Strong US economy showing few signs of trade concerns

The US economy has continued to perform well on many fronts, with positive readings for growth, employment and inflation. In terms of growth, the stimulus effect from tax cuts was clearly visible in second-quarter 2018 data, and could be maintained for at least another quarter, in our view. We would expect to see a gradual rise in both wage growth and the rate of inflation, as companies respond to labour market shortages and try to push through price increases. We believe the main uncertainty facing the economy remains the ultimate impact of the Trump administration’s trade policies. As the mid-term congressional elections approach—and with little sign of negative economic or political consequences domestically from President Donald Trump’s actions thus far—any tempering of his administration’s unilateral agenda on trade seems unlikely.

The bank of Japan’s move could indicate a more significant monetary shift

The monetary policy changes announced by the Bank of Japan (BoJ) in July may have appeared minor, but we would argue their significance should not be underestimated. Understandably, the Japanese central bank remains keen to avoid sparking the market volatility that an overt move towards a less accommodative stance would likely trigger. But a widening of the trading band for Japanese government bond (JGB) yields could indicate the BoJ is not impervious to the moves of its peers, and indeed that its broader aims may have changed. From a wider perspective, any such change of stance by the BoJ—albeit at the margin—could spill over into other markets, possibly reducing the impetus towards flatter yield curves that has been such a feature of global interest rates in recent years.

Domestic strength underpins growth in Eurozone despite trade headwinds

With growth in the eurozone still at a reasonable level, the path for the European Central Bank (ECB) to cease its bond purchases at the end of 2018 looks relatively clear, in our view. Domestic fundamentals are strong in several countries, most importantly Germany, and a slight lessening of trade tensions between the European Union (EU) and the United States—which had been creating something of a headwind—may help to bolster sentiment amongst European businesses. But we think the ECB is wise to retain some flexibility over the timing of its transition to more conventional monetary policies. The central bank has voiced concerns about the impact of the Turkish crisis on some European lenders. Additionally, volatility can be exaggerated at this time of year, as shown by the extent of recent moves in Italian bond markets.

Strong US economy showing few signs of trade concerns

The US economy has continued to perform well on many fronts, with positive readings for growth, employment and inflation. In terms of growth, the stimulus effect from tax cuts was clearly visible in second-quarter 2018 data, and could be maintained for at least another quarter, in our view. We would expect to see a gradual rise in both wage growth and the rate of inflation, as companies respond to labour market shortages and try to push through price increases. We believe the main uncertainty facing the economy remains the ultimate impact of the Trump administration’s trade policies. As the mid-term congressional elections approach—and with little sign of negative economic or political consequences domestically from President Donald Trump’s actions thus far—any tempering of his administration’s unilateral agenda on trade seems unlikely.

Second-quarter gross domestic product (GDP) data provided confirmation of the current favourable conditions for the US economy. The annualised growth rate of 4.1%—the quickest pace of expansion in four years—was boosted by higher consumption and investment, as tax cuts passed late in 2017 stimulated spending. The figures also contained some evidence of changes in trade patterns due to concerns amongst overseas customers about future tariffs, particularly relating to agricultural products. A near 10% rise in exports during the second quarter was driven by a sharp increase in soybean and corn shipments. Overall, trade accounted for nearly 1% of the increase in GDP, although much of this effect was offset by a decline in inventories. A reversal of these effects could occur in the next quarter, should distortions due to tariff concerns be unwound.

Consensus third-quarter GDP estimates remained close to 3%, and the statement from the US Federal Reserve’s (Fed’s) July meeting reflected the steady flow of positive data. Growth, spending, investment and the labour market were all deemed by policymakers to be strong. Interest rates were left on hold, but the Fed’s messaging bolstered widespread expectations amongst market participants that the year’s third rate increase would likely occur in September.

Earlier, some attention was given to Fed Chair Jay Powell’s use of the caveat “for now” in comments referring the central bank’s policy of continued rate increases. In the remarks, he flagged the potential risks from protectionism, stressing that the outcome of trade disputes would play a significant part in determining the future course of the economy. Early in August, the US and China announced further tariffs on the other’s imports, increasing the total amount affected to US$100 billion. Uncertainty over trade was reflected in the fed funds futures market, which pointed to a fourth rate rise in December, but indicated a pause until June 2019 before a subsequent rate hike was likely to occur.

July’s Institute for Supply Management survey of US manufacturers suggested their level of activity remained solid, if somewhat constrained by labour shortages, supply chain issues and rising input costs—in some cases including sharp hikes in tariff-affected steel and aluminium prices. During a strong second-quarter earnings season, a number of companies expressed confidence in their ability to recoup some of these higher costs through price increases.

There were some signs access to credit was becoming easier, as occurred in the later stages of the previous economic cycle. Though overall business and consumer credit conditions remained relatively tight, the Fed’s latest survey of senior loan officers indicated a moderate share of banks have been easing standards in some categories of residential real estate loans. Combined with a set of sharp upward historical revisions to the US savings rate, such a development appeared to increase the possibility consumer spending could maintain the strong trend seen in recent quarters.

Elsewhere, US inflation data were mixed. Wage growth was unchanged at 2.7% year-on-year (y/o/y) in July’s labour market report. It failed to respond to the solid pace of job creation, which maintained momentum to show an average of roughly 224,000 positions added over the past three months. The June reading for the Fed’s favoured gauge of inflation, the core personal consumption expenditures price index, stayed at 1.9% y/o/y, remaining just shy of the central bank’s 2% target for the third consecutive month. However, July’s core Consumer Price Index data beat consensus forecasts, with an annual rise of 2.4% marking its highest point since 2008. Expectations in the Treasury Inflation-Protected Securities market for the path of inflation generally held steady despite the strong economic data, as the relatively high readings in August and September of 2017 looked set to have a potentially dampening effect on y/o/y calculations in the coming months.