q17 with real GDP growth accelerated
  • Japan: Recovery persisting with economic data stayed encouraging, buoyed by domestic demand as consumer spending recovered and firms increased capital investment
  • China: July FX reserves unexpectedly hit nine-month high on boost from weak dollar; initiatives to deflate asset valuations and detox the debt market are working; China’s 751 million Internet users are equivalent to entire population of Europe
  • LEIs: Still solid but milder 2H17 global activity

On the U.S.

U.S. producer prices, as measured by the Producer Price Index (PPI), unexpectedly fell in July 2017, recording their biggest drop in 11 months and pointing to a further moderation in inflation that could delay a Federal Reserve interest rate hike. The PPI for final demand declined 0.1% in July, seasonally adjusted, according to the U.S. Bureau of Labor Statistics (BLS), as compared to the up 0.1% in June and unchanged in May. On an unadjusted basis, the PPI for final demand increased 1.9% for the 12 months ended in July. Over 80% of the July decrease in final demand prices is attributable to the index for final demand services, which fell 0.2%. Prices for final demand goods edged down 0.1%. The index for final demand less foods, energy, and trade services was unchanged in July, following a 0.2% advance in June. For the 12 months ended July, prices for final demand less foods, energy, and trade services rose 1.9%. Inflation, the Fed’s another mandate, remains below the 2% target.

U.S. worker productivity picked up more than expected in the second quarter, as hours worked rose at the fastest pace in one and a half years. Nonfarm business-sector productivity increased at a 0.9% seasonally-adjusted annual rate, and between the second quarter of 2016 and the second quarter of 2017, U.S. productivity increased 1.2%, reflecting a 2.7% increase in output and a 1.5% increase in hours worked, according to the BLS. The panelists at National Federation of Independent Business (NFIB), America’s leading small business association, were saying they were planning to raise worker compensation and finding qualified applicants is a top issue. The qualified labor shortage is a factor causing historically low production.

A better second-quarter productivity is consistent with the climb in the Job Opening and Labor Turnover Survey (JOLTS) Quits. The number of job openings increased to 6.2 million as of the last business day of June. Over June, hires and separations were little changed at 2.1% and 1.2%. Within separations, the quits rate and the layoffs and discharges rate were litter changed, according to the BLS.

On Eurozone

Firms, investors, and consumers in the euro area are reacting positively to the recent diminishment of political uncertainty and anti-euro threats. Eurozone economic, business and consumer confidence made new highs in July. Soft and hard data released this week eased slightly, but remain robust.

Emmanuel Macron has won the hearts of business leaders in France, who are counting on him to push through radical reforms to sustain an economic recovery. Confidence is at a six-year high, and executives from Société Générale SA to building materials firm Cie. de Saint-Gobain SA have spoken of a brighter mood since the new president was elected in May. On August 9, the Bank of France reported a better-than-forecast jump in manufacturing confidence and said the economy could grow 0.5% this quarter.

German industrial production unexpectedly fell for the first time this year in June, but remain near May’s historical high. Output declined by 1.1% on the month after rising 1.2% in May, but factories and construction firms in Germany produced 1.8% more in the second quarter than the previous quarter. Order levels, along with business climate indicators, pointed to the upward trend continuing.

German export and import growth disappointed, with exports falling 2.8% month on month and imports 4.5% month on month. The trade surplus though improved to EUR 21.2 billion from EUR 20.3 billion, leaving the total for the second quarter at EUR 61.3 billion, up from EUR 59.9 billion in the first quarter. German exports and imports are still upward trending which is an encouraging sign of global economic activity.

On the U.K.

The Brexit continued to have varied effects on the U.K. economy. The Brexit dulled another quarter of U.K.’s economic activity but has not yet impacted employment and is disappearing from inflation. The U.K. Headline CPI softened to 2.7% year on year and the core series slid to 2.5% year on year in June. However, another step down in the exchange rate would likely lead to an additional bout of inflation, so risks remain.

U.K. employers continue to hire, sending the employment rate to its highest level ever and the unemployment rate down to 1975 levels in May. This seems counterintuitive given the uncertainty Brexit is generating. One explanation could be hiring is quicker and more reversible than CapEx to meet short- to medium-term demand.

The U.K. real GDP growth accelerated to 0.3% quarter on quarter in the second quarter, which was better than the first quarter, despite it is still far from the 0.5% of the post-crisis average. Economic activity was buoyed by services during the quarter; services comprise 78% of U.K.’s GDP and the sector grew by 0.5%. Production and construction contracted. Agriculture grew 0.6% but comprises a sliver of the economy. Film activities comprise 8.2% and supplied a one-off boost.

Retail sales growth slowed in July, but grocery sales continued on an upward trend due to inflation. Overall sales for the industry edged up 0.9% year on year, according to the British Retail Consortium (BRC), down from a growth of 1.1% of the previous year.

On Japan

Japan’s economic data stayed encouraging, buoyed by domestic demand as consumer spending recovered and firms increased their capital investment. Consumers’ appetite for durable goods remains persistent as auto sales for June grew 7.9% in 12 months year on year. The Q2 Tankan Survey showed domestic demand, financial position, lending attitude, and prices all improved across all firm sizes while production capacity and employment became more insufficient.

The Cabinet Office’s leading index, which measures the future economic activity, improved to 106.3 in June, a three-year high. The coincident index, which reflects the current economic activity, came in at 117.2, the highest since March 2014. Export growth slowed to 10.5%, but the pace is still impressive.

The total value of machinery orders, a leading indicator of production which tracks trends in Japanese machine tool orders placed with major manufacturers in Japan, increased by 2.1% in June from May on a seasonally adjusted basis. In the second quarter, it increased by 1.7% compared with the first quarter. Private-sector machinery orders, excluding volatile ones for ships and those from electric power companies, decreased a seasonally adjusted by 1.9% in June and showed fell by 4.7% in the second quarter. Robust global demand boosted Japanese business confidence to a three-year high in the second quarter, heightening policymakers’ hopes that cautious companies will finally increase spending on plant and equipment.

On China

FX Reserves rose for a fifth month to $3.08 trillion in July partly due to that the yuan strengthened around 0.8% against the dollar in July. Capital controls are working. Meanwhile, the pricier currency has affected trade volumes. Export growth slowed for a second month to 8.9% year on year; import growth decelerated for a third month to 14.2%. The stronger currency has been coinciding with milder inflation.

Initiatives to deflate asset valuations and detox the debt market are working. Property prices eased overall and by tier in June; the 70-city average growth rate cooled for the sixth month to 9.4% year on year. On the other hand, aggregate financing and new yuan loans remain in up trends. This hot credit is warranting further regulatory changes.

China’s population of Internet users rose 2.7% over the first half of the year to 751 million, exceeding the population of Europe, according to the China Internet Network Information Center (CINIC). The increase in Internet users in China indicates how the rise of mobile internet services has driven growth in China’s online population and its Internet penetration. In China, 96.3% of internet users had access through their cell phones, an increase of 1.2% from the end of 2016. Among mobile internet applications, food delivery, wealth management, and bike-sharing put up some of the biggest growth numbers. At the end of June, online food delivery services had 274 million users, a 41.4% increase from the end of 2016, making it the fastest-growing sector. The number of people that used the Internet to manage their money grew 27.5% over the first six months to 126 million. China’s online payment industry has also taken off over the last six months, hitting a record 502 million online payment users, making China one of the most cashless countries in the world. Users of bike-sharing services are another major growth group. The number of users surged from zero just over a year ago to 106 million in June, accounting for 14.1% of all internet users, according to the CINIC report.

On LEIs

The OECD’s Leading Economic Indicators (LEIs) continue to indicate economic activity for the second half of 2017 will be milder in most G7 countries, as the nominal reacceleration concludes, the “spinach” period commences in U.S. politics, and real growth drivers are delayed till early 2018.

Looking ahead, activity for the second half will temper in most G7 countries, according to the July release of LEIs. The reacceleration in the global economy this year has bought time, but the recent batch of LEIs plus inflation growth peaking stresses the urgency of real growth drivers, e.g., fiscal policy, to carry forward the momentum. Unlike the rest of the world, the LEIs for European countries are indicating the expansion will continue to steam ahead.