United States – Macro fundamentals are not signalling a cyclical reversal, even though financial conditions have tightened significantly since early 2016. The Fed is likely to “watchfully wait” and “closely monitor” global developments, without changing the baseline scenario……
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Intesa Sanpaolo – Research Department For professional investors and advisers only
United States – Macro fundamentals are not signalling a cyclical reversal, even though financial conditions have tightened significantly since early 2016. The Fed is likely to “watchfully wait” and “closely monitor” global developments, without changing the baseline scenario.
– To what extent are the recent financial turbulences a result of fresh data on US macroeconomic fundamentals? In mid-December 2015, the Bloomberg consensus forecast for 2016 growth was 2.5%, and was lowered in mid-January to 2.4%, mostly due to 4Q GDP data. Recently, some surveys warned about higher probability of a recession in 1 year: what has changed? In our view, renewed pessimism is not based on a radical change in domestic macroeconomic fundamentals. January macroeconomic data confirmed 1) contraction of the manufacturing sector and expansion, albeit at a moderate pace, of the services sector (manuf. ISM at 48 in January, non-manufacturing ISM at 53.5); 2) solid increase in households’ real disposable income (+3.1% y/y in December), with a positive outlook thanks to the new plunge in gasoline prices, and with the savings rate at 5.5%; 3) ongoing improvement in labour market conditions (NFPs in January +151 k, unemployment rate at 4.9%; hourly wages + 0.5% m/m); 4) in December, orders were markedly negative, although the orders component of the manufacturing ISM in January retuned above the 50-point mark (51.5).
– The “major” shocks to the scenario at the beginning of 2016 originated mostly in financial markets, and panned out between the end of December and mid-January: oil prices (-28%) and appreciation of the dollar (+2.7%); on top of these shocks, the S&P 500 index dropped by -9%. The decline in oil prices implies a modestly positive net effect on US growth, even taking into account the drag from the mining sector, and is slowing the inflation trend (potentially pushing back the next fed funds rate hike): therefore, it is unlikely to justify mounting pessimism on the trend of economic activity. The dollar, on the other hand, is making a negative “net” contribution through net exports and corporate earnings, but may delay the Fed’s actions on rates. The financial stress index built by the Cleveland Fed provides a measure of the change in financial conditions since the beginning of 2016. On the eve of the December FOMC meeting, the index was around zero. Following the fed funds hike, the index stabilised at around 0.4 until 31 Dec. In January, the trend picked up sharply, to over 1 (1.25 on 5 Feb.). Levels of between -0.6 and 0.6 are defined as “normal stress”, and between 0.6 and 1.7 stress is considered “moderate”; the history of the index shows that phases at levels higher than 1 are associated with important slowdowns.
– The tightening of financial conditions is the crucial point for the growth and interest rate outlook. In its January statement, the FOMC maintained a positive assessment of the macro picture, while indicating that it is “closely monitoring global economic and financial developments and is assessing their implications for the labour market and inflation, and for the balance of risks to the outlook”. In recent speeches, several FOMC participants acknowledged growing financial restriction from external sources, expressing different views on the implications for monetary policy. Proceeding from hawks to doves, George believes the upward rate path should continue in any case, Williams sees rate hikes slower by a “smidgen”, Fischer for the time being “simply doesn’t know”, for Kaplan “it’s wise to be patient”, and Dudley thinks recent events “may be in the process of altering the outlook for growth and the risk to the outlook”. Lastly, Brainard believes global events may slow economic activity and inflation in the US, and further tighten financial conditions: “recent developments reinforce the case for watchful waiting”. We believe Yellen’s testimonies to Congress next week (10/2 at the House, 11/2 at the Senate) may adopt to Brainard’s leitmotif, albeit with slightly less dovish overtones. Yellen should reassert a generally positive assessment of the macro picture, while assuring that the Fed is acknowledging the significant tightening of financial conditions since the beginning of 2016, and will therefore “watchfully wait” for more information. In our view, this does not imply a zero probability of further hikes in 2016, as the market seems to believe, but rather a reduction and/or a pushing back of the next moves after having assessed the evolution of data and of the markets.
Source: BONDWorld.ch
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