U.S. Economic Activity Heats Up, First Swap With LIBOR Replacement Printed


The market had plenty to digest last week, between strong economic data out of the U.S., which further affirmed Fed Chair Powell’s upbeat outlook on the economy (Powell presented his semi-annual testimony to Congress last week) and the Fed’s path towards gradual rate hikes. 

As earnings season has kicked off, the market has largely expected strong results with some analysts predicting earnings to increase by up to 20% last quarter. Nearly ten percent of the S&P 500 released their second-quarter earnings and Q2 results have been up by roughly 23%.

Though corporate earnings were mostly positive, equity markets ended the week lower with the S&P 500 down 2.66 points to 2,801.83. Treasury yields bear steepened with the ten-year note increasing by nearly 5 basis points and was trading around 2.958% at the time of this writing. Oil ended the week down 0.25% with WTI trading at 68.09. U.S. oil production hit 11 million barrels per day for the first time mid-week.

Finally, the first over-the-counter swap based off of LIBOR’s replacement, the Secured Overnight Funding Rate (“SOFR”), traded according to LCH, a global clearinghouse (see more below).

I. U.S. Economic Data

  • June Retail Sales came in line with expectations, rising 0.5%, fueling prospects for strong 2Q GDP results to be released this week.
  • May retail sales data was revised upward to 1.2% from 0.8%. Tax cuts in part propelled consumer demand. Further, low unemployment and stronger consumer confidence on the back of a robust economy also drove spending. 
  • Fed’s Beige Book reflected concerns by manufacturers across the country regarding tariffs and increases prices and supply chain disruptions. Tightening labor markets was also reflected in the report, with wage growth moderating and/or remaining on the balance.
  • Weekly jobless claims – U.S. jobless claims fell to a near five-decade low at a seasonally adjusted level of 207k.
  • Philadelphia Fed Manufacturing surprised on the upside climbing to 25.7 in July (vs. market expectations of 22) and relative to a June reading of 19.9. The report reflects activity within the manufacturing sector.

II. Fed Chair Powell’s semi-annual Monetary Policy report: the chairman delivered a relatively upbeat outlook on the economy, which comes as no surprise, given the recent slew of positive data. Powell reiterated the Fed’s path towards gradual rate hikes. Other takeaways included: 

  • While prolonged higher tariffs for a broad range of goods and services would be bad for the economy, if the Trump Administration’s trade policies ultimately result in lower tariffs overall – this may be a positive for the U.S. and its trading partners.
  • Recent tax reforms implemented will serve as a boon to GDP over the next few years.
  • With the appropriate monetary policy, the job market will remain resilient and inflation will stay near 2% over the next several years. 
  • The risk of the economy unexpectedly weakening is on balance with any faster economic growth than currently anticipated.
  • Treasury yields across the curve moved higher on the back of Powell’s testimony, while the likelihood of two further rate hikes this year increased.

III. First OTC Swaps executed based off of SOFR, LIBOR’s replacement

  • While not many details were provided regarding the trades, Goldman Sachs, J.P. Morgan, and Credit Suisse were among the first participants to clear the swaps based off of the new rate.
  • Fed Official Randal Quarles supports the new index and suggested that the Fed could publish a compounded average of SOFR, (suggesting the average rate be called SAFR – secured average financing rate) to further build confidence in the index, in a speech last week.
    • Quarles also noted that LIBOR’s liquidity has become “extraordinarily thin” and argued that there are more transactions currently underlying SOFR than LIBOR.
    • At the time of this writing, SOFR was 1.90% and one-month LIBOR was at 2.08625%, an 18.625 bps spread between the secured and unsecured rate.

IV. Other

  • China’s GDP for the second quarter grew 6.7% y-o-y slightly below expectations of 6.8%. It is the lowest reading for China since 2016.
    • While escalating trade tensions have not impacted economic growth as of yet, future GDP readings could be impacted starting with the manufacturing and logistics services sectors. Some economists predict the impact of trade tariffs will not trickle into GDP readings until early next year. The U.S. comprises about 20% of China’s total exports. 
    • China’s industrial production for June was also weaker-than-expected at 6% relative to expectations of 6.5%.
    • China’s Commerce Ministry reportedly filed a complaint to the World Trade Organisation over the Trump Administration’s proposed levies on $200 billion worth of Chinese goods.
  • U.K. unemployment remained steady at 4.2%, while wage growth slightly dipped to 2.5% between March and May from the previous three-month reading of 2.6%.
    • While addressing parliament, BoE Gov. Carney noted that a no deal regarding Brexit could have big economic consequences and prompt the BoE to reassess its monetary policy and economic outlook. 
    • UK retail sales dropped unexpectedly by 0.5% in June, although sales growth for the second quarter was the strongest since February 2015.
    • BMA believes the BoE will hike at its meeting next month given economic fundamentals coupled with the likelihood of the UK coming to a trade agreement with the EU.
  • Canadian retail sales and inflation data from the Bank of Canada surprised to the upside and is likely to keep the pressure on the BoC to raise rates again this year.
    • President Trump noted he may pursue separate trade deals with Canada and Mexico, casting doubt on the viability of the North American Free Trade Agreement.

This week:

  • A hearing will be on held on Tuesday, July 24 regarding tariffs on $16 billion of Chinese products while the U.S. House of Representatives will have a hearing on exclusions for steel tariffs.
  • Major data releases are scheduled towards the latter half of the week. All eyes on second-quarter U.S. GDP data scheduled for Friday to see if it is in-line with the Fed’s expectations for growth. The Fed’s key inflation indicator, the Personal Consumption Expenditures index will be released late in the week as well. Overseas, the focus will be on the ECB who is expected to keep its key rate unchanged, but market participants will look for any changes in strategy at the post-meeting press conference.

Other key data/events include:

  • U.S. June existing home sales (Monday)
  • Eurozone and U.S. Markit data (Tuesday)
  • NZD trade data (Tuesday)
  • AUD CPI (Wednesday)
  • U.S. new home sales (Wednesday)
  • ECB rate decision (Thursday)
  • U.S. durable goods (Thursday)
  • JPY Tokyo CPI (Thursday)
  • U.S. 2Q GDP (Friday)
  • U.S. Core and Personal Consumption Expenditures (Friday)

U.S. Economic Data includes:

Chicago Fed National Activity Index (Monday), existing home sales, Markit PMI composite (Tuesday), Markit manufacturing and services PMI, housing price index, API weekly crude oil stock, new home sales (Wednesday), EIA crude oil stock change, durable goods (Thursday), EIA natural gas storage change, Q2 GDP (Friday), Core and Personal Consumption Expenditures, Michigan consumer sentiment index, Baker Hughes Oil Rig Count.

Overseas Economic Data includes: French/German/EUR Markit Manufacturing PMI (Tuesday), French/German/EUR Markit Services PMI, French/German/EUR Markit PMI composite, NZD trade data, AUD CPI (Wednesday), Swiss ZEW survey, German IFO business climate/expectations/ current assessment data, JPY foreign investment in stocks and bonds, German Gfk consumer confidence survey (Thursday), ECB rate decision, JPY CPI data, AUD PPI (Friday).