Not Exactly Summer Doldrums!
By Nan Wang | August 22, 2017
Global equity markets had a volatile two weeks in August. Early last week, markets bounced back after tumbling for a few days due to heightened tension between the U.S. and North Korea. U.S. retail sales in July showed surprising strength, with 10 of 13 major retail categories showing gains, including department stores and building materials outlets. Overall sales climbed 0.6% versus the estimate of 0.3%. The U.S. job market remains solid with jobless claims decreasing to the lowest level since February. Last Thursday, major stock indices declined after the U.S. political turmoil and the terrorist attack in Barcelona.
The July FOMC meeting minutes were released last Wednesday. Despite continued concern for low inflation, discussions indicated a high likelihood of a balance sheet reduction plan announcement at the September meeting. The currently low inflation rate, as measured by the Price Consumption Expenditure (PCE), of 1.5 percent in the strong job market is counterintuitive. Two key drivers of low inflation are globalization and improved technology.
While some members still expect inflation to reach target of 2% in the medium term, according to the FOMC minutes, “Many participants, however, saw some likelihood that inflation might remain below two percent for longer than they currently expected, and several indicated that the risks to the inflation outlook could be tilted to the downside.” Ten-year Treasury yields fell five basis points, to 2.22 percent immediately following the meeting minutes release.
On the political front, several CEOs including those of Intel Corp, Merck & Co Inc and Under Armor Inc resigned from the President’s business councils to protest Trump’s handling of the tragic event in Charlottesville, Virginia. Trump responded by disbanding two high profile business councils, the American Manufacturing Council and Strategic and Policy Forum. After the violent incident where a car driven by a suspected white nationalist rammed into counter protesters, resulting in one death and 19 injuries, Trump commented “there is blame on both sides” and that there were “very fine people” on both sides. His lack of condemnation of the neo-Nazi group has disturbed many top executives. Losing business leaders support could threaten Trump’s policy agenda, but likely corporations will still support tax reform and infrastructure spending as these policies are pro-business.
Last Thursday, the ECB also released meeting minutes. Committee members are concerned over the strong euro, which could undermine efforts to restore price stability in the
euro zone. This month, the euro reached its highest level against the dollar since January 2015. While eurozone gross domestic product (GDP) grew 0.6 percent quarter-over-quarter, inflation of 1.3 percent is still below the ECB’s target of close to two percent. Officials kept the wording on policy unchanged, Draghi commented that discussions about quantitative easing policy will be held off until after the summer.
Looking ahead to the reminder of the year, investors will continue to watch central banks’ movements around the world. Despite concerns over the bond market in a rising rate environment, fixed income investments have shown steady performance year-to-date. Even though we live in a time of tightening monetary policy, that does not necessarily imply a bear bond market.
While central bank policy affects short-term rates directly, long term yields are mostly determined by market sentiment. Persistently low inflation or adverse geopolitical events will drive up demand for safer investment vehicles. Therefore, one should not overlook the diversification effect of fixed income in the overall portfolio. That being said, in the tightened spread market, security selection is especially important to control risk while gaining stable income. Furthermore, inaccessibility to most fixed income issues by retail investors makes a stronger case for professional money management.