Global Economic Perspective: October

More Positive US Data Build Hopes for Better Performance in Second Half of 2016

As the third quarter ended, there were some encouraging signs the US economy remained on course to deliver a better showing over the second half of 2016, after the sub-trend growth seen since late 2015. Though September’s employment report came in a little shy of consensus expectations, the pickup in data elsewhere added further weight to speculation the US Federal Reserve (Fed) could announce a rise in US interest rates at its December meeting, a move that has seemed increasingly likely ever since the dissenting votes by several Fed policymakers in favor of an immediate rate hike at September’s meeting.

We would concur with this broadly positive outlook for the economy over the rest of the year, in large part due to the contribution from US consumers, whose well-being—thanks mainly to a robust labor market—was apparent in one measure of consumer confidence during September, which hit its highest level in nine years. The strength of job creation is likely to slow as the economy nears its perceived level of full employment, and thus we think the boost to growth from consumer spending may moderate a little in future quarters, but we are encouraged uncertainty surrounding the forthcoming US elections has not appeared to weigh on consumers thus far.

Just as August’s weakness in the Institute for Supply Management’s purchasing managers’ indexes (PMIs) for services and manufacturing had unsettled investors, their strong rebound in September boosted confidence that the US economy was not entering a soft patch. The services PMI was particularly healthy, jumping to its highest level in nearly a year. The details within the services report hinted at ongoing strength in future months, as new orders rose significantly, while the employment component of the index for this part of the economy climbed at its fastest rate of growth in 12 months. The equivalent report for manufacturing also beat consensus expectations, moving back above the 50 level that divides expansion from contraction. New orders were again the standout, regaining most of August’s hefty fall, and overall the report suggested the manufacturing sector could be modestly strengthening after its previous difficulties caused by lower overseas demand, a stronger US dollar and a decline in energy investment. As a result of the positive data on both areas of the economy, many market participants concluded the weakness in the August reports was likely to have been an outlier and unreflective of the economy’s underlying strength.

September’s employment report was a touch softer than forecast but did little to move the dial on interest-rate expectations. Jobs added from a month earlier totaled 156,000, with the below-expectations result partly due to the largest drop in government employment in a year and as education jobs were scaled back. The unemployment rate inched up to 5.0%, but the 0.1% rise from the prior month was due to a positive move in the labor force participation rate, which rose to a six-month high of 62.9%. Wage data again failed to reflect the robust job market, as average hourly earnings rose by 0.2% from August, undershooting expectations of a 0.3% increase. However, there was better news from the annual figures, which showed wage growth quickening from 2.4% to 2.6%.

Offsetting the strong consumer confidence and PMI data were some weaker numbers, with consumer income and spending for August coming in softer than generally expected. Income rose just 0.2% from the previous month, and consumer spending was unchanged over the same period. Retail sales fell 0.3%, and once adjusted to exclude autos and gasoline, they also shrank by 0.1%, the second consecutive monthly decline for this core measure.

Market sensitivity to inflation data remained minimal, suggesting the long period of negligible pricing pressures had persuaded most investors any risks from inflation were well contained. Nevertheless, in August the core personal consumer expenditures price index—the Fed’s favored inflation measure—inched closer to the US central bank’s 2% inflation target, ticking up to 1.7% year-on-year (y/y). Based on the Consumer Price Index, US core inflation showed the largest monthly rise since February, pushing the annual rate up to 2.3%.

Despite the potentially hawkish inference from September’s split vote among Fed policymakers, Fed Chair Janet Yellen pointed out at the meeting the economy showed little sign of overheating, adding to perceptions dovish members of the rate-setting committee retained their sway. The Fed reduced its forecasts for growth and the federal funds target rate, and in doing so underlined how policymakers’ perceptions of the likely appropriate monetary policy setting have shifted lower during the year-to-date. Growth predictions for the current year were cut from 2.0% to 1.8%, while the longer-run growth rate was also trimmed to 1.8%, and the Fed’s median interest-rate projections for 2017 and 2018 were accordingly reduced from 1.6% to 1.1% and from 2.4% to 1.9%, respectively. Some analysts have noted any dovish tilt to Fed policy may receive further support following the rotation of committee members scheduled for later this year, due to the seemingly dovish tendencies of the new joiners.