The Economy: A Look Back and What’s Ahead
Last Week
If economic data had been “Goldilocks” (meaning good, but not so good that the Fed would “taper” QE early) domestically during the past two months, then last week’s data was decidedly “anti-Goldilocks.” (It wasn’t bad enough to remove the prospects of tapering, but it wasn’t good enough to give people confidence the economy can keep growing if the Fed pulls back.)
Retail sales were basically flat last week, meeting low estimates. The first look at August manufacturing data via the Empire State and Philly Fed reports showed continued expansion but at a slower pace than July. Jobless claims fell to the lowest levels since October ’07, implying we’re seeing incremental improvement in the labor market, and the Consumer Price Index rose slightly. But it has been increasing for three consecutive months, which is helping to ease some fears about dis-inflation.
So, the latter two reports helped solidify the expectation of “tapering” being announced at the September Fed meeting. Meanwhile retail sales, Empire State manufacturing, Philly Fed, Industrial Production and Friday’s new home sales (which met expectations) basically showed an economy that’s still expanding, but at a slower pace than the previous few months.
Bottom line: The data rekindled the market’s primary fear that the Fed has to taper QE because of the potential negative side effects they risk by keeping it going, but that the economy isn’t strong enough to handle the rise in interest rates that will accompany the tapering of QE. The economic data last week didn’t directly imply that’s what’s happening, but it certainly made people think about it. With the S&P 500 up 18% year-to-date, that’s a reason to de-risk a bit, which is what happened.
The opposite was true in Europe, as the data there almost universally showed the EU economy is indeed starting to turn, although many investors remain skeptical. EU GDP turned positive thanks to strength in Germany and France, while the ZEW index, German industrial production, UK retail sales and labor market report were all better-than-expected.
So, from a rate-of-change perspective, last week implied that the EU economy is actually outperforming the U.S. economy. The data there implies an acceleration while the data here implies continued recovery, but at a stagnant pace—meaning, we may see continued outperformance from EU markets over the near term.
This Week
There isn’t a lot of data this week but what’s reported is important, and this is by far the most important week of the month from an economic and a WWFD (What Will the Fed Do) perspective.
The headline this week is the global flash PMIs from China (Wed night) and the EU and U.S. (Thursday morning). International markets and basic materials have outperformed thanks to better economic data internationally, and this trend needs to continue for those markets to rally further.
The next most-watched event this week will be the FOMC minutes, as investors will parse the release for insight into whether tapering will be announced in September, October or December. Right now the consensus remains on a September announcement, but that’s no sure thing. Anything beyond September will probably be taken as peripherally “dovish” by the market. The important thing to keep in perspective here is that the Fed is tapering, whether it’s in September, October or December.
We get more housing data also this week in the form of existing and new home sales (Wednesday and Friday respectively). The new home sales figure was “OK” and the market will welcome more signs that the housing recovery isn’t losing too much positive momentum in the face of higher mortgage rates. It is very important for the market that housing doesn’t show signs of backtracking.
Finally, weekly jobless claims will be watched to see if the six-year low set last week sticks, or if there are some big revisions. Regardless, the anecdotal evidence implies the job market is incrementally improving, and that supports the September taper argument.
Internationally, it’s quiet outside of the flash PMIs, as most of Europe will be on “holiday.”
This could be an important week with regard to resolving what’s expected of the Fed and specifically answering the question of whether or not we will see tapering announced in September.
One important thing to remember, though, as the week unfolds: Good economic news is still good for the market, regardless of the very short-term reaction. Better economic data is the only way this rally has legs over the medium and longer term—if the market sells off on good data, then that’s probably a place to nibble on the long side.