By Lance Gaitan
The Bank of Japan (BoJ) shook the global credit markets last Tuesday.
Even Treasury bond investors perceived the BoJ’s tweaks to its monetary policy as a signal that the transition away from extraordinarily accommodative measures may be coming.
The BoJ introduced forward guidance and will allow the 10-year government note to trade in a slightly wider band.
The central bank didn’t change its plan to purchase assets (quantitative easing) or key interest rates.
With core inflation hovering around 0.8% and the BoJ targeting 2%, don’t expect the central bank to scale back its security purchases anytime soon.
Harry has written about Japan’s demographic problems for decades and has explained why there’s really no way for the central bank to fix these issues.
I’m not sure why global interest rates shot higher in response to the BoJ’s tweaks, but they did.
The market’s animal spirits sometimes work in mysterious ways.
London Calling
Last Thursday, the Bank of England (BoE) increased its key interest rate by 25 basis points to 0.75%.
The move didn’t come as a surprise. At 2.4%, inflation had crept above the BoE’s 2% target. That said, the Brexit fallout could damage the UK’s recent economic recovery.
Further rate hikes aren’t expected until next year, if the recovery continues and if the Brexit process is resolved in an orderly fashion.
Those are a couple of big “ifs,” but the markets didn’t react much to the BoE’s actions.
Exporting Inflation
What do we take away from the BoJ and BoE’s recent policy decisions?
The Federal Reserve’s efforts to normalize monetary policy and shrink its balance sheet have started to export inflation to economies around the world.
Will it persist?
It’s too soon to tell, but we’ll keep an eye on the situation – and alert you to any trading opportunities that emerge.
The Fed Holds Steady
As expected, the Federal Reserve held rates steady at its most recent meeting.
However, market participants did receive a signal that another hike is on the horizon.
The Fed upgraded its view of the economy from “solid” to “strong” and noted that consumer spending has “grown strongly.”
That’s based on the robust, preliminary estimate of economic growth that came out last Friday.
It’s not a lock that the Fed will hike interest rates in September, but the market has already priced in another bump.
Meanwhile, the housing market has started to show some initial cracks in the foundation. That trend bears monitoring.
Trading Tariffs
Aside from worsening housing data, President Trump’s escalating war of words and tariffs with China and the rest of the world remains a big concern and creates a lot of uncertainty.
Stocks sold off sharply last week, after Trump threatened to increase the 10% tariff on $200 billion worth of Chinese goods to 25%. His reasoning: China is playing currencygames to negate the original tariffs.
Inflation Watch
Last Tuesday, the U.S. Bureau of Economic Analysis released data on personal income and outlays for June.
Consumers continue to spend, but incomes have increased at a similar pace – 0.4% on the month. Both figures were in line with expectations.
The Fed’s preferred inflation gauge – the personal consumption expenditures (PCE) index – pulled back in June.
Month over month, inflation grew by 0.1%, as expected.
However, core inflation, which excludes volatile food and energy prices, came in at 0.1%, which was below the consensus estimate.
On a year-over-year basis, inflation fell to 2.2% from 2.3%. Core inflation also slipped to 1.9% from 2%.
The market didn’t react to the PCE data, perhaps because the Fed’s policy statement was slated to come out that afternoon.
I expect a big reaction if this week’s consumer inflation data falls short of expectations.
Manufacturing Slows
A slowdown in manufacturing didn’t move the markets, either.
The Institute for Supply Management’s (ISM) manufacturing index fell from a blistering 60.2 in June to 58.1 in July. As a reminder, readings above 50 indicate an expansion in manufacturing activity.
Orders slowed, but demand remained strong. Backlogs weakened somewhat, and production eased. However, U.S. manufacturing industries appear to be in good shape.
Not surprisingly, participants in the ISM survey cited the trade wars as a major concern.
The Main Event: Employment Data
The July employment data released last Friday turned out to be a mix of good and bad news.
Whereas the consensus estimate called for the U.S. to add 193,000 non-farm jobs last month, payrolls increased by only 157,000.
On the plus side, the Labor Department tacked on 35,000 new jobs to June’s non-farm payrolls, taking some of the sting out of the disappointing July data. The unemployment also rate fell to 3.9%, as expected.
Wage gains were more important to the Fed and market participants.
The good news is that monthly hourly earnings met expectations, growing by 0.3%; the bad news is that last month’s earnings growth estimate was cut in half to 0.1%.
Year over year, earnings grew by 2.7%, the same as last month.
Overall, the jobs report was just okay and probably won’t prompt the Fed change its policy course.
Lance