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Tuesday, August 6, 2019

Special Guest Blogger: Tim Kearney

A volatile August kicked off in July, with the Federal Open Market Committee’s messaging that its July 31 interest-rate cut was essentially a “mid-course correction.” It appeared at that point the Fed was data-dependent. The Trump administration’s decision to impose further tariffs on Chinese goods affected that outlook from the growth side as well as the policy side. On the growth side, there already was evidence that uncertainty over trade and the global economy was inhibiting investment, thus hindering the potential for growth to break out on the upside. On the policy side, it is not clear how or if the Fed will respond to the trade tensions, and that in itself adds uncertainty.

Good economic news gave a helpful but temporary lift to sentiment. Nonfarm payrolls printed a whisper below the 165,000 consensus. Most interestingly, manufacturing payrolls continued to rebound, up by 16,000 and well above the consensus for a 5,000 rise. Payrolls are a coincident indicator; the manufacturing statistics could reflect stabilization or a slight increase in that sector. Given the business uncertainty over trade and consequent slowing of capital investment, however, the paradigm might just be that businesses are seeing continued demand and are filling it with labor rather than committing to capital inputs.

Please follow capital expenditure, on page 11, and employment, on pages 63–65, of the Global Perspectives book.

Thursday, August 1, 2019

The Federal Reserve got nautical on Wednesday, and instead of sailing directly into a storm chose to tack around it through calmer waters. The market initially thought the Fed’s “tack” — a 25-basis-point cut of the fed funds target rate — was not enough, but the blue skies were quickly in sight. Markets expect another rate cut in September and the bulls are running. Despite this market-friendly news, there has been a relentless negative counter-narrative that has kept investors too cautious. We do not advocate “irrational exuberance,” but instead urge investors to get back to their “normal” equity allocations. In our view, keeping equities well below normal targets is not prudent, instead we consider such a stance “thoughtlessly cautious.”

To see our expectations for 2019 earnings per share growth, please see page 42 of the Global Perspectives book.

Tuesday, July 30, 2019

Special Guest Blogger: Daniel Wang

Recent U.S. expectations reports have shown a bit of life: the University of Michigan’s (UMich) indexes of consumer expectations and inflation expectations, the Bloomberg indexes of consumer comfort and economic expectations and the Philadelphia Federal Reserve’s manufacturing business outlook were all positive. Preliminary U.S. Markit PMI data for July printed at levels congruent with trend U.S. growth, but still soft.

Consumers are still reacting to the good labor market. Retail sales data show three-month growth rates are higher than twelve-month growth rates. For example, sales less autos and gasoline were up 7.4% over three months, versus 5.2% over twelve months. Similarly, the headline sales rate was up 5% versus 3.4%. The Atlanta Fed GDPNow PCE forecast continues to move higher. For the Fed outlook, UMich five–ten year inflation expectations rose from 2.3% to 2.6%.

The trade related downturn in manufacturing has hit Europe hard, with Eurozone Aggregate PMI sliding from 55 to 47.5 over the past year. Recent IP data are showing a stabilization at that level. These data indicate that the slowdown may be ending. Importantly, European Composite PMI is turning up and the market expects the European Central Bank to ease in September.

For background on manufacturing and consumer spending, please pages 9–13 of the Global Perspectives book.

Thursday, July 25, 2019

Special Guest Blogger: Tim Kearney

To state the obvious, the Federal Reserve is set to deliver a rate cut on July 31. In his Congressional testimony, Federal Reserve Chair Jay Powell said that there is room to cut for a number of reasons, citing trade tensions and the global slowdown. In addition, he described the Phillips curve relationship between inflation and unemployment as “weak” and “becom[ing] weaker and weaker and weaker.” (I agree, and expect that “employment Friday” may be a bit less stressful for a few rounds). Analytically, he offered that since there have been few issues arising from the low unemployment rate, monetary policy may have been tighter than necessary.

What is the background to a rate cut? Domestically, U.S. GDP growth appears to have slowed but is still above trend. Retail sales data are accelerating, with the three-month growth rate now higher than the 12-month growth rate. The inflation rate appears to be heading slowly to the Fed’s 2% target. Since the Fed’s model points to small impacts from a single rate cut, there have been some arguments for a 50 basis-point (bp) cut over the past week. I’m looking for 25 bp this month and another cut in September, with December still a possibility for a third; but that will depend on conditions in the intervening months.

Please follow the fed funds target rate on page 34 of the Global Perspectives book.

Thursday, July 18, 2019

The Federal Reserve looks set to deliver a rate cut on July 31 as potential insurance against global economic weakness. Someone forgot to send U.S. consumers the memo about a slowdown, however. Retail sales popped again, up 0.4% in June, and up a whopping 0.7% if gasoline sales are stripped out. (This is because gasoline prices fell in June, another positive for consumers.) June is the fourth straight month of retail sales increases and bodes well for 2Q19 GDP reports. Consumer spending offers a clear window into the U.S. economy, as it accounts for more than two-thirds of U.S. GDP. Although consumer spending is up, so are household savings rates – hovering around a solid 6%.

Meanwhile 2Q19 earnings season has kicked off with more than 80% of the 66 companies to report so far having beaten expectations. Our expectations for 2Q19 earnings call for continued positive growth on the back of record high levels last year. Sure, building permits and housing starts reported lousy numbers yesterday, but the Philadelphia Fed’s July Manufacturing Business Outlook Survey was a blowout, positive surprise, hitting the highest activity levels this year. Good news is outweighing the negative. The Fed may be worried, but for now consumers are sending the slowdown memos to spam and enjoying a summer of spending.

Please watch retail sales on page 12 of the Global Perspectives book and read the Global Perspectives Midyear Update.

Tuesday, July 16, 2019

Special Guest Blogger: Tim Kearney

It seems that the Federal Open Market Committee (FOMC) has shifted its monetary policy approach from data dependence to pre-emptive risk management. Last summer, Federal Reserve Chairman Powell appeared to endorse such an approach. His Congressional testimony last week emphasized that (headline) inflation is below the FOMC’s “symmetric 2% objective” and that “cross-currents” weigh on economic activity and the outlook. The question remains: will this approach deliver the three rate cuts by year-end that the market expects?

My expectation is that the FOMC will validate expectations for a 25 basis-point (bp) cut in July but not deliver 50 bp. The FOMC will remain open to a 25 bp cut in September, which likely will happen. I doubt that the Fed is on autopilot to cut based on market expectations. Between now and the December 11 meeting there will be a lot of data that should clear up the direction of economic cross-currents. These are the keys: investment trends, productivity data, nonfarm payrolls, business confidence and trade tensions. I would feel more confident about the outlook being above trend if we see business confidence remaining high among investment firms.

For background on the fed funds target rate, please see page 34 of the Global Perspectives book.

Thursday, July 11, 2019

Special Guest Blogger: Tim Kearney

It’s difficult to understand how markets got so over their skis on monetary policy expectations. As recently as July 3, markets had fully priced in at least a 25-basis-point (bp) cut of the fed funds rate in July, and expectations were moving towards a 50 bp cut. The logic was a combination of an economy which was slowing — though still above trend — and inflation that was a bit below the Federal Reserve’s 2% target. Then those expectations crashed into the hard place of a 224,000 monthly job report accompanied by modest wage increases.

In our view, the 50 bp cut was always unlikely given that those sorts of cuts usually signal a recession is upon us. The economy seems set to remain at an above-trend growth rate, without inflation or wage pressure. Odds still favor a 25 bp cut on July 31, but any actions beyond that depend on the economic data, which could make the Fed’s communications strategy more difficult. Note this, however; if the Fed stops the rate cut cycle it will be for a good economic reason: growth is good.

For background on the fed funds target rate, please see page 34 of the Global Perspectives book.

Tuesday, July 2, 2019

Special Guest Blogger: Tim Kearney

The weekend news — a pause in trade tensions between China and the United States — is a positive development that should help the global economy, though it does leave the sword of Damocles hanging over the manufacturing sector. The reasons for this overhang are twofold: one, the uncertainty has already led to a worldwide manufacturing slowdown; two, a pause implies that the trade problems can kick up again if the talks go badly. Net/net, the sluggishness in the manufacturing sector needs a true boost to shift into higher gear.

Fortunately, central banks are communicating that they stand ready to provide the liquidity the global economy needs; especially as the Federal Reserve’s December 2018 hike appears in hindsight to have been unnecessary. Beyond trade, then, keep your eye on the July 5 nonfarm payrolls report, which may give a good bit of information about the state of the economy and the Fed’s likely next steps.

For background on nonfarm payrolls, please see page 63 of the Global Perspectives book.

Thursday, June 27, 2019

Economic data are coming in weaker across manufacturing, which is often a precursor to weak earnings or worse. The Philadelphia Federal Reserve Manufacturing Business Outlook Survey is at a four-month low, and the Empire State Manufacturing Survey is at a three-year low, as China-U.S. trade war fears persist. The markets are slipping in tandem — a sure sign of a bear market or not? I think not. We have advised not to Washington-proof your portfolio because politicians are a whimsical bunch: today threats, tomorrow hugs. Even the stalwart Fed has “changed its mind,” from multiple rate increases in 2019 to a possible cut of the fed funds target rate as soon as July.

Let’s look at the positives, which include an affirmation of robust 1Q19 GDP growth of 3.1%; record corporate earnings in 1Q19; broad, strong year-to-date market gains in 2019; and robust consumer spending of more than half a trillion dollars per month. Focus on the fundamentals and don’t try to second-guess political risk.

Please see page 7 of the Global Perspectives book for record 2019 corporate earnings expectations.

Tuesday, June 25, 2019

Special Guest Blogger: Tim Kearney

The Federal Open Market Committee changed tack towards the “dovish” end of the spectrum at its June meeting. Market-based indicators are pointing to a cut of the federal funds target rate at the July FOMC meeting, and indicating investors expect a total of four cuts over the coming 12 months. These expectations seem premature on a couple of fronts. Most important, markets are expecting a bounce-back in nonfarm payrolls as early as July 5; it is difficult to square the likelihood of continued, above-trend employment growth with the need to cut interest rates.

Interestingly, the historical data imply that the only times the Federal Reserve has cut rates by 100 basis points in a year was when the economy was already in recession. While the 2Q19 economy has slowed from the recent 3% growth path, it remains above trend, which is not usually when the Fed cuts aggressively. So before the July 31 FOMC meeting, watch the data closely (PCE deflator inflation, employment market and CPI). Don’t be surprised if the data stay the Fed’s hand a bit over the balance of the year.

For background on the fed funds target rate, please see page 34 of the Voya Global Perspectives book.

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