On Wednesday and Thursday, Federal Reserve Chair Janet Yellen signalled to Congress that the US economy was in good enough shape to endure tighter monetary policy in the form of some interest rate hikes this year.
That didn’t come as a surprise to most Fed-watchers. The US labour market continues to get tighter, wage growth indicators are increasingly pointing higher, corporate profits continue to look better-than-expected, consumer sentiment remains high, and the housing market is gathering momentum.
From a global perspective, the big stories continue to be Greece and China. Some argue that Greece is a bigger story as it affects the entire eurozone. However, years of crisis and ringfencing have made the rest of Europe much more immune to contagion from Greece. This has strengthened the argument that China is the much bigger story.
“With China now accounting for more than a third of global GDP growth, it is natural to worry about spillovers to other economies,” Goldman Sachs’ David Mericle and Karen Reichgott said in a note to clients on Saturday.
Here’s your Monday Scouting Report:
About China. Years of red-hot growth have catapulted China to being the world’s second largest economy, right behind the US. But more recently, policymakers have pushed to restructure the economy so that it’s one driven by consumption rather than exports and investment. Add to that a clamp down on corruption, tighter regulation in financial markets, and a cooldown in the housing market and you’re left with a massive economy that’s decelerating much more dramatically than many were ready for.
Goldman’s Mericle and Reichgott took a closer look at what a slowdown in China could mean for US in the context of exports, finance, and commodity prices. Here’s some of what they found: “Exports to China account for less than 1% of US GDP, suggesting that the trade effect should be modest. Looking across a range of models, both our own and several drawn from other economic research, we estimate that a 1 percentage point (pp) hit to Chinese growth is likely to result in a roughly 0.05pp hit to US growth … Direct US financial exposure to China is very limited, as China accounts for only about 1⁄2% of US corporate profits and only 1⁄4% of US residents’ securities holdings. But the potential impact on US financial conditions could be somewhat more meaningful, especially the potential effect on dollar appreciation against the currencies of other emerging markets or commodity producers … Balancing these negative effects, lower commodity prices as a result of softer Chinese demand should provide a modest boost to US growth. Adding up the three channels, we estimate that a 1pp hit to Chinese growth would result in a roughly 0.06pp decline in US growth.”
- Existing Home Sales (Wed): Economists estimate the pace of sales increased 0.9% to an annualized rate of 5.4 million units. From Bank of America Merrill Lynch: “After the strong 5.1% gain in May, we expect existing home sales to slip back, falling 1.0% to 5.3 million in June. Smoothing through the monthly swings, this would still imply a modestly higher pace of activity. Pending home sales, which track signed contracts, have increased steadily since January. Moreover, mortgage purchase applications have been on a higher trend. Thus, while we expect a slight decline in June, it does not offset the gain in May and continues to point to improving home sales.”
- Initial Jobless Claims (Thurs): Economists estimate initial claims fell to 280,000 from 281,000 a week ago. Here’s Wells Fargo’s Sam Bullard: “The annual summer auto plant retooling season is underway and has, as expected, resulted in volatility in the weekly readings of initial jobless claims. We find the four-week moving average of claims to be an important measure during these volatile periods. The four-week moving average stands at a favourable 282,500 and points to further progress being made towards full employment. Note, this week’s initial claims reading marks the survey week for the BLS July employment survey.”
- Kansas City Fed Manufacturing Activity (Thurs): Economists estimate this regional manufacturing index improved to -5 in July from -9 in June.
- Markit US Manufacturing PMI (Fri): Economists estimate this manufacturing index was unchanged at 53.6 in July from 53.6 in June. From UBS’s Kevin Cummins: “Early signals of July manufacturing activity have been soft, with weakness in the Philadelphia and New York Fed surveys. Since the start of the year, the Markit PMI has been consistently stronger than the manufacturing ISM index (along with most regional factory surveys) and has overstated the trend in manufacturing output growth.”
- New Home Sales (Fri): Economists estimate the pace of sales fell 0.1% in June to an annualized rate of 546,000 units. From Bank of America Merrill Lynch: “New home sales are likely to continue to improve, increasing to 555,000 in June. The NAHB homebuilder survey has been strong, reaching a 60 level in June and July. Builders are reporting an increase in traffic, which is also consistent with the pickup in mortgage purchase applications.”
UBS’s Julian Emanuel reflects on the resilience of the US stock market: “July started out promising for the US equity market bears, as [the S&P 500] traded below its 200-day moving average for the first time since October 2014… Combined with a ‘no’ vote from the Greek people on continued European austerity and a Chinese equity market in the midst of a 35% plunge from the mid-June highs, further US market downside looked inevitable…
“However, much like Marlon Brando’s prizefighting character Terry Malloy, the bears are bloodied and have little to show for their tenacity of recent weeks … The European situation is becalmed as volatility crashes, rallying stocks across the Continent … And in China, UBS economist Tao Wang’s view that the recent equity-market decline is not a reflection of current or prospective material economic weakness has been reinforced by this week’s 7.0% 2Q GDP report.”
The S&P 500 closed Friday at 2,126, down just 0.4% from its all-time high of 2,134.
Emanuel and his team of “steadfast US equity market bulls” have a 2,225 year-end target for the S&P 500.