DR.CHENJIAZI ZHONG

In Brief

• U.S.: Consumer confidence steadfast ahead of political turmoil; U.S. dollar weakened notably
• Eurozone: “Euphoric” soft data points and growth spurt loses momentum for second month running
• Germany: The Ifo business climate index rose to another record high at 116.0 in July; German private sector output growth eases in July
• France: July PMI to further robust increases in output and employment; French confidence also remained elevated
• U.K.: Brexit weighing down economic activity; U.K. CBI showed still-solid industry
• Japan: Encouraging data package; the IMF revised up its outlook for Japan
• China: GDP forecast raised by economists after growth beats estimates; better growth is extending window for officials
• Fed’s July 26 meeting and its implications

On the U.S.

Despite the political tumult, U.S. consumer confidence strengthens and remains at 16-year highs. The Confidence Index rose to 121.1 in July 2017, beating Economists’ expectation for a decline. Consumers in the U.S. found the current environment to be improving and are more hopeful about the future.

U.S. dollar has weakened notably recently. A weakening currency typically would lead to concern about inflation. Theoretically, a weaker U.S. dollar should significantly help corporate earnings. A weaker U.S. dollar historically has been associated with higher commodity prices, which could be a concern for consumers. But the recent decline in oil, which looks mainly driven by supply and technology, is inhibiting this relationship. The bottom line is business cycles do not end with profits up and wages up together. The weaker U.S. dollar should support business profits now. Full employment in the U.S. should support wage gains, and cheap energy should make these real wage gains.

On Eurozone

Soft data continues to be upbeat in Eurozone as the recovery firms and political uncertainty subsides despite certain geopolitical tensions persisting. the eurozone started the third quarter on a solid footing and the Eurozone PMI Composite fell for a second successive month in July, down to a six-month low of 55.8 from 56.3 in June. The Eurozone Manufacturing PMI recorded 56.9 compared to 58.7 in June. Manufacturers, buoyed in particular by further robust export order book growth, continued to report stronger output growth than service providers, despite the rate of expansion easing to the weakest since January. The Markit PMIs softened but still well in expansionary territory.

On Germany

The German’s Ifo business climate index rose to 116.0 from 115.2 in June, beating Reuters’ consensus forecast for 114.9. German business and consumer confidence hit a record high as “euphoric” manufactures, shrugging off the impact of a strong euro, anticipated a surge in already robust exports from the biggest economy in Europe.

On the other hand, German private sector output growth slowed for the second month running in July but remained strong overall. Germany PMI Composite was down to 55.1 in July from 56.4 in June, a six-month low, a trend reflected in both manufacturing output and services business activity. New business inflows increased at the softest rate since the start of 2017. That said, job creation quickened during July and outstanding business continued to grow solidly, reflecting manufacturing backlogs. German firms remained as optimistic regarding output expectations in July as they had been in June.

On France

The France Composite Output Index posted well above the neutral 50.0 level at 55.7, while down from 56.6 in June and marked a further decline from May’s six-year peak. The rate of expansion remained sharp overall. Softer increases in output were seen across both manufacturers and service providers in July. French private sector companies also noted a steep increase in overall new business at the start of the third quarter. Greater output and new orders prompted companies to add to their payrolls for the ninth month running in July. Despite higher staff numbers, capacity pressures persisted in July as highlighted by a further solid rise in backlogs of work. French July PMIs signaled greater average input costs faced by French private sector firms.

French confidence remained strong and is holding multi-year highs. While services companies expressed a weaker degree of optimism towards 2018, the level of confidence across the manufacturing sector improved to its strongest in the five-year series history

On the U.K.

The U.K. economy was a bit better in the second quarter, but the data is still ominous. U.K. real GDP growth accelerated to 0.3% quarter over quarter in the second quarter. The pace is better than the first quarter, but still far from the 0.5% level of post-crisis average.

Economic activity was buoyed by services in the second quarter. Services comprise 78% of the U.K. GDP and grew 0.5%. Production and construction contracted. Agriculture grew 0.6% but comprises a silver of the economy. Film activities 8.2% supplied a one-off boost. CBI business optimism was also slightly better but still lackluster compared to prior business cycles, due to the Brexit and the rollercoaster ride resulting from it.

On Japan

Japan is improving glacially and quietly in the background of the global stage. The Markit Mfg PMI ticked down fractionally to 52.2 due to mixed results. The third quarter started with exports stagnating, but hiring and optimism hit multi-year highs according to the July reading. All in all, The Japan Mfg PMI is steading in expansionary territory. Moreover, the IMF revised its Japan outlook, where positive surprises to activity in late 2016 and early 2017 point to solid momentum, which is also encouraging.

On China

China’s GDP will expand by 6.7% from the previous year in the third quarter and 6.6% in the fourth quarter, according to the median of 57 economist estimates in a July 17-24 Bloomberg survey. Both points were 0.1% higher than a year ago. Economists raised their forecasts for China’s economic output after growth in the first half beat estimates. The robust activity is giving policy makers’ room to curb excessive and speculative borrowing.

In the IMF July World Economic Outlook Update, the IMF mentioned “The unchanged global growth projections mask somewhat different contributions at the country level. China’s growth projections have also been revised up, reflecting a strong first quarter of 2017 and expectations of continued fiscal support.”

Fed’s July 26 Meeting: Expected to Do Nothing Does Not Mean Bond Market Will Not Move

The Federal Reserve said at its July 26 meeting that the job market is still getting stronger, and it left interest rates alone after three hikes since December 2016. In a statement after the Fed’s two-day meeting, central bankers said they expected the economy to “warrant gradual increases’ in rates. Most Fed officials expect at least one more hike in 2017, either in September, October, or December.

This does not mean there cannot be surprises. Recent language from Fed speakers has seemed to deny any plans to target asset levels, but there is a difference between targeting asset levels and challenging market complacency, and challenge market complacency may be exactly what the Fed does now. True, inflation data has been too soft to justify another tightening in July, or in September for that matter, so there is little reason to expect anything hawkish on that front. And plans for balance sheet runoff appear to be going smoothly with expectations for a September announcement and October start having been well-digested. So, why risk that with a tantrum? First, expect the Central Bank to simply strengthen the view that balance sheet runoff will start in the fall. The purpose of this would be to bring any holdouts in line with the consensus view that runoff is coming and to keep the topic front and center for the rest of the summer. But there should also be some mention of expectations for continued rate hikes if the economy progresses as expected. Although this is a logical statement, the purpose here would be to keep December checked off for at least one more hike in 2017. These two points, even though they are expected in advance, could be just enough of a reminder to push yields in the 1-10 year bucket up.