FINANCIAL NEWS HIGHLIGHTS OF THE WEEK

  • Markets had no summer vacation this week, with a new British PM, dovish message from the European Central Bank, and new U.S. GDP data to digest.
  • Advanced economy central banks are all sounding dovish, with the Bank of England likely to be more cautious next week now that the risks of a disorderly Brexit have risen.
  • Second quarter GDP data showed that U.S. domestic growth remained solid in Q2. But the Fed is likely more concerned with weakness in investment and exports as it prepares to cut rates next week.


 Summertime and the Policy’s Easy

Financial News- European Manufacturing Slowed First Now U.S. FollowsThe global economy certainly didn’t take a vacation this week. Between a new UK Prime Minister, an ECB prepared to step up the stimulus, and fresh data on U.S. growth, markets had a lot to digest. And let’s not forget the Federal Reserve is likely to cut rates for the first time in over 10 years when it meets next week. So much for the dog days of summer.

Former London mayor Boris Johnson is now Britain’s Prime Minister. Johnson faces an Oct 31st deadline to either leave the EU under the terms of the agreement negotiated by Theresa May, or face a disorderly exit without a deal. The EU had agreed that a UK election would trigger an automatic extension to this deadline, but so far the new PM says an election is off the table. How PM Johnson threads the needle on this one remains to be seen, but it is likely to be a wild ride similar to this past spring. Overall, the odds of a hard Brexit have ticked up in the last two months, and we expect the Bank of England to step back from a hiking bias at its decision next week.

The European Central Bank also hinted at easier monetary policy ahead. Further data this week pointed to a sagging European economy in the second half of the year. Consumer and business confidence have not rebounded from lows consistent with past recessions. Morever, the slump in manufacturing activity is broadening into other regions and industries. This is bad news, as it could trigger a broader pullback on spending, locking in a downward cycle.

Financial News- GDP Tally Masks Domestic Strength Our recent report discusses how this global chill has slowed U.S. manufacturing (Chart 1). This is a key reason why the Fed is likely to attempt to cushion the economy from further weakening by cutting rates a quarter point next week. There are real risks to the expansion, and the Fed needs to get in front of them. Research has shown that when policy rates are close to the zero lower bound, central banks need to act pre-emptively in the face of downside risks since they have less ammunition to combat them.

Today’s GDP report (Chart 2) showed that second quarter growth was supported by strong consumer spending. But, the Fed is likely most concerned about the slowdown in investment and the weakness in exports. For now, the consumer is strong enough to keep economic growth sturdy. And now the U.S. economy looks to get a helping hand from Washington. Congress recently agreed to suspend the debt ceiling until after the next election, and raised the spending caps, removing a key fiscal risk this fall. In fact, spending has been raised slightly higher than we assumed in our forecast, presenting a slight upside risk to growth in 2020.

Monetary policy is set to get a little easier both in the U.S. and abroad, and now U.S. fiscal policy is looking a little easier too. These factors should support growth heading into 2020 just as it was starting to look like the edges of the expansion were fraying. This seems to have put markets in a relaxed mood, just in time for summer vacations.

Leslie Preston, Senior Economist | 416-983-7053

 


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