World markets seemed to have second thoughts about Brexit last week with bonds, stocks, and commodities all moving sharply higher, in some cases topping pre-Brexit levels. While real worries about the consequences persist, the potential benefits of lower interest rates for longer, steady if not accelerating US growth rates, and few investment alternatives seemed to at least temporarily outweigh those risks.
The US Treasury bond yields fell to just 1.46%, down from 1.8% just a few weeks ago and 2% at the beginning of the year. All of this seems to assure us that the US Federal Reserve won't be doing much, especially in the short run, which is probably what really cheered markets, especially emerging markets. Emerging markets and European markets were both up about 6% this week.
News on both the European and US manufacturing sector was excellent, while both China and Japan appeared to be struggling. Other US data was mixed. Pending home sales suggested the May spike may have been a statistical mirage as the data in June returned quickly to earlier levels, indicating existing-home sales will be going nowhere fast. Auto sales data also surprised to the downside in June, with luxury cars leading the way.
Offsetting that gloom, US GDP growth for the first quarter was revised modestly higher from 0.8% to 1.1%, and consumption data through May looked strong and even suggested an acceleration in consumer spending and consumer confidence despite months of gloomy headlines. Early trade reports for May also suggest that trade will have a neutral effect on GDP in the second quarter, with neither non-oil-related imports nor exports changing very much.
The jury is still out on the Brexit impact. Weekly retail sales saw little effect from Brexit, but auto sales unexpectedly slumped at the end of June. Headlines from forecasters on Friday morning trumpeted potential 5% year-over-year growth in unit auto sales that turned out to be less than 2% and worse than that if adjusted for selling days. However, everyone seemed to enjoy the talk of continued low interest rates and tame commodity prices.
Consumption Growth Holds Steady Even as Consumer Tastes Shift
Consumption and housing continue to drive US economic growth with little net growth elsewhere in the economy. Consumption makes up about 70% of the US economy while housing composes a smaller 4% of GDP.
The consumption news, at least through May, was very reassuring. Recall that while consumption grew in the first quarter, the news wasn't nearly as good as it has been in recent quarters, as weather, auto sales, and utility usage hit the first quarter hard, as has been the case in first-quarter reports in other years. Consumption growth, after revisions earlier this week, was just 1.5% after averaging 2.7% over the previous four quarters, though not statistically different from the 1.8% consumption growth rate of first-quarter 2015.
However, growth looks destined to rebound sharply in the second quarter, to perhaps as high as 4%. That consumption growth rate for the full second quarter could be achieved even if there was no growth in consumption between May and June.
A consumption growth rate of 4% translates into a 2.8% GDP growth rate for the second quarter with no help from the other categories. Our 3% second-quarter growth rate now doesn't seem as outlandish as it did just a few short weeks ago. All of this analysis is based on sequential quarter growth rates, annualised.
Turning to the details of the consumption report, month-to-month data increased an above-average 0.3% after inflation, despite the strong 0.8% growth experienced in April. Exceptionally good data usually reverses itself in the subsequent month. That didn't happen this time around. The growth rate matched the consensus forecast.
We prefer to look at the year-over-year data, which helps to avoid those pesky seasonal adjustment figures and puts the growth rates in a much more familiar context. It also removes a lot of the volatility. Month-to-month data has ranged from negative 0.1% to the 0.8% rate in April. As a very rough approximation, readers can multiply those monthly rates by 12 to see an annualized rate. However, the year-over-year numbers, which are less reliant on the endpoint month, have been much more stable and have generally been in the 2.5%-3% range, and sometimes just a bit higher.
Manufacturing Looking Up in the West; Asia Not So Much
Markit purchasing manager data indicated that China remains in contraction mode, at an accelerating rate, although the graph shows that Chinese data has bounced around these low levels for three years with no clear trend. The text that went with the Markit data read terribly, probably a bit worse than reality. The worst fall in four months, 32 straight months of manufacturing employment declines, fewer new orders, and falling prices, again.
All of these numbers have been in such a narrow range for so long, we wouldn't necessarily read that much into the data. Still, China's manufacturing sector is going nowhere fast.
In contrast, the more negative the IMF and the World Bank get on Europe, the faster manufacturing continues to accelerate. The acceleration has not been a one-month wonder, either, with the readings well above 50 and trending up since February.
Germany is leading the way, and only France is showing a reading below 50. Even the French number is being depressed by recent strikes more than poor demand. Exports are generally still trending up, though not uniformly through the region. Even job growth has been strong, with the largest improvement in 22 months. Unfortunately, the Brexit situation could mean that all my happy talk on the European economy is for naught. Still, with a lot of exports going outside the EU and internal consumer demand increasing, maybe pundits are overthinking this one.
