2016 | www.selectasset.com
September 2016 Market Update
At the end of August, global economists began focusing attention on reports coming out of the U.S. Federal Reserve Board of Governors, as speculation grew regarding the possibility of another increase in interest rates. On August 21, Board Vice Chair Stanley Fischer said “We are close to our targets,” when referring to the Fed’s dual mandate to aim for maximum sustainable employment and an inflation rate of 2%, as measured by the price index for personal consumption expenditures (PCE). Employment, he reported, has increased impressively over the last six years and unemployment has hovered around 5% since August 2015. Core PCE inflation is now at 1.6% while core consumer price index inflation is currently over 2%. All the positive numbers have come in spite of numerous economic shocks ranging from the Greek debt crisis to Brexit. But Fischer also pointed out that that U.S. “GDP growth has been mediocre at best” over the four quarters ending this spring and labor productivity growth has been “exceptionally slow” from 2006 to 2015. Board Chair Janet Yellen painted a slightly different picture on August 26 when she said, “I believe the case for an increase in the federal funds rate has strengthened in recent months.” Yellen also said that the Federal Open Market Committee expects moderate GDP growth to continue along with strengthening employment, but qualified her statements by saying “the economic outlook is uncertain, and so monetary policy is not on a preset course.” Perhaps in response, U.S. stocks closed higher at the end of the month with banks and other financial institutions making the most gains. Maybe it's a sign that markets are anticipating a rate increase before the end of the year.
Two months have passed since the UK voted to leave the EU. Initially, the Brexit vote rocked Britain’s economy as the value of the pound dropped sharply against the U.S. dollar and other currencies. Initial surveys reported plunging consumer and business confidence. In response, on August 4, the Bank of England cut interest rates by a quarter point, to 0.25%, expanded its quantitative easing scheme and introduced new funding for banks. Since then, the picture has changed. Recent market data indicates that retail sales grew 1.4% in July, far more than expected, and unemployment decreased. This contrasts with a report by the well-respected GfK (Gesellschaft für Konsumforschung), Germany’s largest market research institute, stating that consumer confidence in the UK has experienced its biggest drop since 1990, which has many economists wondering aloud if standard forecasting metrics are even applicable today. In the meantime, Britain’s annual GDP growth rate, last forecasted as 2.2% in the second quarter by the Office for National Statistics, is now predicted to be 1.2% by the end of this quarter. Unemployment is expected to rise from 4.9% to 5.1% and inflation is expected to increase from 0.6% to 0.8%, with the core inflation rate moving from 1.3% to 1.5%. The UK’s Balance of Trade is expected to be minus GBP 4645 million by the end of this quarter. Overall, the value of pound, relatively stable one month after the Brexit vote, decreased only 1.10% during August to trade at about USD 1.30. Ironically, given the Brexit referendum, Britain’s Department for International Trade reported at the end of August that a record number of investments (2,213) were made in the UK by foreign firms during the year ending in April 2016 (up 11% from the previous year), making the UK the most popular trade point of entry to the EU. One of the highest profile foreign deals was the July purchase of UK computer chip designer ARM Holdings by Japan's Softbank for GBP 24 billion.
Brexit seems to have had negligible effect on business in the Eurozone so far. The composite IHS Markit survey (which includes manufacturing, services and construction) for August indicated that GDP would continue to grow across the 19-country Eurozone at 0.3% per quarter and at 1.2% for the year. However, conditions vary widely from country to country. France has returned to growth, while its unemployment dropped below 10% for the first time since 2012. In Germany, strong exports by manufacturers offset a slowdown in services. However, political and financial instability are plaguing several countries. In Italy, the total value of non-performing bank loans are now said to be about USD 406 billion (almost double the amount reported a month ago), which almost one-fifth of the country’s GDP. Though measures have been taken to rescue Italy’s most severely endangered banks, long term handling of nonperforming loans (NPLs) poses a real challenge because, unlike NPLs in Britain, Ireland and Spain, which are largely collateralized by real estate, Italian NPLs are mostly uncollateralized loans to small businesses and consumers. For example, Spain has fared better by taking advantage of a weaker euro and looser fiscal policies to expand exports and grow its economy by 0.7% in the second quarter. Yet, Spain still faces sanctions from Brussels. In Greece, one year after receiving its third bailout package, government debt is 180% of GDP, unemployment is just under 24% (the highest in Europe), and half a million people (out of a total population of 11 million) are believed to have migrated to escape severe economic conditions. According to media reports, fewer Greek consumers are confident that conditions will improve anytime soon and anti-EU sentiment is on the rise.
Japan, the world’s third largest economy, continues to struggle with a stronger-than-desired yen and weaker-than- desired trade with China and other markets. The government of Prime Minister Abe continues to pledge that his Abenomics plan will produce results, although, according to the media, skepticism abounds. In mid-August the government reported that exports in July decreased 14% from the previous year, but an even larger drop of nearly 25% in imports managed to produce a trade surplus of 513.5 billion yen (compared to a deficit of 261.4 billion yen in July 2015). Most economists agree that the strong yen has helped to reduce the cost of oil and gas imports, which have fallen 42%, but the general mood remains very cautious. Perhaps anticipating difficulties ahead, the government announced, on August 2, a fiscal stimulus package of 13.5 trillion yen (including cash payouts to low-income earners and infrastructure spending). Unfortunately, the latest GDP figures released by Japan’s Cabinet Office in mid-August revealed no growth for the quarter ending in June due to slower than expected private consumption and government spending and decreases in capital expenditures and exports. Calculated on an annual basis the economy is expected to grow by only 0.2% in 2016, far below the expectations of the Abe cabinet. However, the rate of unemployment fell to 3%, to its lowest since 1995. Nationwide, for the firth straight month, consumer prices fell 0.4% year-on-year in July. In Tokyo they also fell 0.5% in August. In industrial manufacturing, Japan’s aerospace sector suffered a slight setback when air conditioning trouble forced Mitsubishi Aircraft to halt tests of its new regional passenger jet, the first all Japanese-made passenger plane in nearly 50 years. The company claims it will still deliver its first of 407 orders on schedule in 2018.