GDP Grows Fastest Pace in Four Years, Fannie Mae Tests LIBOR Replacement

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The markets wrestled with strong headline 2Q U.S. GDP data last week, positive trade chatter between the U.S. and EU coupled with mixed earnings results from some of the biggest companies within the equity indices. The mighty Facebook suffered its biggest one day decline last week since its IPO, losing about $100 billion in market value on the back of disappointing earnings and outlook. Twitter and Intel followed suit with lackluster results.

On the flip side, the behemoth, Amazon, hit record highs after results reflected the company more than doubled some analysts’ predictions of its second-quarter earnings per share. Market practitioners expect earnings from the S&P 500 to rise 22.6% in the second quarter relative to earlier estimates of 20.7%. The index closed the week higher and was trading at 2,818 at the time of this writing.

The overall positive sentiment did not go unnoticed in the bond markets. Ten-year Treasury yields closed the week higher and were trading around 2.962% at the time of this writing.

This week, central banks globally will take center stage with the Federal ReserveBank of Japan and Bank of England scheduled to share their current monetary policy outlook (see more below). The central banks will have to share the spotlight with a number of key data releases including July unemployment data to be released in the U.S. and abroad and key inflation indicators.

I.   U.S. Economic Data

  • GDP grew at 4.1% in the second quarter, the fastest pace in four years
    • Both a bounce in consumer spending and net exports largely fueled the data. Consumer spending comprises about two-thirds of U.S. GDP.
    • The data reflects a robust economy, particularly compared to the same time period last year (2Q 2017), which resulted in growth at 2.8%
    • The housing sector continued on its decline, with residential fixed investments falling for the second consecutive quarter. Higher mortgage rates and changes in the tax code partly attributed to the 1.1% rate decline in the second quarter.
    • Economists predict that GDP growth will wane for the rest of the year with some predicting 3% and 2.9% output for the third and fourth quarters respectively. The New York Fed released its third-quarter outlook on Friday predicting a 2.83% annualized growth rate relative to a week ago when the prediction was closer to 2.38%. Robust durable goods data released early prompted the upward revision.
  • Housing Sector – the housing sector seems to be cooling given a slew of lackluster data. Existing home sales continued its decline, dropping in June for a third consecutive month at 5.38 million. Further new home sales are running at the slowest pace in eight months as inventory has steadily increased. Prices for existing homes resulted in a 6.4% increase in May, the smallest y-o-y uptick since early 2017.
  • Consumer Confidence dropped to a six-month low in July as potentially higher inflation and trade tensions linger. July’s Michigan sentiment report resulted in a 97.9 reading compared to the previous month’s reading of 98.2

II.   Fannie Mae sold about $6 billion in adjustable-rate securities based off of SOFR, the Secured Overnight Funding Rate (LIBOR’s suggested replacement), last week. The bonds had maturities ranging between six to 18 months.

  • The robust demand reflects the market’s move and potential comfort towards LIBOR’s replacement
  • Fannie Mae serves on the advisory group of the Alternative Reference Rate Committee convened by the Fed in 2014 to find a replacement for LIBOR

III.  Trade Chatter: After a meeting between President Trump and European Commission President Jean-Claude Juncker, it appeared that they would hold off on further tariffs and begin discussions on eliminating trade levies and subsidies. The two sides provided no conclusion, but rather signaled a deal was predicated on negotiating in good faith.
Separately, the U.S. Senate unanimously cut tariffs on various goods made outside of the U.S.,  nearly half of which are reportedly made in China.
A possible agreement may be underway between the U.S. and its NAFTA trade partners in August. Further details have yet to be disclosed.

IV.  Other

  • ECB – as widely expected the ECB left its key rate unchanged at its policy meeting late last week. The Euro was largely unchanged on the back of the meeting. Key takeaways included:
    • The Bank’s quantitative easing program will wind down by the end of 2018.
    • The bank reaffirmed its stance on leaving rates unchanged through the summer of 2019
    • Despite uncertainty regarding trade, ECB President Draghi reaffirmed the Eurozone’s strong economic footing
  • The Bank of Japan – intervened twice last week to buy bonds to help push government yields lower. The recent rise in JGB yields (to 18-month highs as of Friday) has partly been driven by speculation that the BoJ will be pulling back its stimulus program. The BoJ is scheduled to meet this week (see below) and is expected to keep rates unchanged.
  • China – While trade disputes between the U.S. and China linger, China is taking a more proactive approach to boost growth. Such Chinese measures include increased infrastructure spending, tax cuts and potentially easing capital requirements for Chinese banks to boost lending.

This week:
A slew of data and key events are scheduled throughout the week, including three key central bank meetings at home and abroad. While the market largely expects the Fed to keep rates unchanged at this meeting, the market will pay close attention to any key tweaks to the policy statement.

Similarly, the Bank of Japan will likely leave its key rate unchanged, due to weak inflation, despite reports the bank might consider changing its interest rate targets. In contrast, the Bank of England is largely expected to raise rates, with the market pricing an approximate 80% chance of a 25 basis point rate hike as of this writing, on the back of tightening labor markets and increased inflationary pressures.

Other key data/events include

  • German CPI data (Monday)
  • JPY unemployment data (Monday)
  • BoJ Rate Decision (Tuesday)
  • Eurozone Q2 unemployment/CPI data (Tuesday)
  • U.S. core personal consumption expenditures (Tuesday)
  • AUD trade data (Thursday)
  • BoE Rate Decision (Thursday)
  • U.S. July unemployment data (Friday)

U.S. Economic Data includes:
Pending Home Sales (Monday), Dallas Fed Manufacturing Business Index, personal income (Tuesday), core personal consumption expenditures, personal spending, Chicago PMI, S&P/ Case Shiller Home Price index, ISM Manufacturing (Wednesday), July ADP unemployment change, ISM prices paid, FOMC meeting, weekly jobless claims (Thursday), factory orders, July jobs data (Friday), June trade balance

Overseas Economic Data includes: Swiss KOF leading indicator (Monday), GBP Mortgage Approvals, EUR business climate, German Harmonized Index of Consumer Prices, NZD building permits, GBP Gfk consumer confidence, JPY July unemployment data, AUD HIA New Home Sales (Tuesday), CNY non-manufacturing PMI, NBS manufacturing PMI, AUD building permits, BoJ rate decision, German retail sales, French CPI, Spanish GDP, German unemployment, Italian unemployment, EUR Q2 GDP, EUR July CPI, EUR June Unemployment, Italian GDP, CAD GDP, NZD Q2 Unemployment data, CNY Caixin Manufacturing PMI (Wednesday), German/EUR/GBP/CAD July Markit Manufacturing PMI, JPY foreign bond and equity investments, AUD June Trade data (Thursday), Swiss retail sales, GBP PMI construction, Swiss SECO consumer climate, BoE rate decision, AUD retail sales (Friday), Swiss CPI, CNY Caixin China Services PMI, German/EUR/GBP/Spanish Markit Services PMI, German/EUR Markit PMI Composite, CAD trade data