HIGHLIGHTS OF THE WEEK
- It was a good start to the week for U.S. equities, with stock prices boosted by another round of strong earnings reports and a weakening in the US dollar to its lowest level in over a year. However, these gains were offset by dips in health care and tech stocks by Friday afternoon.
- As expected, the FOMC voted unanimously to leave its benchmark rate unchanged, while signalling that the balance sheet normalization process will likely begin in October.
- The American economy accelerated in Q2, returning to a slack-absorbing pace of 2.6% growth, led by strength in consumption and private fixed investment.
Growth Accelerates in Q2
It was a good start to the week for U.S. equities, with stock prices boosted by another round of strong earnings reports. Consumer discretionary and staples led the sectors in performance, a reflection of the increasingly important role that consumer spending is having in lifting growth. Energy stocks also posted large gains, helped by a rebound in the price of oil amid Saudi Arabia’s commitment to restrict oil exports in August and another bullish U.S. inventory report (Chart 1). By the end of the week, the weighty tech and health care sectors offset these gains. A weakening in the USD provided support for equities, notably early in the week, while European indices were weighed down by an appreciation in the sterling and the euro vis-à-vis the greenback –which fell to its lowest level in over a year.
The dollar did not get much support from the FOMC. As expected, the Committee voted unanimously to leave its benchmark rate unchanged, but the policy statement highlighted a dovish turn, with the Committee appearing more concerned about the tepid inflation data. This led markets to push out Fed hike expectations. Despite this, the Committee expressed their intention to begin the process of balance sheet normalization “relatively soon”. This is likely to be announced at the FOMC meeting in September, with run-off to begin in October. However, another rate hike is unlikely until at least the end of the year. We expect that a December hike may yet happen, but such an outcome depends on inflation firming in the coming months. Many of the disinflationary pressures appear to be transitory in nature, with cell phone discounts, lower commodity prices, and falling prices of imported goods related to past US dollar strength. But these pressures should ease in the second half of the year, while the USD upside potential remains limited for three reasons. For one, the Fed’s rate hike trajectory looks to be more gradual than previously communicated. Secondly, the balance sheet normalization will have a smaller currency impact than an equivalent rate increase, and lastly, strengthening global economies should allow central banks such as the ECB and BoE to pare back supportive monetary policy measures. Second quarter data supports this view, with both French and Spanish economies having expanded at a healthy pace in Q2.
The American economy also accelerated in the second quarter, largely as expected, returning to a slack-absorbing pace of growth (Chart 2). Led by strength in consumption and private fixed investment, the second quarter saw the economy expand by 2.6%. The consumer’s role in Q2 growth was highlighted by strength in spending on goods after a weak showing at the start of the year. And with job and income growth remaining strong, there is room for further advancement on this front over the remainder of the year.
Remaining top-tier domestic data releases this week telegraphed a mixed picture of the housing market. Existing home sales pulled back to a still healthy 5.52 million (annualized) as lack of inventory and eroding affordability prevented purchases. At the same time, new home sales ticked up 9.1% from a year ago, suggesting that demand remains intact. We look forward to next week’s bevy of reports that should clarify how the economy has done in the first month of the third quarter, with the employment, income & spending, and ISM survey reports being top of mind, as we seek confirmation that economic momentum remains robust during the third quarter.
Katherine Judge, Economic Analyst
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