US purchasing managers’ indexes, which are published by the Institute for Supply Management (ISM), revealed declining confidence in August in both manufacturing and services (see left-hand chart on the next page). The Services PMI continues to point to expansion, yet the extent of its downturn, from 55.5 to 51.4, was surprising. An industry-by-industry analysis of this sector shows that consumer spending fared less well in August, as shown by the latest retail sales figures. Health Care, Educational Services, Real Estate and Public Administration all reported growth.
These unexpected figures were accompanied by a disappointing employment indicator: the Labor Market Conditions Index, one of the key numbers the Fed looks to, slipped back into negative territory (see right-hand chart on the next page). This indicator has 19 components, two of which appear to account for the decline: 1. the percentage of companies that plan to hire has contracted, and 2. workers who choose to leave their job are having more trouble finding a new one. The first factor is not surprising, given the current full-employment situation and the growing disconnect between employers’ needs and the skills on offer. In addition, we expect Q3 GDP to rise under our core scenario.
These disappointing reports should have pushed long-term interest rates downward, yet US bond yields continued to rise. Between 7 and 13 September, the 10-year Treasury yield rose by 19 basis points to 1.73%. This rise paralleled a similar movement by sovereign yields in most developed countries. For example, over the same period, German and British 10-year yields climbed by 19 and 23 basis points, respectively, to 0.07% and 0.91%. The Japanese 10-year yield added only 4 basis points during this period but had already risen sharply in August from a low of -0.29% on 27 July and sat at the symbolic level of 0.00% at close on 12 September.
This steep rise in sovereign yields is probably, in part, an upward correction following their sharp drop in response to the Brexit vote. This movement also reflects a growing belief among some investors that monetary policies have reached their limits and that central banks will have trouble maintaining negative interest rates for much longer and will have to halt their bond purchases. We disagree with this assessment. We believe that monetary expansion is firmly on track, as confirmed by recent monetary policy decisions in Switzerland and the UK.
The Swiss National bank (SNB) has indeed confirmed its intention to abide by its negative interest rate policy and to continue intervening on currency markets. Following its meeting on 15 September, it kept its deposit interest rate at -0.75% and noted its intention to limit the franc’s rise through market interventions. Importantly, while raising its 2016 GDP growth estimate from 1.0-1.5% to 1.5%, it also lowered its inflation forecast for 2017 and 2018 in view of the “slightly less favourable global economic outlook”. Despite the improving Swiss economy, the SNB expects inflation of only 0.2% in 2017 and 0.6% in 2018, and this is in line with its decision to keep its deposit interest rate at -0.75% for the foreseeable
The Bank of England (BoE) looks set to cut interest rates again before the end of the year, as we expect. It too left its monetary policy unchanged at its 15 September meeting. But it noted that, despite better-than-expected UK data for the recent period, it still planned to cut its benchmark rate again this year.